(Registrant’s telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for
such shorter period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past
90 days.
þ Yes o No
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of
the Exchange Act). þ Yes o No
Number of shares outstanding of each of the Registrant’s classes of Common Stock, as of July 31,2005: Common Stock, par value $0.01 per share, 131,159,264 shares outstanding.
Property, plant, equipment and mine development, net of accumulated
depreciation, depletion and amortization of $1,474,006 at June 30, 2005
and $1,333,645 at December 31, 2004
4,883,277
4,781,431
Investments and other assets
368,162
342,559
Total assets
$
6,404,661
$
6,178,592
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities
Current maturities of long-term debt
$
21,861
$
18,979
Liabilities from coal trading activities
34,812
63,565
Accounts payable and accrued expenses
748,514
691,600
Total current liabilities
805,187
774,144
Long-term debt, less current maturities
1,393,049
1,405,986
Deferred income taxes
400,991
393,266
Asset retirement obligations
402,071
396,022
Workers’ compensation obligations
230,044
227,476
Accrued postretirement benefit costs
942,201
939,503
Other noncurrent liabilities
326,597
315,694
Total liabilities
4,500,140
4,452,091
Minority interests
1,713
1,909
Stockholders’ equity
Preferred Stock — $0.01 per share par value; 10,000,000 shares authorized,
no shares issued or outstanding as of June 30, 2005 or December 31, 2004
—
—
Series Common Stock — $0.01 per share par value; 40,000,000 shares authorized,
no shares issued or outstanding as of June 30, 2005 or December 31, 2004
—
—
Common Stock — $0.01 per share par value; 400,000,000 shares authorized,
131,201,979 shares issued and 130,940,799 shares outstanding as
of June 30, 2005 and 150,000,000 shares authorized, 129,829,134 shares
issued and 129,567,954 shares outstanding as of December 31, 2004
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS JUNE 30, 2005
(1) Basis of Presentation
The consolidated financial statements include the accounts of the Company and its controlled
affiliates. All intercompany transactions, profits and balances have been eliminated in
consolidation.
Effective March 30, 2005, the Company implemented a two-for-one stock split on all shares of
its common stock. All share and per share amounts in these condensed consolidated financial
statements and related notes reflect the stock split.
The accompanying condensed consolidated financial statements as of June 30, 2005 and for the
quarters and six months ended June 30, 2005 and 2004, and the notes thereto, are unaudited.
However, in the opinion of management, these financial statements reflect all normal, recurring
adjustments necessary for a fair presentation of the results of the periods presented. The balance
sheet information as of December 31, 2004 has been derived from the Company’s audited consolidated
balance sheet. The results of operations for the quarter and six months ended June 30, 2005 are not
necessarily indicative of the results to be expected for future quarters or for the year ending
December 31, 2005.
(2) New Pronouncements
At the March 17, 2005 Emerging Issues Task Force (“EITF”) meeting, the Task Force reached a
consensus in EITF Issue 04-6 “that stripping costs incurred during the production phase of a mine
are variable production costs that should be included in the costs of the inventory produced during
the period that the stripping costs are incurred.” Advance stripping costs include those costs
necessary to remove overburden above an unmined coal seam as part of the surface mining process,
and are included as the “work-in-process” component of “Inventories” in the consolidated balance
sheets ($224.1 million and $197.2 million as of June 30, 2005 and December 31, 2004, respectively -
see Note 6). This is consistent with the concepts embodied in Accounting Research Bulletin No. 43,
“Restatement and Revision of Accounting Research Bulletins,” which provides that “the term
inventory embraces goods awaiting sale . . . , goods in the course of production (work in process),
and goods to be consumed directly or indirectly in production . . . .” At the June 15-16, 2005
EITF meeting, the Task Force clarified that the intended meaning of “inventory produced” is
“inventory extracted.” Based on this clarification, stripping costs incurred during a period will
be attributed only to the inventory costs of the coal that is extracted during that same period.
EITF Issue 04-6 is effective for the first reporting period in fiscal years beginning after
December 15, 2005 (January 1, 2006 for the Company), with early adoption permitted. At the June
EITF meeting, the Task Force modified the transition provisions of EITF Issue 04-6, indicating that
companies that adopt the consensus in periods beginning after June 29, 2005 may utilize a
cumulative effect adjustment approach where the cumulative effect adjustment is recorded directly
to retained earnings in the year of adoption. Alternatively, a company may recognize this change
in accounting by restatement of its prior-period financial statements through retrospective
application of this consensus. The Company is currently evaluating which method of adoption it
will use. The Company expects to adopt this consensus on January 1, 2006.
The Financial Accounting Standards Board (“FASB”) issued FASB Interpretation (“FIN”) No. 47,
“Accounting for Conditional Asset Retirement Obligations” in March of 2005. FIN 47 clarifies that
an entity must record a liability for a conditional asset retirement obligation if the fair value
of the obligation can be reasonably estimated. This interpretation also clarifies the
circumstances under which an entity would have sufficient information to reasonably estimate the
fair value of an asset retirement obligation. FIN 47 is effective no later than the end of fiscal
years ending after December 15, 2005. The Company expects to adopt this interpretation on December31, 2005. The adoption of this interpretation will not have a material impact on the Company’s
financial condition, results of operations or cash flows.
The Securities and Exchange Commission has deferred the adoption date of Statement of
Financial Accounting Standard (“SFAS”) No. 123R, “Share-Based Payment,” to the beginning of fiscal
years that begin after June 15, 2005 (January 1, 2006 for calendar year companies). SFAS No. 123R
requires the recognition of share-based payments, including employee stock options, in the income
statement based on their fair values. The Company expects to adopt this standard on January 1,2006. Based on stock option grants made in 2005 and currently anticipated for 2006, the Company
estimates it will (assuming the modified prospective method is used) recognize stock option expense
for the year ending December 31, 2006 of $3.9 million, net of taxes. The Company began utilizing
restricted stock as part of its equity-based compensation
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, continued
strategy in January 2005. Based on the restricted stock grants made in 2005 and years prior,
and those currently anticipated for 2006, the Company estimates it will recognize expense related
to restricted stock of $1.0 million, net of taxes, in 2005 and $1.9 million, net of taxes, in 2006.
The Company recognized expense for the six months ended June 30 2005 of $0.5 million, net of
taxes, for restricted stock grants made in 2005 and years prior.
(3) Significant Transactions and Events
Gains on Disposal of Assets
In June 2005, the Company recognized an aggregate $12.5 million gain from three property sales
involving non-strategic coal assets and properties. As a result of the property transactions,
asset retirement obligations were reduced by $9.2 million.
In March 2005, the Company sold its remaining 0.838 million PVR units for net proceeds of
$41.9 million and recognized a $31.1 million gain on the sale. In the first quarter of 2004, the
Company sold 0.575 million PVR units for net proceeds of $18.5 million and recognized a $9.9
million gain on the sale. The sales of the PVR units were accounted for under SFAS No. 66, “Sales
of Real Estate.” In December 2002, the Company entered into a transaction with Penn Virginia
Resource Partners, L.P. (“PVR”) whereby the Company sold 120 million tons of coal reserves in
exchange for $72.5 million in cash and 2.76 million units, or 15%, of the PVR master limited
partnership. The Company’s subsidiaries leased back the coal and pay royalties as the coal is
mined. No gain or loss was recorded at the inception of this transaction. As of March 2005 (the
time of the final sale of units), a deferred gain from the sales of the reserves and units of $19.0
million remained and will be amortized over the minimum term of the leases.
The Company recorded contract losses of approximately $34 million in the quarter ended March31, 2005, primarily related to the breach of a coal supply contract by a producer. The estimated
loss related to the supply contract breach reflected amounts accrued for estimated costs to obtain
replacement coal in the current market, and no offsetting receivable from the producer who breached
the contract was assumed. The loss recorded is not equivalent to, nor indicative of, the economic
losses (i.e. legal damages) sought by the Company as a result of the breach.
During the second quarter of 2005, the Company reduced its estimated loss related to the
supply contract breach by approximately $12.5 million, primarily as a result of negotiating a
settlement late in the second quarter with the producer who breached the contract. The settlement
mitigates the loss recognized in the first quarter and enables the Company to secure replacement
coal at prices lower than originally anticipated. See Note 12 for more details on the breach of
contract, subsequent lawsuit and the negotiated settlement.
(4) Acquisition of Mining Assets
In March 2005, the Company purchased mining assets from Lexington Coal Company for $61.0
million, $59.0 million of which was paid on the closing date and up to $2.0 million is to be paid
within 12 months of the close pending no outstanding claims related to the acquired mining assets.
The purchased assets included $2.5 million of materials and supplies that were recorded in
“Inventories” in the condensed consolidated balance sheet. The remaining purchased assets
consisted of approximately 70 million tons of reserves, preparation plants, facilities and mining
equipment that were recorded in “Property, plant, equipment and mine development” in the condensed
consolidated balance sheet. The Company is using the acquired assets to open a new mine that is
expected to produce two to three million tons per year, after it reaches full capacity, and to
provide other synergies to existing properties. The new mine, which began production early in the
third quarter, will supply coal under a new agreement with Northern Indiana Public Service Company
with terms that can be extended through 2015 (and a minimum term through the end of 2008). The
Company also recorded $21.6 million for preliminary estimates of asset retirement obligations
associated with the acquired assets.
(5) Business Combinations
On April 15, 2004, the Company purchased, through two separate agreements, all of the equity
interests in three coal operations from RAG Coal International AG. The combined purchase price,
including related costs and fees, of $442.2 million was funded from the Company’s equity and debt
offerings in March 2004. Net proceeds from the equity and debt offerings were $383.1 million and
$244.7 million, respectively. The purchases included two mines in Queensland, Australia that
collectively produce 7 to 8 million tons per year of metallurgical coal and the Twentymile Mine in
Colorado, which produces 7 to 8 million tons per year of steam coal with a planned production
expansion up to 12 million tons per year by
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, continued
2008. The results of operations of the two mines in Queensland, Australia are included in the
Company’s Australian Mining Operations segment and the results of operations of the Twentymile Mine
are included in the Company’s Western U.S. Mining Operations segment. The acquisition was accounted
for as a purchase.
The purchase accounting allocations related to the acquisition have been finalized and
recorded in the accompanying consolidated financial statements as of, and for periods subsequent
to, April 15, 2004. The following table summarizes the fair values of the assets acquired and the
liabilities assumed at the date of acquisition (dollars in thousands):
Accounts receivable
$
46,639
Materials and supplies
5,669
Coal inventory
11,543
Other current assets
6,234
Property, plant, equipment and mine development
463,567
Accounts payable and accrued expenses
(48,688
)
Other noncurrent assets and liabilities, net
(63,699
)
Total purchase price, net of cash received of $20,914
$
421,265
The following unaudited pro forma financial information presents the combined results of
operations of the Company and the operations acquired from RAG Coal International AG, on a pro
forma basis, as though the companies had been combined as of the beginning of the period presented.
The pro forma financial information does not necessarily reflect the results of operations that
would have occurred had the Company and the operations acquired from RAG Coal International AG
constituted a single entity during this period (dollars in thousands, except per share data):
During the first quarter of 2004, prior to the Company’s acquisition, the
Australian underground mine acquired by the Company in April 2004
experienced a roof collapse on a portion of the active mine face,
resulting in the temporary suspension of mining activities. Due to the
inability to ship during a portion of this downtime, costs to return the
mine to operations and shipping limits imposed as the result of unrelated
restrictions of capacity at a third party loading facility, the Australian
operation experienced a pro forma net loss in the quarter immediately
prior to acquisition.
Ninety-nine percent of the contracts in the Company’s trading portfolio as of June 30,2005 were valued utilizing prices from over-the-counter market sources, adjusted for coal quality
and traded transportation differentials, and 1% of the Company’s contracts were valued based on
similar market transactions.
As of June 30, 2005, the timing of the estimated future realization of the value of the
Company’s trading portfolio was as follows:
Year of
Percentage
Expiration
of Portfolio
2005
91
%
2006
6
%
2007
1
%
2008
2
%
100
%
At June 30, 2005, 70% of the Company’s credit exposure related to coal trading activities
was with investment grade counterparties. The Company’s coal trading operations traded 8.5 million
tons and 8.3 million tons for the quarters ended June 30, 2005 and 2004, respectively, and 17.7
million tons and 18.3 million tons for the six months ended June 30, 2005 and 2004, respectively.
These interim financial statements include the disclosure requirements of SFAS No. 123,
“Accounting for Stock-Based Compensation,” as amended by SFAS No. 148, “Accounting for Stock-Based
Compensation — Transition and Disclosure.”The Company applies Accounting Principles Board (“APB”)
Opinion No. 25 and related interpretations in accounting for its equity incentive plans. The
Company recorded in “Selling and administrative expenses” in the condensed consolidated statements
of operations $0.4 million and $0.1 million of compensation expense for equity-based compensation
during each of the quarters ended June 30, 2005 and 2004, respectively, and $0.8 million and $0.1
million in the six months ended June 30, 2005 and 2004, respectively. The following table reflects
pro forma net income and basic and diluted earnings per share as if compensation cost had been
determined for the Company’s non-qualified and incentive stock options based on the fair value at
the grant dates consistent with the methodology set forth under SFAS No. 123 (dollars in thousands,
except per share data):
The following table sets forth the after-tax components of comprehensive income for the
quarters and six months ended June 30, 2005 and 2004 (dollars in thousands):
Increase (decrease) in fair value of cash flow
hedges, net of tax of ($6,755) and $7,558 for the
quarters ended June 30, 2005 and 2004, respectively,
and $13,073 and $6,093 for the six months ended
June 30, 2005 and 2004, respectively
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, continued
Other comprehensive income differs from net income by the amount of unrealized gain or
loss resulting from valuation changes of the Company’s cash flow hedges (which include fuel hedges,
foreign exchange hedges and interest rate swaps) during the period. Changes in interest rates,
crude and heating oil prices, and the U.S. dollar/Australian dollar exchange rate affect the
valuation of these instruments.
(10) Pension and Postretirement Benefit Costs
Components of Net Periodic Pension Costs
Net periodic pension costs included the following components (dollars in thousands):
The curtailment loss resulted from the planned closure during 2005 of two of the Company’s
three operating mines that participate in the Western Surface UMWA Pension Plan (the “Plan”). The
loss is actuarially determined and consists of an increase in the actuarial liability, the
accelerated recognition of previously unamortized prior service cost and contractual termination
benefits under the Plan resulting from the closures.
Contributions
The Company previously disclosed in its financial statements for the year ended December 31,2004 that it expected to contribute $4.6 million to its funded pension plans and make $1.2 million
in expected benefit payments attributable to its unfunded pension plans during 2005. As of June30, 2005, $1.8 million of contributions have been made to the funded pension plans and $0.5 million
of expected benefit payments attributable to the unfunded pension plans have been made. The
Company presently anticipates it will contribute $5.1 million in total to its funded pension plans
during 2005.
Components of Net Periodic Postretirement Benefits Costs
Net periodic postretirement benefits costs included the following components (dollars in
thousands):
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, continued
Cash Flows
The Company previously disclosed in its financial statements for the year ended December 31,2004 that it expected to pay $85.7 million attributable to its postretirement benefit plans during
2005. As of June 30, 2005, payments of $42.4 million attributable to the Company’s postretirement
benefit plans have been made.
(11) Segment Information
The Company reports its operations primarily through the following reportable operating
segments: “Western U.S. Mining,”“Eastern U.S. Mining,”“Australian Mining” and “Trading and
Brokerage.” The principal business of the Western U.S. Mining, Eastern U.S. Mining and Australian
Mining segments is the mining, preparation and sale of steam coal, sold primarily to electric
utilities, and metallurgical coal, sold to steel and coke producers. Western U.S. Mining
operations are characterized by predominantly surface mining extraction processes, lower sulfur
content and Btu of coal, and longer shipping distances from the mine to the customer. Conversely,
Eastern U.S. Mining operations are characterized by a majority of underground mining extraction
processes, higher sulfur content and Btu of coal, and shorter shipping distances from the mine to
the customer. Geologically, Western operations mine primarily subbituminous and Eastern operations
mine bituminous coal deposits. Australian Mining operations are characterized by surface and
underground extraction processes, mining low sulfur, high Btu coal sold to an international
customer base. The Trading and Brokerage segment’s principal business is the marketing, brokerage
and trading of coal. “Corporate and Other” includes selling and administrative expenses, net gains
on property disposals, costs associated with past mining obligations, joint venture earnings
related to the Company’s 25.5% investment in a Venezuelan mine and revenues and expenses related to
the Company’s other commercial activities such as coalbed methane, generation development and
resource management.
Operating segment results for the quarters and six months ended June 30, 2005 and 2004 are as
follows (dollars in thousands):
Western U.S. Mining results include a charge related to the reserves established for
disputed legal fees billed to customers as discussed in Note 12.
(2)
Adjusted EBITDA is defined as income from continuing operations before deducting early
debt extinguishment costs, net interest expense, income taxes, minority interests, asset
retirement obligation expense and depreciation, depletion and amortization.
(3)
Trading and Brokerage results include a benefit for the quarter and a charge for the
six months ended June 30, 2005 related to contract losses and a settlement agreement as
discussed in Note 3.
(4)
Corporate and Other results include the gains on the sales of PVR units discussed in
Note 3.
On March 9, 2005, the Company’s subsidiary, COALTRADE, LLC (“COALTRADE”), filed a lawsuit
against Massey Coal Sales Company, Inc. (“Massey”) in the U.S. District Court for the Eastern
District of Kentucky. The lawsuit sought to enforce COALTRADE’s contractual rights under a
three-year coal supply agreement entered into by the parties effective January 1, 2003, and to
recover damages caused by Massey’s repudiation and material breach of that agreement. On April 8,2005, COALTRADE cancelled the coal supply agreement based upon Massey’s continuing refusal to
deliver coal in accordance with its terms, and filed an amended complaint seeking recovery of
damages for breach of contract and breach of duty of good faith and fair dealing. On April 18,2005, Massey filed a counterclaim. The Company believes it has a significant contractual and
factual basis for its claim.
During the quarter ended June 30, 2005, the Company worked to mitigate damages resulting from
the breach, and negotiated a settlement with Massey. The Company and Massey signed a settlement
agreement and mutual release, and the lawsuit has been stayed pending expected completion during
the third quarter of 2005 of the transactions contemplated by the settlement. See Note 3 for more
details on the negotiated settlement.
Environmental
Superfund and similar state laws create liability for investigation and remediation in
response to releases of hazardous substances in the environment and for damages to natural
resources. Under that legislation and many state Superfund statutes, joint and several liability
may be imposed on waste generators, site owners and operators and others regardless of fault.
Environmental claims have been asserted against a subsidiary of the Company, Gold Fields
Mining, LLC (“Gold Fields”), at 22 sites in the United States and remediation has been completed or
substantially completed at four of those sites. Gold Fields is a dormant, non-coal producing
entity that was previously managed and owned by Hanson PLC, a predecessor owner of the Company. In
the February 1997 spin-off of its energy businesses, Hanson PLC transferred ownership of Gold
Fields to the Company, despite the fact that Gold Fields had no ongoing operations and the Company
had no prior involvement in its past operations. These sites are related to activities of Gold
Fields or its former subsidiaries. Some of these claims are based on the Comprehensive
Environmental Response Compensation and Liability Act of 1980 (“CERCLA”), as amended, and on
similar state statutes.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, continued
The Company’s policy is to accrue environmental cleanup-related costs of a non-capital nature
when those costs are believed to be probable and can be reasonably estimated. The quantification
of environmental exposures requires an assessment of many factors, including changing laws and
regulations, advancements in environmental technologies, the quality of information available
related to specific sites, the assessment stage of each site investigation, preliminary findings
and the length of time involved in remediation or settlement. For certain sites, the Company also
assesses the financial capability of other potentially responsible parties and, where allegations
are based on tentative findings, the reasonableness of the Company’s apportionment. The Company
has not anticipated any recoveries from insurance carriers or other potentially responsible third
parties in the estimation of liabilities recorded on its consolidated balance sheets. Undiscounted
liabilities for environmental cleanup-related costs totaled $40.0 million at June 30, 2005 and
$40.5 million at December 31, 2004, $14.5 million and $15.1 million of which was a current
liability, respectively. These amounts represent those costs that the Company believes are
probable and reasonably estimable. Significant uncertainty exists as to whether claims will be
pursued against Gold Fields in all cases, and where they are pursued, the amount of the eventual
costs and liabilities, which could be greater or less than this provision. The Company anticipates
that all significant remaining environmental remediation costs discussed above will be paid by the
end of 2009.
Although waste substances generated by coal mining and processing are generally not regarded
as hazardous substances for the purposes of Superfund and similar legislation, some products used
by coal companies in operations, such as chemicals, and the disposal of these products are governed
by the statute. Thus, coal mines currently or previously owned or operated by the Company, and
sites to which it has sent waste materials, may be subject to liability under Superfund and similar
state laws.
Navajo Nation
On June 18, 1999, the Navajo Nation served the Company’s subsidiaries, Peabody Holding
Company, Inc., Peabody Coal Company and Peabody Western Coal Company (“Peabody Western”), with a
complaint that had been filed in the U.S. District Court for the District of Columbia. The Navajo
Nation has alleged 16 claims, including Civil Racketeer Influenced and Corrupt Organizations Act
(“RICO”) violations and fraud and tortious interference with contractual relationships. The
complaint alleges that the defendants jointly participated in unlawful activity to obtain favorable
coal lease amendments. Plaintiff also alleges that defendants interfered with the fiduciary
relationship between the United States and the Navajo Nation. The plaintiff is seeking various
remedies including actual damages of at least $600 million, which could be trebled under the RICO
counts, punitive damages of at least $1 billion, a determination that Peabody Western’s two coal
leases for the Kayenta and Black Mesa mines have terminated due to Peabody Western’s breach of
these leases and a reformation of the two coal leases to adjust the royalty rate to 20%. On March15, 2001, the court allowed the Hopi Tribe to intervene in this lawsuit. The Hopi Tribe has
asserted seven claims including fraud and is seeking various remedies including unspecified actual
damages, punitive damages and reformation of its coal lease.
On March 4, 2003, the U.S. Supreme Court issued a ruling in a companion lawsuit involving the
Navajo Nation and the United States. The court rejected the Navajo Nation’s allegation that the
United States breached its trust responsibilities to the Tribe in approving the coal lease
amendments and was liable for money damages.
On February 9, 2005, the U.S. District Court for the District of Columbia granted a consent
motion to stay the litigation until further order of the court. Peabody Western, the Navajo
Nation, the Hopi Tribe and the customers purchasing coal from the Black Mesa and Kayenta mines are
in mediation with respect to this litigation and other business issues.
The outcome of litigation is subject to numerous uncertainties. Based on the Company’s
evaluation of the issues and their potential impact, the amount of any potential loss cannot be
estimated. However, the Company believes this matter is likely to be resolved without a material
adverse effect on the Company’s financial condition, results of operations or cash flows.
Salt River Project Agricultural Improvement and Power District — Mine Closing and Retiree
Health Care
Salt River Project and the other owners of the Navajo Generating Station filed a lawsuit on
September 27, 1996 in the Superior Court of Maricopa County in Arizona seeking a declaratory
judgment that certain costs relating to final reclamation, environmental monitoring work and mine
decommissioning and costs primarily relating to retiree health care benefits are not recoverable by
the Company’s subsidiary, Peabody Western, under the terms of a coal supply agreement dated
February 18, 1977. The contract expires in 2011.
Peabody Western filed a motion to compel arbitration of these claims, which was granted in
part by the trial court. Specifically, the trial court ruled that the mine decommissioning costs
were subject to arbitration but that the retiree health care costs were not subject to arbitration.
This ruling was subsequently upheld on appeal. As a result, Peabody Western,
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, continued
Salt River Project and the other owners of the Navajo Generating Station will arbitrate the
mine decommissioning costs issue and will litigate the retiree health care costs issue. The
Company has recorded a receivable for mine decommissioning costs of $70.8 million and $68.6 million
included in “Investments and other assets” in the condensed consolidated balance sheets at June 30,2005 and December 31, 2004, respectively.
The outcome of litigation is subject to numerous uncertainties. Based on the Company’s
evaluation of the issues and their potential impact, the amount of any potential loss cannot be
estimated. However, the Company believes this matter is likely to be resolved without a material
adverse effect on its financial condition, results of operations or cash flows.
California Public Utilities Commission Proceedings Regarding the Future of the Mohave
Generating Station
Peabody Western has a long-term coal supply agreement with the owners of the Mohave Generating
Station that expires on December 31, 2005. Southern California Edison (the majority owner and
operator of the plant) is involved in a California Public Utilities Commission proceeding related
to the operation of the Mohave plant beyond 2005 or a temporary or permanent shutdown of the plant.
Southern California Edison has stated to the Commission that the Mohave plant is not likely to
return to service as a coal-fueled resource until 2010 at the earliest if the plant is shut down at
December 31, 2005. There is a dispute with the Hopi Tribe regarding the use of groundwater in the
transportation of the coal by pipeline from Peabody Western’s Black Mesa Mine to the Mohave plant.
As a part of the alternate dispute resolution referenced in the Navajo Nation litigation, Peabody
Western has been participating in mediation with the owners of the Mohave Generating Station and
the Navajo Generating Station, and the two tribes to resolve the complex issues surrounding the
groundwater dispute and other disputes involving the two generating stations. Resolution of these
issues is critical to the continuation of the operation of the Mohave Generating Station and the
renewal of the coal supply agreement after December 31, 2005. There is no assurance that the
issues critical to the continued operation of the Mohave plant will be resolved. The owners of the
Mohave Generating Station entered into a consent decree with the Grand Canyon Trust, the Sierra
Club, and the National Parks and Conservation Association that required the owners to install
scrubbers by December 31, 2005 if the Mohave plant was to operate beyond that date. In a letter
dated May 25, 2005, the Grand Canyon Trust, the Sierra Club, and the National Parks and
Conservation Association rejected a request by the Navajo Nation and the Hopi Tribe to extend the
December 31, 2005 deadline and therefore, the Company believes it is likely that the operation of
the Mohave plant will cease or be suspended on December 31, 2005. In the event the Mohave plant
shuts down, the operations of the Black Mesa Mine could be adversely impacted starting in the third
quarter of 2005, and the mine would be shut down at the end of 2005. The Mohave plant is the sole
customer of the Black Mesa Mine, which sold 2.4 million tons of coal in the first six months of
2005 and 4.7 million tons during the year ended December 31, 2004. During the first six months of
2005, the mine generated $11.9 million of Adjusted EBITDA (reconciled to its most comparable
measure under generally accepted accounting principles in Note 11), which represented 3.1% of the
Company’s total of $381.7 million. In 2004, the mine contributed $25.2 million of Adjusted EBITDA,
or 4.5% of the Company’s total Adjusted EBITDA of $559.2 million.
Oklahoma Lead Litigation
Gold Fields, which is a defendant in various litigation discussed below, is a dormant,
non-coal producing entity that was previously managed and owned by Hanson PLC, a predecessor owner
of the Company. In the February 1997 spin-off of its energy businesses, Hanson PLC transferred
ownership of Gold Fields to the Company, despite the fact that Gold Fields had no ongoing
operations and the Company had no prior involvement in its past operations.
Gold Fields and three other companies are defendants in two class action lawsuits filed in the
U.S. District Court for the Northern District of Oklahoma (Betty Jean Cole, et al. v. Asarco Inc.,
et al. and Darlene Evans, et al. v. Asarco Inc., et al.). The plaintiffs have asserted nuisance and
trespass claims predicated on allegations of intentional lead exposure by the defendants and are
seeking compensatory damages for diminution of property value, punitive damages and the
implementation of medical monitoring and relocation programs for the affected individuals. A
predecessor of Gold Fields formerly operated two lead mills near Picher, Oklahoma prior to the
1950’s and mined, in accordance with lease agreements and permits, approximately 1.7% of the total
amount of the ore mined in the county. Gold Fields has agreed to indemnify one of the other
defendants, which is a former subsidiary of Gold Fields.
Gold Fields is also a defendant, along with other companies, in five individual lawsuits
arising out of the same lead mill operations. In July 2004, two lawsuits were filed, one in the
U.S. District Court for the Northern District of Oklahoma and one in Ottawa County, Oklahoma
(subsequently removed to the U.S. District Court for the Northern District of Oklahoma), on behalf
of 48 individuals against Gold Fields and three other companies (Billy Holder, et al. v. Asarco
Inc., et al.). Plaintiffs in these actions are seeking compensatory and punitive damages for
alleged personal injuries from lead exposure. The trials for five of the individual plaintiffs
have been set for November 2005. A second trial for seven individuals has been set for January
2006.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, continued
In December 2003, the Quapaw Indian tribe and certain Quapaw owners of interests in land filed
a class action lawsuit against Gold Fields and five other companies in the U.S. District Court for
the Northern District of Oklahoma. The plaintiffs are seeking compensatory and punitive damages
based on public and private nuisance, trespass, strict liability, natural resource damage claims
under CERCLA, and claims under the Resource Conservation and Recovery Act. Gold Fields has denied
liability to the plaintiffs, has filed counterclaims against the plaintiffs seeking indemnification
and contribution and has filed a third-party complaint against the United States, owners of
interests in chat and real property in the Picher area. In February 2005, the state of Oklahoma on
behalf of itself and several other parties sent a notice to Gold Fields and other potentially
responsible parties (“PRPs”) alleging that they had concluded that there is a reasonable
probability of making a successful claim against the PRPs for damages to natural resources.
The outcome of litigation is subject to numerous uncertainties. Based on the Company’s
evaluation of the issues and their potential impact, the amount of any potential loss cannot be
estimated. However, the Company believes this matter is likely to be resolved without a material
adverse effect on the Company’s financial condition, results of operations or cash flows.
Other
In addition to the matters described above, the Company at times becomes a party to other
claims, lawsuits, arbitration proceedings and administrative procedures in the ordinary course of
business. Management believes that the ultimate resolution of pending or threatened proceedings is
not likely to have a material adverse effect on the financial condition, results of operations or
cash flows of the Company.
Accounts receivable in the condensed consolidated balance sheets as of June 30, 2005 and
December 31, 2004, includes $19.4 and $18.1 million, respectively, of receivables billed between
2001 and 2005 related to legal fees incurred in the Company’s defense of the Navajo lawsuit
discussed above. The billings have been disputed by two customers, who have withheld payment. The
Company believes these billings were made properly under the coal supply agreement with each
customer. The billings were consistent with past practice, when litigation costs related to legal
or regulatory issues were billed under the contracts and paid by the customers. The Company is in
litigation with these customers to resolve this issue. In the second quarter of 2005, the trial
court in one of the cases dismissed the Company’s claim, and the Company will appeal that decision.
Although the Company believes it has meritorious grounds for appeal and has not yet litigated the
other claim, the Company has recognized an allowance against both disputed receivables, which
resulted in a charge of $13.4 million and $16.2 million in the quarter and six months ended June30, 2005, respectively. The receivable balance, net of the allowance, was zero and $18.1 million
at June 30, 2005 and December 31, 2004, respectively.
At June 30, 2005, purchase commitments for capital expenditures were approximately $204.8
million.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, continued
(13) Supplemental Guarantor/Non-Guarantor Financial Information
In accordance with the indentures governing the 6.875% Senior Notes due 2013 and the 5.875%
Senior Notes due 2016, certain wholly-owned U.S. subsidiaries of the Company have fully and
unconditionally guaranteed the 6.875% Senior Notes and the 5.875% Senior Notes, on a joint and
several basis. Separate financial statements and other disclosures concerning the Guarantor
Subsidiaries are not presented because management believes that such information is not material to
the holders of the 6.875% Senior Notes and the 5.875% Senior Notes. The following unaudited
condensed historical financial statement information is provided for the Guarantor/Non-Guarantor
Subsidiaries.
Peabody Energy Corporation
Unaudited Supplemental Condensed Consolidated Statements of Operations
(Dollars in thousands)
Net cash provided by (used in) operating activities
$
(26,666
)
$
103,344
$
5,356
$
82,034
Cash Flows from Investing Activities
Additions to property, plant, equipment and
mine development
—
(55,577
)
(60,281
)
(115,858
)
Additions to advance mining royalties
—
(9,427
)
(250
)
(9,677
)
Acquisitions, net
—
(189,656
)
(232,508
)
(422,164
)
Proceeds from disposal of assets
—
22,261
542
22,803
Net cash used in investing activities
—
(232,399
)
(292,497
)
(524,896
)
Cash Flows from Financing Activities
Proceeds from long-term debt
250,000
—
—
250,000
Payments of long-term debt
(2,250
)
(13,458
)
(989
)
(16,697
)
Net proceeds from equity offering
383,125
—
—
383,125
Proceeds from stock options exercised
11,601
—
—
11,601
Proceeds from employee stock purchases
1,139
—
—
1,139
Increase of securitized interests in accounts
receivable
—
—
50,000
50,000
Payment of debt issuance costs
(8,910
)
—
—
(8,910
)
Distributions to minority interests
—
(694
)
—
(694
)
Dividends paid
(14,852
)
—
—
(14,852
)
Transactions with affiliates, net
(388,084
)
143,996
244,088
—
Net cash provided by financing activities
231,769
129,844
293,099
654,712
Net increase in cash and cash equivalents
205,103
789
5,958
211,850
Cash and cash equivalents at beginning of period
114,575
1,392
1,535
117,502
Cash and cash equivalents at end of period
$
319,678
$
2,181
$
7,493
$
329,352
(14) Guarantees
In the normal course of business, the Company is a party to the following guarantees:
The Company owns a 30.0% interest in a partnership that leases a coal export terminal from the
Peninsula Ports Authority of Virginia under a 30-year lease that permits the partnership to
purchase the terminal at the end of the lease term for a nominal amount. The partners have
severally (but not jointly) agreed to make payments under various agreements which in the aggregate
provide the partnership with sufficient funds to pay rents and to cover the principal and interest
payments on the floating-rate industrial revenue bonds issued by the Peninsula Ports Authority, and
which are supported by letters of credit from a commercial bank. The Company’s maximum
reimbursement obligation of $42.8 million is supported by a letter of credit.
The Company owns a 49.0% interest in a joint venture that operates an underground mine and
preparation plant facility in West Virginia. The partners have severally agreed to guarantee the
debt of the joint venture, which consists of a $17.2 million loan facility as of June 30, 2005.
The total amount of the joint venture’s debt guaranteed by the Company was $8.4 million as of June30, 2005.
The Company has guaranteed the performance of Asset Management Group (“AMG”) under a coal
purchase contract
with a third party, which has terms extending through December 31, 2006. Default occurs upon
AMG’s non-delivery of specified monthly tonnage. In the event of a default, the Company assumes
AMG’s obligation to ship coal at agreed prices for the remaining term of the purchase contract. The
guarantee arose from an agreement by which AMG mines under a royalty-based contract with the
Company. As of June 30, 2005, the maximum potential future payments under this
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, continued
guarantee are
approximately $10 million, based on recent spot coal prices. As a matter of recourse in the event
of a default, the Company has access to cash held in escrow and the ability to trigger an
assignment of the AMG assets to the Company. Based on these recourse options and the remote
probability of non-performance by AMG due to their proven operating history, the Company has valued
the liability associated with the guarantee at zero.
As part of arrangements through which the Company obtains exclusive sales representation
agreements with small coal mining companies (the “Counterparties”), the Company issued financial
guarantees on behalf of the Counterparties. These guarantees facilitate the Counterparties’
efforts to obtain bonding or financing. The total amount guaranteed by the Company was $1.6
million, and the fair value of the guarantees recognized as a liability was less than $0.1 million
as of June 30, 2005. The Company’s obligations under the guarantees extend to the end of 2007.
The Company is the lessee under numerous equipment and property leases. It is common in such
commercial lease transactions for the Company, as the lessee, to agree to indemnify the lessor for
the value of the property or equipment leased, should the property be damaged or lost during the
course of the Company’s operations. The Company expects that losses with respect to leased
property would be covered by insurance (subject to deductibles). The Company and certain of its
subsidiaries have guaranteed other subsidiaries’ performance under their various lease obligations.
Aside from indemnification of the lessor for the value of the property leased, the Company’s
maximum potential obligations under its leases are equal to the respective future minimum lease
payments and assume that no amounts could be recovered from third parties.
The Company has provided financial guarantees under certain long-term debt agreements entered
into by its subsidiaries, and substantially all of the Company’s subsidiaries provide financial
guarantees under long-term debt agreements entered into by the Company. The maximum amounts
payable under the Company’s debt agreements are equal to the respective principal and interest
payments. Supplemental guarantor/non-guarantor financial information is provided in Note 13.
(15) Subsequent Events
On July 21, 2005, the Company announced that its Board of Directors increased the quarterly
dividend by 27 percent and authorized a share repurchase program. The share repurchase program
allows for the repurchase of up to 5 percent of the Company’s common shares; however, any
repurchase under the program requires a separate approval from the Company’s Board of Directors or
its Executive Committee. The repurchases may be made from time to time based on an evaluation of
the Company’s outlook and general business conditions, as well as alternative investment and debt
repayment options. The increase in the regular quarterly dividend on common stock, to $0.095 per
share, is payable on August 25, 2005 to shareholders of record on August 4, 2005.
This report includes statements of our expectations, intentions, plans and beliefs that
constitute “forward-looking statements” within the meaning of Section 27A of the Securities Act of
1933 and Section 21E of the Securities Exchange Act of 1934 and are intended to come within the
safe harbor protection provided by those sections. These statements relate to future events or our
future financial performance, including, without limitation, the section captioned “Outlook.” We
use words such as “anticipate,”“believe,”“expect,”“may,”“project,”“will” or other similar
words to identify forward-looking statements.
Without limiting the foregoing, all statements relating to our future outlook, anticipated
capital expenditures, future cash flows and borrowings, and sources of funding are forward-looking
statements. These forward-looking statements are based on numerous assumptions that we believe are
reasonable, but are open to a wide range of uncertainties and business risks and actual results may
differ materially from those discussed in these statements. Among the factors that could cause
actual results to differ materially are:
•
growth of domestic and international coal and power markets;
•
coal’s market share of electricity generation;
•
future worldwide economic conditions;
•
economic and political stability of countries in which we have operations or serve customers;
•
weather;
•
transportation performance and costs, including demurrage;
variation in revenues related to synthetic fuel production;
•
changes in postretirement benefit and pension obligations;
•
negotiation of labor contracts, employee relations and workforce availability;
•
availability and costs of credit, surety bonds and letters of credit;
•
the effects of changes in currency exchange rates;
•
price volatility and demand, particularly in higher-margin products;
•
risks associated with customers;
•
reductions of purchases by major customers;
•
geology and equipment risks inherent to mining;
•
terrorist attacks or threats;
•
performance of contractors, third party coal suppliers or major suppliers of mining
equipment or supplies;
•
replacement of reserves;
•
implementation of new accounting standards and Medicare regulations;
•
inflationary trends, including those impacting materials used in our business;
•
the effects of interest rate changes;
•
the effects of acquisitions or divestitures;
•
changes to contribution requirements to multi-employer benefit funds; and
•
other factors, including those discussed in Part II, Item 1, “Legal Proceedings.”
When considering these forward-looking statements, you should keep in mind the cautionary
statements in this document, the “Risks Relating to Our Company” section of Item 7 of our 2004
Annual Report on Form 10-K filed with the Securities and Exchange Commission and all related
documents incorporated by reference. We do not undertake any obligation to update these
statements.
We are the largest private sector coal company in the world, with majority interests in 32
active coal operations located throughout all major U.S. coal producing regions and internationally
in Australia. We also own a 25.5% interest in Carbones del Guasare, which owns and operates the
Paso Diablo Mine in Venezuela. In the second quarter and first half of 2005, we sold 57.7 million
and 116.9 million tons of coal, respectively. In 2004, we sold 227.2 million tons of coal that
accounted for 20% of all U.S. coal sales, and were more than 85% greater than the sales of our
closest competitor. According to reports published by the Energy Information Administration, 1.1
billion tons of coal were consumed in the United States in 2004. The Energy Information
Administration also published estimates indicating that domestic consumption of coal by electricity
generators would grow at a rate of 1.6% per year through 2025. Coal-fueled generation is used in
most cases to meet baseload electricity requirements, and coal use generally grows at the pace of
electricity growth. In 2004, coal’s share of U.S. electricity generation was approximately 52%.
Our primary customers are U.S. utilities, which accounted for 90% of our sales in 2004. We
typically sell coal to utility customers under long-term contracts (those with terms longer than
one year). During 2004, approximately 90% of our sales were under long-term contracts. Our
results of operations in the near term can be negatively impacted by poor weather conditions,
unforeseen geologic conditions or equipment problems at mining locations, the performance of
contractors or third party coal suppliers, and by the availability of transportation for coal
shipments. On a long-term basis, our results of operations could be impacted by our ability to
secure or acquire high-quality coal reserves, find replacement buyers for coal under contracts with
comparable terms to existing contracts, or the passage of new or expanded regulations that could
limit our ability to mine, increase our mining costs, or limit our customers’ ability to utilize
coal as fuel for electricity generation. In the past, we have achieved production levels that are
relatively consistent with our projections.
We conduct business through four principal operating segments: Western U.S. Mining, Eastern
U.S. Mining, Australian Mining, and Trading and Brokerage. Our Western U.S. Mining operations
consist of our Powder River Basin, Southwest and Colorado operations, and its principal business is
the mining, preparation and sale of steam coal, sold primarily to electric utilities. Our Eastern
U.S. Mining operations consist of our Appalachia and Midwest operations, and its principal business
is the mining, preparation and sale of steam coal, sold primarily to electric utilities, as well as
the mining of metallurgical coal, sold to steel and coke producers.
Geologically, Western operations mine bituminous and subbituminous coal deposits, and Eastern
operations mine bituminous coal deposits. Our Western U.S. Mining operations are characterized by
predominantly surface extraction processes, lower sulfur content and Btu of coal, and higher
customer transportation costs (due to longer shipping distances). Our Eastern U.S. Mining
operations are characterized by a majority of underground extraction processes, higher sulfur
content and Btu of coal, and lower customer transportation costs (due to shorter shipping
distances).
Our Australian Mining operations consist of four mines. The Burton and North Goonyella mines
were acquired in April 2004. We opened the Eaglefield Mine in 2004, which is a surface operation
adjacent to, and fulfilling contract tonnages in conjunction with, the North Goonyella underground
mine. In addition, we have owned and operated our Wilkie Creek Mine since 2002, our only steam
coal operation in Australia. Our Australian Mining operations are characterized by surface and
underground extraction processes, mining primarily low sulfur, metallurgical coal sold to an
international customer base.
Metallurgical coal represented approximately 5% of our total sales volume and approximately 3%
of U.S. sales volume in the six months ended June 30, 2005. Each of our mining operations is
described in Item 1 of our 2004 Annual Report on Form 10-K.
In addition to our mining operations, which comprised 86% of revenues in the second quarter of
2005, we also generated 13% of our revenues from brokering and trading coal. We generate
additional income and cash flows by extracting value from our vast natural resource position by
selling non-core, idle or reclaimed land holdings and non-strategic mineral interests.
We are developing three coal-fueled generating projects in areas of the U.S. where electricity
demand is strong and where there is access to land, water, transmission lines and low-cost coal.
These projects involve mine-mouth generating plants using our surface lands and coal reserves. The
projects are as follows: the 1,500 megawatt Prairie State Energy Campus in Washington County,
Illinois; the 1,500 megawatt Thoroughbred Energy Campus in Muhlenberg County, Kentucky; and the 300
megawatt Mustang Energy Project near Grants, N.M. The plants, assuming all necessary permits and
financing are obtained and following selection of partners and sale of a majority of the output of
each plant, would be operational following a four-year construction phase. The first of these
plants will not be operational earlier than mid-2010.
The Prairie State Energy Campus project has continued to advance in 2005. In February 2005, a
group of Midwest rural electric cooperatives and municipal joint action agencies entered into
definitive agreements to acquire 47% of the Prairie State Energy Campus project. After an initial
appeal was successfully resolved related to the air permit that was issued in January 2005, the
Illinois Environmental Protection Agency reissued the air permit on April 28, 2005. The same
parties who filed the earlier permit challenge filed a new appeal on June 8, 2005. The Company
believes the permit was appropriately issued and expects to prevail in the appeal process.
In the first quarter of 2005, the Board of Directors, after completing an orderly succession
planning process, elected Gregory H. Boyce, President and Chief Operating Officer, to the position
of President and Chief Executive Officer, effective January 1, 2006. Chairman and Chief Executive
Officer, Irl F. Engelhardt will continue his CEO duties through 2005, and will remain employed as
Chairman of the Board on January 1, 2006. Effective March 1, 2005, Mr. Boyce was also elected to
the Board of Directors and Chairman of the Executive Committee of the Board.
Effective March 30, 2005, we implemented a two-for-one stock split on all shares of our common
stock. Other than as noted in Part II, Item 4, “Submission of Matters to a Vote of Security
Holders,” all share and per share amounts in this Quarterly Report on Form 10-Q reflect the stock
split. During July 2005, we increased our quarterly dividend 27% to $0.095 per share and our Board
of Directors authorized a share repurchase program of up to 5 percent of the outstanding shares of
our common stock. However, any repurchase under the program requires a separate approval from the
Company’s Board of Directors or its Executive Committee. The repurchases may be made from time to
time based on an evaluation of the Company’s outlook and general business conditions, as well as
alternative investment and debt repayment options.
In July 2005, the Board of Directors elected John F. Turner as an independent director who
will serve on the Board’s Nominating and Corporate Governance Committee. Turner is former U.S.
Assistant Secretary of State for Oceans and International Environmental and Scientific Affairs
(OES) within the State Department and is the past President and Chief Executive Officer of the
Conservation Fund, a national nonprofit organization dedicated to public-private partnerships to
protect land and water resources.
Results of Operations
Adjusted EBITDA
The discussion of our results of operations in 2005 and 2004 below includes references to, and
analysis of our segments’ Adjusted EBITDA results. Adjusted EBITDA is defined as income from
continuing operations before deducting early debt extinguishment costs, net interest expense,
income taxes, minority interests, asset retirement obligation expense and depreciation, depletion
and amortization. Adjusted EBITDA is used by management primarily as a measure of our segments’
operating performance. Because
Adjusted EBITDA is not calculated identically by all companies, our calculation may not be
comparable to similarly titled measures of other companies. Adjusted EBITDA is reconciled to its
most comparable measure, under generally accepted accounting principles, in Note 11 to our
unaudited condensed consolidated financial statements included in this report.
Recent Acquisitions Impacting Comparability of Results of Operations
Results in our Western U.S. Mining Operations segment include amounts for our April 15, 2004
acquisition of Twentymile Mine in Colorado. Results in our Australian Mining Operations segment
include amounts for our April 15, 2004 acquisition of the Burton and North Goonyella Mines as well
as the opening of the Eaglefield Mine adjacent to the North Goonyella Mine in the fourth quarter of
2004. Our Corporate and Other segment includes results from our December 2004 acquisition of a
25.5% interest in Carbones del Guasare, which owns and operates the Paso Diablo Mine in Venezuela.
In the second quarter of 2005, our revenues increased $192.0 million to $1,108.8 million, a
20.9% increase over the prior year, primarily driven by improved pricing in most regions. Our
segment Adjusted EBITDA totaled $264.5 million in the second quarter of 2005 compared to $184.8
million in the prior year, a 43.1% increase. Net income improved 129.6% to $95.3 million, or
$0.71 per share, in the second quarter of 2005, compared to $41.5 million, or $0.32 per share, in
the prior year. The improvements were primarily driven by higher sales prices for all of our
products, particularly metallurgical coal, and by demand-driven volume increases for our Midwest
products and for our ultra-low sulfur Powder River Basin products.
Tons Sold
The following table presents tons sold by operating segment for the quarters ended June 30,2005 and 2004:
(Unaudited)
Quarter Ended June 30,
Increase (Decrease)
2005
2004
Tons
%
(Tons in millions)
Western U.S. Mining Operations
36.7
35.0
1.7
4.9
%
Eastern U.S. Mining Operations
13.2
12.7
0.5
3.9
%
Australian Mining Operations
2.1
1.7
0.4
23.5
%
Trading and Brokerage Operations
5.7
7.6
(1.9
)
(25.0
)%
Total
57.7
57.0
0.7
1.2
%
Revenues
The following table presents revenues for the quarters ended June 30, 2005 and 2004:
Overall, our revenues increased $192.0 million, or 20.9%, over the prior year second quarter.
Sales increased $191.2 million in the second quarter of 2005, reflecting increases in every
segment: Western U.S. Mining ($33.5 million), Eastern U.S. Mining ($68.0 million), Australian
Mining ($68.1 million), and Trading & Brokerage ($21.6 million). Western U.S. Mining sales
increased primarily due to higher sales prices in the Powder River and Colorado regions and higher
volumes at our Twentymile Mine due to improved productivity from its longwall and 15 additional
days of operation in the current year and at our Powder River operations due to continued higher
demand for Powder River Basin coal. Average sales prices for the Western U.S. Mining operations
were 4.2% higher despite a $13.4 million charge to provide an allowance for disputed receivables as
discussed in Note 12 to our unaudited condensed consolidated financial statements. Sales volumes
for the Powder River operations were higher in 2005 compared to the prior year despite the negative
impact of two train derailments and subsequent rail maintenance, which lowered shipments through
much of the quarter. The restricted capacity impacted all coal producers in the area, and rail
capacity is not expected to return to pre-derailment levels until late in 2005 as discussed in
“Outlook” below. In our Eastern U.S. Mining operations, increases in average selling prices
continued, rising 15.6% in the second quarter of 2005 compared to prior year and resulting in a
$68.0 million increase in sales due primarily to strong steam and metallurgical coal demand. In
addition, volume in our Midwest operations improved over the prior year. The Australian Mining
operations’ sales increase primarily reflected higher sales prices for metallurgical coal and an
increase in volumes at the mines, primarily due to an additional 15 days of ownership of the Burton
and North Goonyella Mines in the second quarter of 2005. Average sales prices in our Australian
operations improved 62.5%. Improved Trading and Brokerage sales primarily reflected improved
pricing for broker transactions.
Segment Adjusted EBITDA
Our total segment Adjusted EBITDA was $264.5 million for the second quarter of 2005, compared
with $184.8 million in the prior year, detailed as follows:
Increase to
(Unaudited)
Segmented Adjusted
Quarter Ended June 30,
EBITDA
2005
2004
$
%
(Dollars in thousands)
Western U.S. Mining Operations
$
105,639
$
100,389
$
5,250
5.2
%
Eastern U.S. Mining Operations
95,898
66,007
29,891
45.3
%
Australian Mining Operations
47,479
11,948
35,531
297.4
%
Trading and Brokerage Operations
15,439
6,443
8,996
139.6
%
Total Segment Adjusted EBITDA
$
264,455
$
184,787
$
79,668
43.1
%
Western U.S. Mining operations’ Adjusted EBITDA increased $5.3 million, or 5.2%, in the second
quarter of 2005 compared to prior year. Excluding the $13.4 million charge for disputed
receivables discussed in Note 12 to our unaudited condensed consolidated financial statements,
Adjusted EBITDA increased $18.7 million, or 18.6%. The increase primarily reflected increased
volumes and sales prices for the Powder River operations and increased volumes in our Colorado
operations, partially offset by higher per unit operating costs from transportation delays in the
Powder River Basin and rising fuel costs in all regions. Improvements at our Powder River
operations were primarily due to demand-driven sales volume increases and improved margin per ton,
primarily due to higher sales prices. Although strong demand for Powder River Basin coal
continued, sales volumes at the Powder River operations were impacted by two train derailments,
which lowered shipments through much of the quarter and increased per unit costs. Increased
volumes in our Colorado operations reflected strong productivity of the Twentymile Mine’s longwall
operations and increased demand. Costs were also negatively impacted by an increase in
revenue-based production and sales taxes. Excluding the impact of the disputed receivables charge,
the Southwest operations’ results were comparable with prior year.
Eastern U.S. Mining operations’ Adjusted EBITDA increased $29.9 million in the second quarter
of 2005 compared to prior year, primarily driven by higher sales prices for metallurgical and steam
coal in our Appalachia operations. Adjusted EBITDA in our Appalachia operations increased
principally as a result of sales price increases of 25% (over 60% for metallurgical coal) in 2005,
partially offset by lower production at two of our mines, mainly related to problems from excessive
water and geologic issues, and higher contract mining costs. The results in our Midwest operations
were higher than prior year as the benefits of higher volumes and prices were partially offset by
higher fuel costs.
Australian Mining operations’ Adjusted EBITDA increased $35.5 million in the second quarter of
2005 compared to the prior year. Improved results were mainly driven by sales price increases of
over 60% quarter over quarter. Current year results benefited from the strong sales prices, but
were negatively impacted by continued port congestion, related demurrage costs, and lower
production due to geological problems at the longwall operation.
Trading and Brokerage operations’ Adjusted EBITDA increased $9.0 million in the second quarter
of 2005 compared to the prior year, primarily related to a $12.5 million reduction of the
previously established reserve for a contractual dispute with one of our coal suppliers, as
discussed in Note 3 to our unaudited condensed consolidated financial statements.
Income Before Income Taxes And Minority Interests
(Unaudited)
Increase (Decrease) to
Quarter Ended June 30,
Income
2005
2004
$
%
(Dollars in thousands)
Total Segment Adjusted EBITDA
$
264,455
$
184,787
$
79,668
43.1
%
Corporate and Other Adjusted EBITDA
(48,675
)
(51,313
)
2,638
5.1
%
Depreciation, depletion and amortization
(79,309
)
(73,020
)
(6,289
)
(8.6
)%
Asset retirement obligation expense
(7,162
)
(8,627
)
1,465
17.0
%
Interest expense
(25,205
)
(24,595
)
(610
)
(2.5
)%
Interest income
1,810
1,209
601
49.7
%
Income before income taxes and minority
interests
$
105,914
$
28,441
$
77,473
272.4
%
Income before income taxes and minority interests increased $77.5 million compared with the
second quarter of 2004, primarily due to improved segment Adjusted EBITDA results. Corporate and
Other Adjusted EBITDA also improved and asset retirement obligation expense was lower, partially
offset by an increase in depreciation, depletion and amortization.
Corporate and Other Adjusted EBITDA results include selling and administrative expenses, net
gains on asset disposals, costs associated with past mining obligations and revenues and expenses
related to our other commercial activities such as coalbed methane, generation development and
resource management. The improvement of Corporate and Other results by $2.6 million included:
•
higher gain on disposal of assets of $14.5 million primarily related to aggregate gains
of $12.5 million on three sales involving non-strategic coal assets and properties; and
•
income in 2005 of $6.1 million from the December 2004 acquisition of a 25.5% interest
in Carbones del Guasare, which owns and operates the Paso Diablo Mine in Venezuela.
These improvements were offset by the following items:
•
an increase in past mining obligations expense of $10.2 million, primarily related to
higher retiree health care costs. The increase in retiree health care costs was primarily
associated with higher trend rates, lower interest discount assumptions and the
amortization of actuarial losses in 2005; and
•
an $8.5 million increase in selling and administrative expenses primarily related to
higher annual and long-term performance-based incentives, higher outside services related
to business development and support services, and higher administrative costs in our
Australian operations.
Depreciation, depletion and amortization increased $6.3 million in 2005 primarily associated
with increased volumes in 2005 for the mines acquired in April 2004 as well as volume improvements
at existing mines.
Net Income
(Unaudited)
Increase (Decrease) to
Quarter Ended June 30,
Income
2005
2004
$
%
(Dollars in thousands)
Income before income taxes and
minority interests
$
105,914
$
28,441
$
77,473
272.4
%
Income tax (provision) benefit
(10,162
)
15,194
(25,356
)
n/a
Minority interests
(498
)
(390
)
(108
)
(27.7
)%
Income from continuing operations
95,254
43,245
52,009
120.3
%
Loss from discontinued
operations, net of taxes
—
(1,764
)
1,764
n/a
Net income
$
95,254
$
41,481
$
53,773
129.6
%
Net income increased $53.8 million compared to the second quarter of 2004 due to the increase
in income before income taxes and minority interests discussed above, partially offset by an
increase in the income tax provision. The income tax provision recorded in 2005 differs from the
benefit in 2004 primarily as a result of higher pre-tax income and a positive effective tax rate in
2005, which is driven by the magnitude of the percentage depletion deduction relative to pretax
income.
In the first six months of 2005, our revenues increased $497.2 million to $2,186.3 million, a
29.4% increase over the prior year, with a 7.4% increase in sales volume and improved pricing in
all regions. Our segment Adjusted EBITDA totaled $471.9 million in the first six months of 2005
compared to $344.7 million in the prior year, a 36.9% increase. Net income improved 129.7% to
$147.1 million, or $1.10 per share, in the first six months of 2005, compared to $64.1 million, or
$0.52 per share, in the prior year. The improvements were primarily driven by improved
demand-driven volume, improved sales prices, particularly for our metallurgical and Powder River
Basin products, and the impact of mining operations acquired in 2004.
The following table presents tons sold by operating segment for the six months ended June 30,2005 and 2004:
(Unaudited)
Six Months Ended June 30,
Increase (Decrease)
2005
2004
Tons
%
(Tons in millions)
Western U.S. Mining Operations
75.4
67.5
7.9
11.7
%
Eastern U.S. Mining Operations
26.2
25.2
1.0
4.0
%
Australian Mining Operations
4.1
2.0
2.1
105.0
%
Trading and Brokerage Operations
11.2
14.1
(2.9
)
(20.6
)%
Total
116.9
108.8
8.1
7.4
%
Revenues
The following table presents revenues for the six months ended June 30, 2005 and 2004:
(Unaudited)
Increase (Decrease)
Six Months Ended June 30,
to Revenues
2005
2004
$
%
(Dollars in thousands)
Sales
$
2,152,338
$
1,643,033
$
509,305
31.0
%
Other revenues
33,928
46,031
(12,103
)
(26.3
)%
Total revenues
$
2,186,266
$
1,689,064
$
497,202
29.4
%
Overall, our revenues increased $497.2 million, or 29.4%, over the first six months of the
prior year, driven by both increased volumes and sales prices. We acquired three mines in the
second quarter of 2004 that contributed approximately $156 million to the increase in revenue in
the first six months of 2005. The remaining increase of $341 million is primarily attributable to
increases in average sales prices across all segments and increases in volume, particularly in the
Powder River Basin, where strong demand continues to drive expansion of our operating capacity.
Sales increased $509.3 million in the first six months of 2005, reflecting increases in every
segment: Western U.S. Mining ($137.1 million), Eastern U.S. Mining ($143.8 million), Australian
Mining ($162.7 million), and Trading and Brokerage ($65.7 million). Increases in average per ton
selling prices continued, rising 7.9% and 16.7% in our Western U.S. and Eastern U.S. mining
operations, respectively, in the first six months of 2005 compared to prior year. Western U.S.
Mining operations sales increased $137.1 million, or 21.3%, attributable to the 2004 acquisition of
Twentymile Mine and to increases in both sales price and sales volumes in the Powder River Basin.
Excluding the impact of a $16.2 million allowance that was established relative to disputed
receivables (discussed in Note 12 to our unaudited condensed consolidated financial statements),
Western US Mining sales increased $153.3 million, or 23.8%. Production in the Powder River Basin
continued to increase in response to overall higher demand, increasing 4.9 million tons compared to
the prior year, overcoming two train derailments on the main shipping line out of the basin, which
reduced our shipments from the region by an estimated 3.5 million tons in the second quarter of
2005. Eastern U.S. Mining operations’ sales increased $143.8 million, or 20.6%, compared with
prior year primarily due to improved pricing in Appalachia that resulted from strong steam and
metallurgical coal demand, and higher volume in the Midwest. The increase in Australian Mining
operations’ sales were primarily due to the acquisition of two mines and the subsequent opening of
an adjoining mine in 2004 and increases in the selling price for metallurgical coal. Improved
Trading and Brokerage sales primarily reflected increases in coal prices for brokerage sales.
Other revenues decreased $12.1 million in the first six months of 2005 compared to the prior
year, primarily as the result of a $12.7 million decrease in coal trading revenues in 2005. In
2004, higher trading revenues were driven by significant pricing increases related to our Eastern
trading portfolio. Appalachia steam coal prices remain strong in 2005, but are more stable and
have not provided the same opportunities for trading revenues as in 2004.
Segment Adjusted EBITDA
Our total segment Adjusted EBITDA was $471.9 million for the first six months of 2005,
compared with $344.7 million in the prior year, detailed as follows:
Increase (Decrease) to
(Unaudited)
Segmented Adjusted
Six Months Ended June 30,
EBITDA
2005
2004
$
%
(Dollars in thousands)
Western U.S. Mining Operations
$
226,064
$
183,757
$
42,307
23.0
%
Eastern U.S. Mining Operations
190,704
127,421
63,283
49.7
%
Australian Mining Operations
61,565
12,878
48,687
378.1
%
Trading and Brokerage Operations
(6,429
)
20,675
(27,104
)
n/a
Total Segment Adjusted EBITDA
$
471,904
$
344,731
$
127,173
36.9
%
Western U.S. Mining operations’ Adjusted EBITDA increased $42.3 million, or 23.0%, in the
first six months of 2005 compared to prior year. The increase reflected the addition of the
Twentymile Mine to our Colorado operations in April 2004 and increased productivity from its
operations as well as improvements in the Powder River Basin. The improvement at our Powder River
operations was primarily due to an 8.7% increase in volume, in response to increased demand, and
improved margin per ton, primarily due to higher sales prices. In 2005, second quarter volumes
were reduced from record volume in the first quarter due to constraints on the region’s rail
system. Improved revenues overcame increased unit costs that resulted from higher fuel costs,
lower than anticipated volume due to rail difficulties, an increase in revenue-based royalties and
sales taxes, and the impact of adding higher value Twentymile production in our cost mix.
In the first quarter, we recorded approximately $9.5 million of operating expenses related to
pension curtailment charges at our Black Mesa and Seneca mines, which are expected to close during
2005. The impact to Western U.S. Mining operations’ segment Adjusted EBITDA was not significant as
the majority of these curtailment costs are billable under current supply agreements.
Eastern U.S. Mining operations’ Adjusted EBITDA increased $63.3 million in the first six
months of 2005 compared to prior year, primarily driven by higher sales prices for metallurgical
and steam coal. Adjusted EBITDA in our Appalachia operations increased principally as a result of
sales price increases of 30% in 2005, partially offset by lower production at two of our mines
mainly related to problems from excessive water at one mine and higher costs related to geologic
issues, contract mining, and roof support. The results in our Midwest operations were improved
compared to the prior year results, as the benefits of higher volumes and prices were partially
offset by higher operating costs due to the impact of heavy rainfall on surface operations in the
first quarter and higher fuel costs.
Australian Mining operations’ Adjusted EBITDA increased $48.7 million in the first six months
of 2005 compared to the prior year. Volumes in Australia increased due to the acquisition of two
metallurgical coal mines and the opening of a new surface operation at the end of 2004. Current
year results benefited from strong sales prices, but were negatively impacted by port congestion,
related demurrage costs and lower production due to geological problems at the longwall operations.
Trading and Brokerage operations’ Adjusted EBITDA decreased $27.1 million compared with the
prior year, primarily related to a net $14.1 million charge associated with a contractual dispute
(see Note 3
to our unaudited condensed consolidated financial statements) with one of our coal suppliers
and less favorable trading results in 2005 compared to 2004, discussed above.
Income Before Income Taxes And Minority Interests
(Unaudited)
Increase (Decrease) to
Six Months Ended June 30,
Income
2005
2004
$
%
(Dollars in thousands)
Total Segment Adjusted EBITDA
$
471,904
$
344,731
$
127,173
36.9
%
Corporate and Other Adjusted EBITDA
(90,173
)
(99,657
)
9,484
9.5
%
Depreciation, depletion and amortization
(155,262
)
(132,860
)
(22,402
)
(16.9
)%
Asset retirement obligation expense
(16,357
)
(21,664
)
5,307
24.5
%
Interest expense
(50,761
)
(45,923
)
(4,838
)
(10.5
)%
Interest income
3,183
2,128
1,055
49.6
%
Income before income taxes and minority
interests
$
162,534
$
46,755
$
115,779
247.6
%
Income before income taxes and minority interests increased $115.8 million compared with the
first six months of 2004, primarily due to improved segment Adjusted EBITDA results, improved
Corporate and Other Adjusted EBITDA, and lower asset retirement obligation expense, partially
offset by increases in depreciation, depletion and amortization and interest expense.
Corporate and Other Adjusted EBITDA results include selling and administrative expenses, net
gains on asset disposals, costs associated with past mining obligations and revenues and expenses
related to our other commercial activities such as coalbed methane, generation development and
resource management. The $9.5 million improvement in Corporate and Other results included:
•
higher gains on disposal of assets of $35.2 million primarily related to Penn Virginia
(“PVR”) unit sales ($21.2 million) and to three sales involving non-strategic coal assets
and properties ($12.5 million) in 2005. In 2005, we recognized a $31.1 million gain (see
Note 3 to our unaudited condensed consolidated financial statements) from the sale of all
of our remaining 0.838 million PVR units compared to a gain of $9.9 million on the sale of
0.575 million PVR units in 2004;
•
income in 2005 of $11.0 million from our recently acquired 25.5% interest in Carbones
del Guasare, which owns and operates the Paso Diablo Mine in Venezuela; and
•
lower net expenses related to generation development of $2.6 million, primarily due to
reimbursements from the Prairie State Energy Campus partnership group. The reimbursements
include $1.8 million for expenses previously incurred on behalf of the project and the
amortization of a $4.9 million non-refundable payment over the project development service
period (which ends in mid-2006).
These improvements were offset by the following items:
•
an increase in past mining obligations expense of $21.9 million, primarily related to
higher retiree health care costs. The increase in retiree health care costs was due to
higher trend rates, lower interest discount assumptions and the amortization of actuarial
losses in 2005; and
•
an $18.5 million increase in selling and administrative expenses primarily related to
higher annual and long-term performance-based incentives and higher personnel and outside
services costs, which are being driven by business development initiatives and the support
and management of the Twentymile Mine and Australia operations acquired during 2004.
Depreciation, depletion and amortization increased $22.4 million in 2005 with approximately
46% of the increase due to acquisitions made in 2004 and the remainder of the increase due
primarily to improved volume at existing mines in 2005. Asset retirement obligation expense
decreased $5.3 million due to expenses in 2004 related to the acceleration of planned reclamation
of certain closed mine sites. Interest expense increased $4.8 million primarily related to the
issuance of $250 million of 5.875% Senior Notes due 2016 in late March of 2004.
Net Income
(Unaudited)
Increase (Decrease) to
Six Months Ended June 30,
Income
2005
2004
$
%
(Dollars in thousands)
Income before income taxes and
minority interests
$
162,534
$
46,755
$
115,779
247.6
%
Income tax (provision) benefit
(14,586
)
20,796
(35,382
)
n/a
Minority interests
(804
)
(653
)
(151
)
(23.1
)%
Income from continuing operations
147,144
66,898
80,246
120.0
%
Loss from discontinued
operations, net of taxes
—
(2,837
)
2,837
n/a
Net income
$
147,144
$
64,061
$
83,083
129.7
%
Net income increased $83.1 million compared to the first six months of 2004 due to the
increase in income before income taxes and minority interests discussed above, partially offset by
an increase in the income tax provision. The income tax provision recorded in 2005 differs from
the benefit in 2004 primarily as a result of higher pre-tax income and a positive effective tax
rate in 2005, which is driven by the magnitude of the percentage depletion deduction relative to
pretax income.
Outlook
Events Impacting Near-Term Operations
Shipments from our Powder River mines were reduced in the second quarter of 2005 due to two
train derailments and the beginning of a six-month remedial maintenance program undertaken by the
two railroad companies serving the Powder River Basin. The maintenance and repairs are expected to
be completed by late 2005 to early 2006. We expect these repairs may restrict shipments from our
Powder River operations for the remainder of the current year, but continue to anticipate record
shipment levels in 2005 and 2006.
We are continuing to experience transportation difficulties at our Australian operations due
to port congestion at Dalrymple Bay Coal Terminal at the Port of Hay Point in Queensland,
Australia. The port congestion began in early 2004 as demand began exceeding port capacity and has
not eased over the last year. Discussions regarding capacity expansion are on-going. In May
2005, we were notified of a reduced port allocation that is aimed at improving the loading of
vessels and reducing demurrage.
Outlook Overview
Our outlook for the coal markets remains positive. We believe strong coal markets will
continue worldwide, as long as growth continues in the U.S., Asia and other industrialized
economies that are increasing coal demand for electricity generation and steelmaking. The U.S.
economy grew almost 4% in the first quarter of 2005 as reported by the U.S. Commerce Department,
and China’s economy grew 9.5% as published by the National Bureau of Statistics of China. Strong
demand for coal and coal-based electricity generation in the U.S. is being driven by the
strengthening economy, low customer stockpiles, production difficulties for some producers,
favorable weather, capacity constraints of nuclear generation and high prices of natural gas and
oil. The high price of natural gas is leading some coal-fueled generating plants to operate at
increasing levels. U.S. coal inventories at quarter end remained at levels well below the
five-year average.
Demand for Powder River Basin coal is increasing, particularly for our ultra-low sulfur
products. We control approximately 3.4 billion tons of proven and probable reserves in the
Southern Powder River Basin and sold 115.8 million tons of coal from this region during the year
ended December 31, 2004, and 60.8 million tons through the first half of 2005. Metallurgical coal
is selling at a significant premium to steam coal. We expect to capitalize on the strong global
market for metallurgical coal primarily through a portion of our Appalachia operations and our
Australian operations, which produce mainly metallurgical coal.
We continue to target 2005 production of 210 million to 220 million tons and total sales
volume of 240 million to 250 million tons, including 12 to 14 million tons of metallurgical coal.
As of June 30, 2005, we are essentially sold out of our planned 2005 production.
Management expects strong market conditions and operating performance to overcome external
cost pressures and adverse port and rail performance. We are experiencing increases in operating
costs related to fuel, explosives, steel and healthcare, and have taken measures to mitigate the
increases in these costs. In addition, historically low interest rates also have a negative impact
on expenses related to our actuarially determined, employee-related liabilities. We may also
encounter poor geologic conditions, lower third party contract miner or brokerage source
performance or unforeseen equipment problems that limit our ability to produce at forecasted
levels. To the extent upward pressure on costs exceeds our ability to realize sales increases, or
if we experience unanticipated operating or transportation difficulties, our operating margins
would be negatively impacted. See “Cautionary Notice Regarding Forward-Looking Statements” for
additional considerations regarding our outlook.
Liquidity and Capital Resources
Our primary sources of cash include sales of our coal production to customers, cash generated
from our trading and brokerage activities, sales of non-core assets and financing transactions,
including the sale of our accounts receivable through our securitization program. Our primary uses
of cash include our cash costs of coal production, capital expenditures, interest costs and costs
related to past mining obligations as well as planned acquisitions. Our ability to pay dividends,
service our debt (interest and principal) and acquire new productive assets or businesses is
dependent upon our ability to continue to generate cash from the primary sources noted above in
excess of the primary uses. Future dividends, among other things, are subject to limitations
imposed by our 6.875% Senior Notes, 5.875% Senior Notes and Senior Secured Credit Facility
covenants. We typically fund all of our capital expenditure requirements with cash generated from
operations, and during 2004 and the first six months of 2005, have had no borrowings outstanding
under our $900.0 million revolving line of credit, which we use primarily for standby letters of
credit. As of June 30, 2005, we had letters of credit outstanding under the facility of $412.8
million, leaving $487.2 million available for borrowing. This provides us with available borrowing
capacity under the line of credit to fund strategic acquisitions or meet other financing needs. We
were in compliance with all of the covenants of the Senior Secured Credit Facility, the 6.875%
Senior Notes and the 5.875% Senior Notes as of June 30, 2005.
Net cash provided by operating activities was $253.6 million in the first six months of 2005,
an increase of $171.6 million from the first six months of 2004. The increase was primarily driven
by stronger operational performance in 2005 and the funding of our pension plans for $52.5 million
in 2004 compared to $2.4 million in 2005. Net income increased $83.1 million from the prior year,
and in 2004, we electively funded one of our pension plans $50.0 million. The remainder of the
increase is due to working capital and other changes.
Net cash used in investing activities was $190.2 million during the first six months of 2005
compared to $524.9 million used in 2004. Capital expenditures were $187.7 million in the first six
months of 2005, an increase of $71.8 million over prior year. Included in the 2005 capital
expenditures was a $63.5 million payment for the 327 million ton West Roundup federal coal reserve
lease in the Powder River Basin, which was awarded to us in February 2005. Also in 2005, we
acquired mining assets, including 70 million tons of Illinois and Indiana coal reserves, surface
properties and equipment, from Lexington Coal Company for $61.0 million. The purchase price was
paid with $59.0 million on the closing date and an additional $2.0
million to be paid within 12 months of the close pending no outstanding claims related to the
acquired mining assets. Capital expenditures include $56.5 million paid for reserves and
equipment, and inventories include $2.5 million paid for materials and supplies. Proceeds from the
disposal of assets increased $37.4 million primarily due to higher proceeds in 2005 from the sale
of PVR units and non-strategic property, reserves and equipment. In 2004, we acquired the
Twentymile mine in Colorado and two mines in Australia for $417.2 million, and we made a $5.0
million acquisition earn-out payment related to our April 2003 acquisition of the remaining
minority interest in Black Beauty Coal Company.
Net cash provided by financing activities was $6.3 million during the first six months of 2005
compared to $654.7 million in the prior year, with the decrease primarily related to the 2004
issuance of 17.6 million shares of common stock at $22.50 per share, netting proceeds of $383.1
million; issuance of $250 million of 5.875% Senior Notes due in 2016; and the payment of debt
issuance costs of $8.9 million in connection with the acquisition of the three mines discussed
above. During the first six months of 2005 and 2004, we made scheduled payments on our long-term
debt of $14.1 and $16.7 million, respectively. We received cash of $14.6 and $11.6 million in the
first six months of 2005 and 2004, respectively, from the exercise of stock options. Securitized
interest in accounts receivable increased by $25.0 million in the first six months of 2005 compared
to an increase of $50.0 million in 2004. We paid dividends of $19.6 million and $14.9 million in
the first six months of 2005 and 2004, respectively.
Contractual Obligations
The following table updates, as of June 30, 2005, our contractual coal reserve lease and
royalty obligations presented in our 2004 Annual Report on Form 10-K. These obligations have
changed due to the Federal Coal Lease bid that we won in February 2005. The first payment of $63.5
million on this lease was made during the first quarter 2005, and future payments of the same
amount will be due annually through 2009.
Payments Due by Year
Within
2-3
4-5
After
(Dollars in thousands)
1 Year
Years
Years
5 Years
Coal reserve lease and royalty obligations
$
142,575
$
401,642
$
334,736
$
52,996
At June 30, 2005, we had $204.8 million of purchase obligations related to capital
expenditures for 2005 and 2006. Commitments for coal reserve-related expenditures, including
Federal Coal Leases, are included in the table above. Total projected capital expenditures for
calendar year 2005 are approximately $450 million to $500 million. Approximately 50% of projected
2005 capital expenditures relate to the Federal Coal Leases and longwall equipment at the
Twentymile Mine and longwall replacement components in Australia, and the remainder is expected to
be used to purchase or develop reserves, replace or add equipment, fund cost reduction initiatives
and upgrade equipment and facilities at recently acquired operations. We anticipate funding these
capital expenditures primarily through operating cash flow.
Off-Balance Sheet Arrangements
In the normal course of business, we are a party to certain off-balance sheet arrangements.
These arrangements include guarantees, indemnifications, financial instruments with off-balance
sheet risk, such as bank letters of credit and performance or surety bonds and our accounts
receivable securitization. Liabilities related to these arrangements are not reflected in our
consolidated balance sheets, and we do not expect any material adverse effects on our financial
condition, results of operations or cash flows to result from these off-balance sheet arrangements.
In March 2000, we established an accounts receivable securitization program. Under the
program, undivided interests in a pool of eligible trade receivables that have been contributed to
our wholly-owned,
bankruptcy-remote subsidiary are sold, without recourse, to a multi-seller, asset-backed
commercial paper
conduit (“Conduit”). Purchases by the Conduit are financed with the sale of
highly rated commercial paper. We used proceeds from the sale of the accounts receivable to repay
long-term debt, effectively reducing our overall borrowing costs. The securitization program is
scheduled to expire in September 2009, and the maximum amount of undivided interests in accounts
receivable that may be sold to the Conduit is $225.0 million. The securitization transactions have
been recorded as sales, with those accounts receivable sold to the Conduit removed from the
consolidated balance sheet. The amount of undivided interests in accounts receivable sold to the
Conduit was $225.0 million and $200.0 million as of June 30, 2005 and December 31, 2004,
respectively.
There were no other material changes to our off-balance sheet arrangements during the six
months ended June 30, 2005. Material off-balance sheet arrangements are discussed in “Management’s
Discussion and Analysis of Financial Condition and Results of Operations” in our Annual Report on
Form 10-K for the year ended December 31, 2004. See Note 14 to our unaudited condensed
consolidated financial statements included in this report for a discussion of our guarantees.
Other
Risks Related to Contract Miners and Brokerage Sources
In conducting our trading, brokerage and mining operations, we utilize third party sources of
coal production, including contract miners and brokerage sources, to fulfill deliveries under our
coal supply agreements. Recently, certain of our brokerage sources and contract miners have
experienced adverse geologic mining and/or financial difficulties that have made their delivery of
coal to us at the contractual price difficult or uncertain. Our profitability or exposure to loss
on transactions or relationships such as these is dependent upon the reliability (including
financial viability) and price of the third-party supply, our obligation to supply coal to
customers in the event that adverse geologic mining conditions restrict deliveries from our
suppliers, our willingness to participate in temporary cost increases experienced by our
third-party coal suppliers, our ability to pass on temporary cost increases to our customers, the
ability to substitute, when economical, third-party coal sources with internal production or coal
purchased in the market, and other factors.
During the first quarter of 2005, a producer ceased shipping to us on a coal supply agreement.
We have filed a lawsuit for breach of contract to enforce our contractual rights and to recover
damages caused by this material breach of the coal supply agreement. We have agreed to settlement
terms with the producer, and the lawsuit has been stayed pending completion of the transactions in
the agreed upon settlement. See Notes 3 and 12 to our unaudited condensed consolidated financial
statements.
Mohave Generating Station
See Note 12 to our unaudited condensed consolidated financial statements included in this
report relating to the likely cessation or suspension of the operations of the Mohave Generating
Station on December 31, 2005.
Item 3. Quantitative and Qualitative Disclosures About Market Risk.
The potential for changes in the market value of our coal trading, interest rate and currency
portfolios is referred to as “market risk.” Market risk related to our coal trading portfolio is
evaluated using a value at risk analysis (described below). Value at risk analysis is not used to
evaluate our non-trading, interest rate and currency portfolios. A description of each market risk
category is set forth below. We attempt to manage market risks through diversification,
controlling position sizes, and executing hedging strategies. Due to lack of quoted market prices
and the long term, illiquid nature of the positions, we have not quantified market risk related to
our non-trading, long-term coal supply agreement portfolio.
Coal Trading Activities and Related Commodity Price Risk
We engage in over-the-counter and direct trading of coal. These activities give rise to
commodity price risk, which represents the potential loss that can be caused by an adverse change
in the market value of a particular commitment. We actively measure, monitor and adjust traded
position levels to remain within risk limits prescribed by management. For example, we have
policies in place that limit the amount of total exposure, in value at risk terms, that we may
assume at any point in time.
We account for coal trading using the fair value method, which requires us to reflect
financial instruments with third parties, such as forwards, options, and swaps, at market value in
our consolidated financial statements. Our trading portfolio included forwards and swaps at June30, 2005 and December 31, 2004.
We perform a value at risk analysis on our coal trading portfolio, which includes
over-the-counter and brokerage trading of coal. The use of value at risk allows us to quantify in
dollars, on a daily basis, the price risk inherent in our trading portfolio. Value at risk
represents the potential loss in value of our mark-to-market portfolio due to adverse market
movements over a defined time horizon (liquidation period) within a specified confidence level.
Our value at risk model is based on the industry standard variance/co-variance approach. This
captures our exposure related to both option and forward positions. Our value at risk model
assumes a 15-day holding period and a 95% one-tailed confidence interval. This means that there is
a one in 20 statistical chance that the portfolio would lose more than the value at risk estimates
during the liquidation period.
The use of value at risk allows management to aggregate pricing risks across products in the
portfolio, compare risk on a consistent basis and identify the drivers of risk. Due to the
subjectivity in the choice of the liquidation period, reliance on historical data to calibrate the
models and the inherent limitations in the value at risk methodology, we perform regular stress and
scenario analysis to estimate the impacts of market changes on the value of the portfolio. The
results of these analyses are used to supplement the value at risk methodology and identify
additional market-related risks.
We use historical data to estimate our value at risk and to better reflect current asset and
liability volatilities. Given our reliance on historical data, value at risk is effective in
estimating risk exposures in markets in which there are not sudden fundamental changes or shifts in
market conditions. An inherent limitation of value at risk is that past changes in market risk
factors may not produce accurate predictions of future market risk. Value at risk should be
evaluated in light of this limitation.
During the six months ended June 30, 2005, the actual low, high, and average values at risk
for our coal trading portfolio were $1.3 million, $3.9 million, and $2.4 million, respectively. As
of June 30, 2005, the timing of the estimated future realization of the value of the Company’s
trading portfolio was as follows:
Year of
Percentage
Expiration
of Portfolio
2005
91
%
2006
6
%
2007
1
%
2008
2
%
100
%
We also monitor other types of risk associated with our coal trading activities,
including credit, market liquidity and counterparty nonperformance.
Credit Risk
Our concentration of credit risk is substantially with energy producers and marketers,
electric utilities, steel producers, and financial institutions. Our policy is to independently
evaluate each customer’s creditworthiness prior to entering into transactions and to constantly
monitor the credit extended. In the event that we engage in a transaction with a counterparty that
does not meet our credit standards, we generally seek to protect our position by requiring the
counterparty to provide appropriate credit enhancement. When appropriate (as determined by our
credit management function), we have taken steps to reduce our credit exposure to customers or
counterparties whose credit has deteriorated and who may pose a higher risk of failure to perform
under their contractual obligations. These steps include obtaining letters of credit or cash
collateral, requiring prepayments for shipments or the creation of customer trust accounts held for
our benefit to serve as collateral in the event of a failure to pay. To reduce our credit exposure
related to trading and brokerage activities, we seek to enter into netting agreements with
counterparties that permit us to offset receivables and payables with such counterparties.
Counterparty risk with respect to interest rate swap, foreign currency forwards and options
transactions, and fuel hedging derivatives is not considered to be significant based upon the
creditworthiness of the participating financial institutions.
Foreign Currency Risk
We utilize currency forwards and options to hedge currency risk associated with anticipated
Australian dollar expenditures. Our currency hedging program for the remainder of 2005 involves
hedging approximately 75% of our anticipated, non-capital Australian dollar-denominated
expenditures. As of June 30, 2005, we had in place forward contracts designated as cash flows
hedges with Australian dollar-denominated notional amounts outstanding totaling $610 million of
which $175 million, $280 million, $120 million, and $35 million will expire in 2005, 2006, 2007 and
2008, respectively. Our current expectation for the remaining 2005 non-capital, Australian
dollar-denominated cash expenditures is approximately $240 million. A change in the Australian
dollar/U.S. dollar exchange rate of US$0.01 (ignoring the effects of hedging) would result in an
increase or decrease in our operating costs of $4.8 million per year.
Interest Rate Risk
Our objectives in managing exposure to interest rate changes are to limit the impact of
interest rate changes on earnings and cash flows and to lower overall borrowing costs. To achieve
these objectives, we manage fixed rate debt as a percent of net debt through the use of various
hedging instruments. As of June 30, 2005, after taking into consideration the effects of interest
rate swaps, we had $865.9 million of fixed-rate borrowings and $549.0 million of variable-rate
borrowings outstanding. A one-percentage point increase in interest rates would result in an
annualized increase to interest expense of $5.5 million on our variable-rate borrowings. With
respect to our fixed-rate borrowings, a one-percentage point increase in interest rates would
result in a $56.6 million decrease in the estimated fair value of these borrowings.
We manage our commodity price risk for our non-trading, long-term coal contract portfolio
through the use of long-term coal supply agreements, rather than through the use of derivative
instruments. We sold 90% of our sales volume under long-term coal supply agreements during 2004
and 2003. As of June 30, 2005, we are essentially sold out of our planned 2005 production. Also
as of June 30, 2005, we had 35 to 45 million tons and 110 to 120 million tons of expected
production available for sale or repricing at market prices for 2006 and 2007, respectively. We
have an annual metallurgical coal production capacity of 12 to 14 million tons, all of which is
priced for 2005 and approximately 50% of which is priced for 2006.
Some of the products used in our mining activities, such as diesel fuel and explosives, are
subject to commodity price risk. To manage some of this risk, we use a combination of forward
contracts with our suppliers and financial derivative contracts, primarily swap contracts with
financial institutions. In addition, we utilize derivative contracts to hedge some of our
commodity price exposure. As of June 30, 2005, we had derivative contracts outstanding that are
designated as cash flow hedges of anticipated purchases of fuel. Notional amounts outstanding
under these contracts, scheduled to expire through 2007, were 55.7 million gallons of heating oil
and 27.3 million gallons of crude oil. Overall, we have fixed prices for approximately 90% of our
anticipated diesel fuel requirements in 2005.
We expect to consume approximately 95 million gallons of fuel per year. On a per gallon
basis, based on this usage, a change in fuel prices of one cent per gallon (ignoring the effects of
hedging) would result in an increase or decrease in our operating costs of approximately $1 million
per year. Alternatively, a one dollar per barrel change in the price of crude oil would increase
or decrease our annual fuel costs (ignoring the effects of hedging) by approximately $2.3 million.
Item 4. Controls and Procedures.
Our disclosure controls and procedures are designed to, among other things, provide reasonable
assurance that material information, both financial and non-financial, and other information
required under the securities laws to be disclosed is identified and communicated to senior
management on a timely basis. Under the direction of the Chief Executive Officer and Executive
Vice President and Chief Financial Officer, management has evaluated our disclosure controls and
procedures as of June 30, 2005 and has concluded that the disclosure controls and procedures were
effective.
During the second quarter of 2005, we completed the integration of our Australian operations
acquired in 2004 into our system of internal control over financial reporting. We implemented new
general ledger and reporting systems in our Australian operations and will complete our assessment
of the effectiveness of related controls over financial reporting by the end of 2005. Other than
changes made in our Australian operations, during the most recent fiscal quarter, there have been
no other changes to our internal control over financial reporting that materially affected, or are
reasonably likely to materially affect, our internal control over financial reporting.
PART II – OTHER INFORMATION
Item 1. Legal Proceedings.
See Note 12 to the unaudited condensed consolidated financial statements included in Part I,
Item 1 of this report relating to certain legal proceedings, including proceedings brought against
us by the Navajo Nation, the Hopi and Quapaw Tribes, two class action lawsuits brought on behalf of
the residents of the towns of Cardin, Quapaw and Picher, Oklahoma and natural resource damage
claims asserted by Oklahoma and several other parties, which is incorporated by reference herein.
See Part I, Item 3, “Legal Proceedings” in our 2004 Annual Report on Form 10-K for a discussion of
our legal proceedings.
Item 4. Submission of Matters to a Vote of Security Holders.
Peabody Energy Corporation’s annual meeting of stockholders was held on May 6, 2005. The
shares of common stock eligible to vote were based on a record date of March 15, 2005 and do not
reflect the March 30, 2005 two-for-one stock split. Four Class I directors were elected to serve
for three-year terms expiring in 2008. A tabulation of votes for each director is set forth below:
For
Withheld
B.R. Brown
59,711,173
1,986,575
Henry Givens, Jr.
58,745,000
2,952,748
James R. Schlesinger
45,976,481
15,721,267
Sandra Van Trease
59,716,590
1,981,158
Stockholders also voted to ratify Ernst & Young LLP as our independent registered public
accounting firm for 2005 and voted to approve an increase in the number of authorized common stock
shares from 150,000,000 shares to 400,000,000 shares and number of total authorized capital stock
shares from 200,000,000 shares to 450,000,000 shares. Three stockholder proposals were voted on at
the annual meeting, including a proposal regarding director independence submitted by Amalgamated
Bank LongView MidCap 400 Index Fund, a proposal to declassify the Board for the purpose of director
elections submitted by the AFL-CIO Reserve Fund, and a proposal to require a majority of
affirmative votes for the election of director nominees submitted by the Sheet Metal Workers’
National Pension Fund. The result of the vote on each of these matters is set forth below:
Broker
For
Against
Abstentions
Non-votes
Ratification of
independent
registered public
accounting firm
61,153,591
383,733
160,424
—
Approval of
increase in number
of authorized
common stock shares
57,046,627
4,636,333
14,743
—
Proposal regarding
director
independence
22,560,474
30,184,555
84,274
8,868,445
Proposal regarding
declassification of
Board
37,246,968
15,482,029
100,305
8,868,445
Proposal regarding
majority vote for
election of
director nominees
19,465,711
33,061,714
301,877
8,868,445
Each of the shareholder proposals submitted at the annual meeting was advisory in nature. The
Nominating & Corporate Governance Committee, which consists entirely of independent directors, is
evaluating the impact of the vote on these proposals and will recommend a course of action for
consideration by the full Board.
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.
Certificate of Amendment of Third Amended and Restated Certificate
of Incorporation of Peabody Energy Corporation.
10.1*
Federal Coal Lease WYW151134 effective May 1, 2005: West Roundup.
10.2
Indemnification Agreement dated April 8, 2005 by and between
Peabody Energy Corporation and Gregory H. Boyce (incorporated by
reference to Exhibit 10.1 to the Company’s Current Report on Form
8-K filed on April 14, 2005).
31.1*
Certification of periodic financial report by Peabody Energy
Corporation’s Chief Executive Officer pursuant to Rule 13a-14(a)
under the Securities Exchange Act of 1934, as amended pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.
31.2*
Certification of periodic financial report by Peabody Energy
Corporation’s Executive Vice President and Chief Financial Officer
pursuant to Rule 13a-14(a) under the Securities Exchange Act of
1934, as amended pursuant to Section 302 of the Sarbanes-Oxley Act
of 2002.
32.1*
Certification of periodic financial report pursuant to 18 U.S.C.
Section 1350, adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002, by Peabody Energy Corporation’s Chief
Executive Officer.
32.2*
Certification of periodic financial report pursuant to 18 U.S.C.
Section 1350, adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002, by Peabody Energy Corporation’s
Executive Vice President and Chief Financial Officer.
