Summary of ARCH COAL INC - Yahoo! Finance

Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations.
This document contains "forward-looking statements" - that is, statements related to future, not past, events. In this context, forward-looking statements often address our expected future business and financial performance, and often contain words such as "expects," "anticipates," "intends," "plans," "believes," "seeks," or "will." Forward-looking statements by their nature address matters that are, to different degrees, uncertain. For us, particular uncertainties arise from changes in the demand for our coal by the domestic electric generation industry; from legislation and regulations relating to the Clean Air Act and other environmental initiatives; from operational, geological, permit, labor and weather-related factors; from fluctuations in the amount of cash we generate from operations; from future integration of acquired businesses; and from numerous other matters of national, regional and global scale, including those of a political, economic, business, competitive or regulatory nature. These uncertainties may cause our actual future results to be materially different than those expressed in our forward-looking statements. We do not undertake to update our forward-looking statements, whether as a result of new information, future events or otherwise, except as may be required by law. For a description of some of the risks and uncertainties that may affect our future results, see "Risk Factors" under Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2008 and under Part II, Item 1A of this report. Overview
We are one of the largest coal producers in the United States. We sell substantially all of our coal to power plants, steel mills and industrial facilities. The locations of our mines enable us to ship coal to most of the major coal-fueled power plants, steel mills and export facilities located in the United States.
Our three reportable business segments are based on the low-sulfur U.S. coal producing regions in which we operate - the Powder River Basin, the Western Bituminous region and the Central Appalachia region. These geographically distinct areas are characterized by geology, coal transportation routes to consumers, regulatory environments and coal quality. These regional similarities have caused market and contract pricing environments to develop by coal region and form the basis for the segmentation of our operations.
The Powder River Basin is located in northeastern Wyoming and southeastern Montana. The coal we mine from surface operations in this region has a very low sulfur content and a low heat value compared to the other regions in which we operate. The price of Powder River Basin coal is generally less than that of coal produced in other regions because Powder River Basin coal exists in greater abundance, is easier to mine and thus has a lower cost of production. In addition, Powder River Basin coal is generally lower in heat value, which requires some electric power generation facilities to blend it with higher Btu coal or retrofit some existing coal plants to accommodate lower Btu coal. The Western Bituminous region includes western Colorado, eastern Utah and southern Wyoming. Coal we mine from underground and surface mines in this region typically has a low sulfur content and varies in heat value. Central Appalachia includes eastern Kentucky, Tennessee, Virginia and southern West Virginia. Coal we mine from both surface and underground mines in this region generally has a high heat value and low sulfur content. In addition, we may sell a portion of the coal we produce in the Central Appalachia region as metallurgical coal, which has high heat content, low expansion pressure, low sulfur content and various other chemical attributes. As such, the prices at which we sell metallurgical coal to customers in the steel industry generally exceed the prices offered by power plants and industrial users for steam coal.
In 2009, we expect U.S. power generation to decline approximately 4.0% due to weaker domestic and international economic conditions. We also expect U.S. coal consumption to decline in 2009 in response to reduced consumption for electricity generation, lower metallurgical coal demand resulting from global steel production cuts and increased use of natural gas by some electricity generation facilities. As a result of these market pressures, coupled with continued geological challenges, cost pressures, regulatory hurdles and limited access to capital, we expect coal production and capital spending levels across the domestic coal industry will be curtailed. Due to weakening demand in response to challenging domestic economic conditions, we have decreased our estimates of the amount of coal we plan to sell in 2009. In addition, we have decreased our expected capital expenditures for 2009 and have established other process improvement initiatives and cost containment programs.
During the first quarter of 2009, we announced our plans to purchase the Jacobs Ranch mining complex in the Powder River Basin from Rio Tinto Energy America for a purchase price of $761.0 million. At December 31, 2008, Jacobs Ranch controlled approximately 381 million tons of coal reserves, as reported by Rio Tinto Energy America, which are adjacent to our Black Thunder mining complex. The transaction is subject to certain governmental and regulatory conditions and approvals, including under competition laws and regulations, and other

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customary conditions. We cannot provide assurance that the transaction will be completed.
Results of Operations
Three Months Ended March 31, 2009 Compared to Three Months Ended March 31, 2008
Summary. Our results during the first quarter of 2009 when compared to the first quarter of 2008 were influenced primarily by lower sales volumes due to weak market conditions, an increase in production costs, a decrease in gains from our coal trading activities from the first quarter of 2008 and an income tax benefit in the first quarter of 2009.
Revenues. The following table summarizes information about coal sales for the three months ended March 31, 2009 and compares it with the information for the three months ended March 31, 2008:

                                                         Three Months Ended March 31                     Increase (Decrease)
                                                       2009                       2008                 Amount               %
                                                           (Amounts in thousands, except per ton data and percentages)
Coal sales                                       $       681,040            $       699,350          $ (18,310 )           (2.6 )%
Tons sold                                                 30,892                     34,828             (3,936 )          (11.3 )%
Coal sales realization per ton sold              $         22.04            $         20.08          $    1.96              9.8 %

Coal sales decreased in the first quarter of 2009 from the first quarter of 2008 due to lower sales volumes in all segments partially offset by the effect of higher price realizations in all segments. We have provided more information about the tons sold and the coal sales realizations per ton by operating segment under the heading "Operating segment results" beginning on page 16.
Costs, expenses and other. The following table summarizes costs, expenses and other components of operating income for the three months ended March 31, 2009 and compares them with the information for the three months ended March 31, 2008:

                                                                                               Increase (Decrease)
                                                   Three Months Ended March 31                    in Net Income
                                                   2009                   2008                  $                 %
                                                             (Amounts in thousands, except percentages)
Cost of coal sales                            $      547,126         $      514,404        $    (32,722 )         (6.4 )%
Depreciation, depletion and amortization              73,041                 73,042                   1              -
Selling, general and administrative
expenses                                              25,114                 25,680                 566            2.2
Change in fair value of coal derivatives
and coal trading activities, net                        (528 )              (30,558 )           (30,030 )        (98.3 )
Costs related to acquisition of Jacobs
Ranch                                                  3,350                      -              (3,350 )          N/A
Other operating (income) expense, net                 (5,635 )                   58               5,693            N/A

                                              $      642,468         $      582,626        $    (59,842 )        (10.3 )%

Cost of coal sales. Our cost of coal sales increased in the first quarter of 2009 from the first quarter of 2008 due to higher spending across all operating segments. We have provided more information about our operating segments under the heading "Operating segment results" beginning on page 16.
Depreciation, depletion and amortization. When compared with the first quarter of 2008, higher depreciation and amortization costs in the first quarter of 2009 resulting from capital additions made in 2008 were offset by lower depletion costs resulting from lower production levels.
Selling, general and administrative expenses. The decrease in selling, general and administrative expenses from the first quarter of 2008 to the first quarter of 2009 is due primarily to a decrease in employee incentive compensation costs of $2.9 million, partially offset by a $1.5 million contribution commitment in the first quarter of 2009 to a company participating in the research and development of technologies for capturing carbon dioxide emissions.

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Change in fair value of coal derivatives and coal trading activities, net. Net gains relate to the net impact of our coal trading activities and the change in fair value of other coal derivatives that have not been designated as hedge instruments in a hedging relationship. Our coal trading function enabled us to take advantage of the significant price movements in the coal markets during in the first quarter of 2008.
Costs related to acquisition of Jacobs Ranch. These costs represent costs we incurred during the first quarter of 2009 related to our announced acquisition of the Jacobs Ranch mine. Under accounting rules we adopted in the first quarter of 2009, the costs of acquiring a business are expensed as incurred.
Other operating (income) expense, net. The change in net other operating income in the first quarter of 2009 from net other operating expense in the first quarter of 2008 is primarily the result of an increase in the net income from bookouts (the offsetting of coal sales and purchase contracts) of $2.8 million and an increase in income from equity investments of $1.7 million, primarily from our interest in Knight Hawk Holdings, LLC. In addition, in 2008 we recognized $1.8 million of unrealized losses on investments in marketable equity securities.
Operating segment results. The following table shows results by operating segment for the three months ended March 31, 2009 and compares it with information for the three months ended March 31, 2008:

                                                    Three Months Ended March 31                 Increase (Decrease)
                                                     2009                  2008                 $                 %

Powder River Basin
Tons sold (in thousands)                              23,133                25,764            (2,631 )           (10.2 )%
Coal sales realization per ton sold (1)         $      13.25          $      11.15          $   2.10              18.8 %
Operating margin per ton sold (2)               $       1.33          $       1.22          $   0.11               9.0 %

Western Bituminous
Tons sold (in thousands)                               3,951                 5,051            (1,100 )           (21.8 )%
Coal sales realization per ton sold (1)         $      28.11          $      26.76          $   1.35               5.0 %
Operating margin per ton sold (2)               $      (2.23 )        $       6.59          $  (8.82 )          (133.8 )%

Central Appalachia
Tons sold (in thousands)                               3,808                 4,013              (205 )            (5.1 )%
Coal sales realization per ton sold (1)         $      61.50          $      58.07          $   3.43               5.9 %
Operating margin per ton sold (2)               $      10.64          $      12.16          $  (1.52 )           (12.5 )%

(1) Coal sales prices per ton exclude certain transportation costs that we pass through to our customers. We use these financial measures because we believe the amounts as adjusted better represent the coal sales prices we achieved within our operating segments. Since other companies may calculate coal sales prices per ton differently, our calculation may not be comparable to similarly titled measures used by those companies. For the three months ended March 31, 2009, transportation costs per ton were $0.21 for the Powder River Basin, $2.90 for the Western Bituminous region and $3.43 for Central Appalachia. Transportation costs per ton for the three months ended March 31, 2008 were $0.07 for the Powder River Basin, $5.33 for the Western Bituminous region and $3.80 for Central Appalachia.

(2) Operating margin per ton sold is calculated as coal sales revenues less cost of coal sales and depreciation, depletion and amortization divided by tons sold.

Powder River Basin - The decrease in sales volume in the Powder River Basin in the first quarter of 2009 when compared with the first quarter of 2008 is due to our production cutbacks in response to weak market conditions. We idled one dragline in the fourth quarter of 2008 at the Black Thunder mine and have since announced plans to idle another dragline in May 2009. Increases in sales prices during the first quarter of 2009 when compared with the first quarter of 2008 primarily reflect higher pricing from contracts committed during periods of higher prices in 2008, partially offset by the effect of lower pricing on market-index priced tons. On a per-ton basis, operating margins in the first quarter of 2009 increased only slightly from the first quarter of 2008 due to an increase in per-ton costs, which partially offset the contribution from higher sales prices. The increase in per-ton costs resulted primarily from the effect of spreading fixed costs over lower production levels and higher labor costs, repairs and maintenance costs and sales-sensitive costs. Our diesel purchases are hedged under our risk management program as discussed further under " Quantitative and Qualitative Disclosures About Market Risk" beginning on page 20.
Western Bituminous - In the Western Bituminous region, in addition to our production cutbacks in response to weakened coal markets, sales volume decreased during the first quarter of 2009 when compared with the first quarter of 2008 due primarily to a roof fall in January 2009 at the West Elk mining complex in Colorado that halted production for 10 days. Higher sales prices during the first quarter of 2009 when compared to the first quarter of 2008 were the result of higher contract pricing that was achieved after the roll off of lower-priced legacy contracts in 2008, partially offset by adverse quality adjustments attributable to the coal produced from the West Elk complex in the first quarter of 2009. Geologic conditions encountered after the transition to the new coal seam at the West Elk

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mining complex have increased the ash content of the coal produced. We expect these conditions to continue into the second quarter of 2009, and it is possible that these geologic conditions may impact our coal quality intermittently in the future. We are exploring long-term solutions to deal with these conditions, including the possibility of constructing a small preparation plant at the mine. Higher sales prices were offset by higher per-ton operating costs, resulting in a decrease in operating margin per ton sold. Higher per-ton operating costs resulted from the lower production levels and the West Elk geology issues, as well as higher labor, supplies and repair and maintenance costs.
Central Appalachia - The decrease in sales volumes in the first quarter of 2009 when compared with the first quarter of 2008 is due primarily to a decrease in 2009 in required volumes under sales contracts that we retained after selling the mining complexes from which they were sourced. Higher realizations in the first quarter of 2009 compared to the first quarter of 2008 from higher base pricing on contracts signed during periods of higher pricing in 2008 were in part offset by a decrease in metallurgical coal sales volumes. We sold 0.4 million tons into metallurgical markets in the first quarter of 2009 compared to 0.8 million tons in the first quarter of 2008, and because metallurgical coal generally commands a higher price than steam coal, the decrease had a detrimental impact on our average realizations. Weak economic conditions in the steel industry have affected metallurgical coal demand. Operating margins per ton for the first quarter of 2009 decreased from the first quarter of 2008 despite the increase in sales prices, due primarily to higher labor, supplies and repairs and maintenance costs and an increase tons sold from higher-cost contract mines, which began production in late 2008.
Net interest expense. The following table summarizes our net interest expense for the three months ended March 31, 2009 and compares it with the information for the three months ended March 31, 2008:

                          Three Months Ended March 31            Increase in Net Income
                           2009                 2008               $                 %
                                   (Amounts in thousands, except percentages)
   Interest expense   $      (20,018 )     $      (20,488 )   $        470              2.3 %
   Interest income             6,468                  425            6,043              N/A

                      $      (13,550 )     $      (20,063 )   $      6,513             32.5 %

The decrease in net interest expense in the first quarter of 2009 compared to the first quarter of 2008 is primarily due to $6.1 million of interest income recorded in the first quarter of 2009 associated with refunds of black lung excise tax. The income recorded in the first quarter of 2009 is an adjustment to our original estimate of the recoverable amount of the refund recorded in the fourth quarter of 2008. Our interest costs in the first quarter of 2009 were lower than in the first quarter of 2008 due to lower interest rates, but the impact was partially offset by a decrease in interest costs capitalized.
Income taxes. Our effective income tax rate is sensitive to changes in estimates of annual profitability and percentage depletion. The following table summarizes our income taxes for the three months ended March 31, 2009 and compares it with information for the three months ended March 31, 2008:

Three Months Ended March 31 Increase in Net Income 2009 2008 $ %

(Amounts in thousands, except percentages)
Provision for (benefit from) income taxes $ (5,550 ) $ 15,240 $ 20,790 136.4 %

The benefit from income taxes in the first quarter of 2009 was the result of lower pre-tax income in the first quarter of 2009 when compared with the first quarter of 2008 and the impact of percentage depletion. Liquidity and Capital Resources
Credit crisis and economic environment The crisis in domestic and international financial markets has had a significant adverse impact on a number of financial institutions. Since the beginning of the crisis, our ability to issue commercial paper up to the maximum amount allowed under the program has been constrained. The ongoing uncertainty in the financial markets may have an impact in the future on: the market values of certain securities and commodities; the financial stability of our customers and counterparties; availability under our lines of credit; the cost and availability of insurance and financial surety programs, and pension plan funding requirements. We believe we have sufficient liquidity under our credit facilities to satisfy working capital requirements and fund capital expenditures, if needed. We had available borrowing capacity of $470.0 million under our lines of credit at March 31, 2009 in addition to our cash on hand. Management will continue to closely monitor our liquidity, credit markets and counterparty credit risk.

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Management cannot predict with any certainty the impact to our liquidity of any further disruption in the credit environment.
Liquidity and capital resources
Our primary sources of cash include sales of our coal production to customers, borrowings under our credit facilities or other financing arrangements, and debt and equity offerings related to significant transactions. Excluding any significant mineral reserve acquisitions, we generally satisfy our working capital requirements and fund capital expenditures and debt-service obligations with cash generated from operations or borrowings under our credit facility, accounts receivable securitization or commercial paper programs. The borrowings under these arrangements are classified as current if the underlying credit facilities expire within one year or if, based on cash projections and management plans, we do not have the intent to replace them on a long-term basis. Such plans are subject to change based on our cash needs.
We believe that cash generated from operations and borrowings under our credit facilities or other financing arrangements will be sufficient to meet working capital requirements, anticipated capital expenditures and scheduled debt payments for at least the next several years. We manage our exposure to changing commodity prices for our non-trading, long-term coal contract portfolio through the use of long-term coal supply agreements. We enter into fixed price, fixed volume supply contracts with terms greater than one year with customers with whom we have historically had limited collection issues. Our ability to satisfy debt service obligations, to fund planned capital expenditures, to make acquisitions, to repurchase our common shares and to pay dividends will depend upon our future operating performance, which will be affected by prevailing economic conditions in the coal industry and financial, business and other factors, some of which are beyond our control. In response to the economic environment and weakening coal markets, we have decreased our 2009 capital spending plans and have established other process improvement initiatives and cost containment programs in order to reduce costs.
We are currently evaluating our options of financing the Jacobs Ranch acquisition. These options include cash from operations, borrowings under credit facilities, and other debt instruments.
Our secured revolving credit facility allows for up to $800.0 million of borrowings and expires June 23, 2011. We had borrowings outstanding under the revolving credit facility of $375.0 million at March 31, 2009 and $205.0 million at December 31, 2008. At March 31, 2009, we had availability of $425.0 million under the revolving credit facility. Borrowings under the credit facility bear interest at a floating rate based on LIBOR determined by reference to our leverage ratio, as calculated in accordance with the credit agreement, as amended. Our revolving credit facility is secured by substantially all of our assets, as well as our ownership interests in substantially all of our subsidiaries, except our ownership interests in Arch Western Resources, LLC and its subsidiaries. Financial covenants contained in our revolving credit facility consist of a maximum leverage ratio, a maximum senior secured leverage ratio and a minimum interest coverage ratio. The leverage ratio requires that we not permit the ratio of total net debt (as defined in the facility) at the end of any calendar quarter to EBITDA (as defined in the facility) for the four quarters then ended to exceed a specified amount. The interest coverage ratio requires that we not permit the ratio of EBITDA (as defined in the facility) at the end of any calendar quarter to interest expense for the four quarters then ended to be less than a specified amount. The senior secured leverage ratio requires that we not permit the ratio of total net senior secured debt (as defined in the facility) at the end of any calendar quarter to EBITDA (as defined in the facility) for the four quarters then ended to exceed a specified amount. We were in compliance with all financial covenants at March 31, 2009.
We entered into an amendment of our revolving credit facility during the first quarter of 2009 that amended certain covenants to make them less restrictive, including those related to lien creation, restricted payments and subsidiary guarantees of debt, in addition to an increase in the maximum leverage ratio, as defined, that we must maintain. In connection with these changes, the borrowing pricing grid was increased by 200 basis points and the rate on the unused portion of the facility was increased to 50 basis points We are party to a $175.0 million accounts receivable securitization program whereby eligible trade receivables are sold, without recourse, to a multi-seller, asset-backed commercial paper conduit. The credit facility supporting the borrowings under the program is subject to renewal annually and was renewed in the first quarter of 2009 and now expires March 31, 2010. Under the terms of the program, eligible trade receivables consist of trade receivables generated by our operating subsidiaries. Actual borrowing capacity is based on the allowable amounts of accounts receivable as defined under the terms of the agreement. Outstanding borrowings under the program were approximately $68.6 million at both March 31, 2009 and December 31, 2008. We also had letters of credit

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outstanding under the securitization program of $59.5 million as of March 31, 2009. At March 31, 2009 we had availability of $45.0 million under the accounts receivable securitization program. Although the participants in the program bear the risk of non-payment of purchased receivables, we have agreed to indemnify the participants with respect to various matters. The participants under the program will be entitled to receive payments reflecting a specified discount on amounts funded under the program, including drawings under letters of credit, calculated on the basis of the base rate or commercial paper rate, as applicable. We pay facility fees, program fees and letter of credit fees (based on amounts of outstanding letters of credit) at rates that vary with our leverage ratio. Under the program, we are subject to certain affirmative, negative and financial covenants customary for financings of this type, including restrictions related to, among other things, liens, payments, merger or consolidation and amendments to the agreements underlying the receivables . . .