SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
[ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended June 30, 1997
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ____ to ____
Commission file number 1-13105
ARCH COAL, INC.
(Exact name of registrant as specified in its charter)
Delaware 43-0921172
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
CityPlace One, Suite 300, St. Louis, Missouri 63141
(Address of principal executive offices) (Zip Code)
CityPlace One, Suite 300, St. Louis, Missouri 63141
(Mailing Address) (Zip Code)
Registrant's telephone number, including area code (314) 994-2700
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes No [ X ]
At August 12, 1997, there were 39,630,896 shares of registrant's common stock
outstanding.
Index
PART I. FINANCIAL INFORMATION PAGE
- ------------------------------ ----
Item 1. FINANCIAL STATEMENTS
Condensed Consolidated Balance Sheets as of June 30, 1997
and December 31, 1996 3
Condensed Consolidated Statements of Income for the Three
Months Ended June 30, 1997 and 1996 and the Six Months
Ended June 30, 1997 and 1996 4
Condensed Consolidated Statements of Cash Flows for the
Six Months Ended June 30, 1997 and 1996 5
Notes to Condensed Consolidated Financial Statements 6
Unaudited Pro Forma Financial Information 11
Unaudited Pro Forma Combined Balance Sheet as of June
30, 1997 (with Accompanying Notes) 12
Unaudited Pro Forma Combined Statement of Income for
the Six Months Ended June 30, 1997 (with Accompanying
Notes) 15
Unaudited Pro Forma Combined Statement of Income for the
Twelve Months Ended December 31, 1996 (with
Accompanying Notes) 16
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS 18
PART II. OTHER INFORMATION
- ---------------------------
Item 1. LEGAL PROCEEDINGS 31
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY
HOLDERS 31
Item 6. EXHIBITS AND REPORTS ON FORM 8-K 31
2
PART I - FINANCIAL INFORMATION
Item 1. FINANCIAL STATEMENTS
ARCH COAL, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands)
June 30 December 31
1997 1996
------ ----------
(Unaudited)
ASSETS
- ------
CURRENT ASSETS
Cash and cash equivalents $ 16,322 $ 13,716
Trade accounts receivable 74,625 75,657
Other receivables 3,849 5,143
Inventories 41,794 35,234
Prepaid royalties 3,337 2,624
Deferred income taxes 14,500 14,500
Prepaid expenses and other assets 5,072 6,738
----- -----
Total current assets 159,499 153,612
------- -------
PROPERTY, PLANT AND EQUIPMENT, NET 552,798 567,067
------- -------
OTHER ASSETS
Prepaid royalties 3,723 3,723
Coal supply agreements less accumulated amortization 79,170 83,369
Deferred income taxes 78,520 67,207
Receivables and other assets 9,994 10,543
----- ------
171,407 164,842
------- -------
Total assets $ 883,704 $ 885,521
-------------- --------------
LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES
- --------------------------------------------------------
Accounts payable $ 56,383 $ 42,712
Accrued expenses 74,732 77,734
------ ------
Total current liabilities 131,115 120,446
------- -------
LONG-TERM DEBT 182,191 212,695
ACCRUED POSTRETIREMENT BENEFITS
OTHER THAN PENSIONS 231,323 228,843
ACCRUED RECLAMATION AND MINE CLOSURE 100,490 97,595
ACCRUED WORKERS' COMPENSATION 65,299 70,849
OTHER NONCURRENT LIABILITIES 25,019 24,467
STOCKHOLDERS' EQUITY
Common stock 209 209
Paid-in capital 8,392 8,392
Retained earnings 139,666 122,025
------- -------
Total stockholders' equity 148,267 130,626
------- -------
Total liabilities and stockholders' equity $ 883,704 $ 885,521
============== ==============
See notes to condensed consolidated financial statements.
3
ARCH COAL, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except per share data)
(Unaudited)
Three Months Ended Six Months Ended
June 30 June 30
---------------- --------------
1997 1996 1997 1996
---- ---- ---- ----
REVENUES
Coal sales $ 190,958 $ 186,728 $ 383,286 $ 370,614
Other revenues 5,199 4,792 10,290 9,394
----- ----- ------ -----
196,157 191,520 393,576 380,008
------- ------- ------- -------
COSTS AND EXPENSES
Cost of coal sales 169,301 168,575 340,925 330,991
Selling, general and
administrative expenses 3,300 4,686 8,197 9,259
Amortization of coal supply
agreements 2,084 2,979 4,200 5,834
Other expenses 5,176 4,168 7,645 7,866
----- ----- ----- -----
179,861 180,408 360,967 353,950
------- ------- ------- -------
Income from operations 16,296 11,112 32,609 26,058
Interest expense, net:
Interest expense (3,239) (4,752) (6,792) (9,818)
Interest income 275 375 535 692
--- --- --- ---
(2,964) (4,377) (6,257) (9,126)
------ ------ ------ ------
Income before income taxes 13,332 6,735 26,352 16,932
Provision for income taxes 1,600 1,500 4,200 4,100
----- ----- ----- -----
Net income $ 11,732 $ 5,235 $ 22,152 $ 12,832
========== ========== ========== =========
Earnings per common share $ 0.56 $ 0.25 $ 1.06 $ 0.61
========== ========== ========== =========
Average common shares
outstanding 20,948 20,948 20,948 20,948
====== ====== ====== ======
Dividends declared per common
share $ 0.11 $ - $ 0.22 $ -
========== ======== ========= =========
See notes to condensed consolidated financial statements.
4
ARCH COAL, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
Six Months Ended
June 30
-------
1997 1996
----- -----
OPERATING ACTIVITIES
Net Income $ 22,152 $ 12,832
Adjustments to reconcile net income to cash
provided by operating activities:
Depreciation, depletion and amortization 57,852 49,896
Net gain on disposition of assets (409) (804)
Changes in:
Trade accounts receivable 1,033 22
Other receivables 1,293 4,122
Coal inventories (7,248) 1,877
Repair parts and supplies inventories 688 (1,731)
Income taxes (11,313) (2,757)
Accounts payable and accrued expenses 12,513 1,694
Accrued postretirement benefits 2,480 5,226
Accrued workers' compensation (7,394) (3,371)
Accrued reclamation and mine closure (1,388) (583)
Other 2,054 (2,619)
----- ------
CASH PROVIDED BY
OPERATING ACTIVITIES 72,313 63,804
------ ------
INVESTING ACTIVITIES
Additions to property, plant and equipment (18,486) (27,834)
Payments for acquisitions (16,990) (14,200)
Proceeds from dispositions of property, plant and
equipment 784 1,188
--- -----
CASH USED IN
INVESTING ACTIVITIES (34,692) (40,846)
------- -------
FINANCING ACTIVITIES
Proceeds from borrowings 140,000 221,500
Payments on borrowings (170,503) (251,684)
Dividends paid (4,512) -
------ ------
CASH USED IN
FINANCING ACTIVITIES (35,015) (30,184)
------- -------
Increase (decrease) in cash and cash equivalents 2,606 (7,226)
Cash and cash equivalents, beginning of period 13,716 17,502
------ ------
Cash and cash equivalents, end of period $ 16,322 $ 10,276
========== ==========
See notes to consolidated condensed financial statements.
5
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
ARCH COAL, INC. AND SUBSIDIARIES
JUNE 30, 1997
(Unaudited)
Note A - GENERAL
The accompanying condensed consolidated financial statements have been prepared
in accordance with generally accepted accounting principles for interim
financial reporting and Securities and Exchange Commission regulations, but are
subject to any year-end audit adjustments which may be necessary. In the opinion
of management, all adjustments (consisting of normal recurring accruals)
considered necessary for a fair presentation have been included. These financial
statements should be read in conjunction with the combined Proxy Statement of
Ashland Coal, Inc./Form S-4 Prospectus of Arch Mineral Corporation (Arch Coal
or the Company) dated May 30, 1997. Arch Mineral Corporation changed its name to
Arch Coal, Inc. effective July 1, 1997. Results of operations for the periods
ended June 30, 1997, are not necessarily indicative of results to be expected
for the year ending December 31, 1997. The Company produces steam coal from
surface and deep mines in Illinois, Kentucky, West Virginia, Virginia and
Wyoming for sale to utility, industrial and export markets. Some members of the
Company's workforce are represented by various labor organizations. Significant
intercompany transactions and accounts have been eliminated in consolidation.
Note B - STOCK SPLIT
On April 4, 1997, the Company changed its capital structure whereby the number
of authorized shares was increased to 100,000,000 common shares, the par value
was changed to $.01 per share, and a common stock split of 338.0859-for-one was
effected. All share and per share information has been retroactively restated to
reflect the stock split.
Note C - MERGER
On July 1, 1997, the Company merged with Ashland Coal, Inc. (Ashland Coal).
Under the terms of the merger, Ashland Coal's stockholders received one common
share of Arch Coal for each common share of Ashland Coal and 20,500 common
shares of Arch Coal for each share of Ashland Coal preferred stock. The merger
will be accounted for under the purchase method of accounting. An unaudited pro
forma combined balance sheet as of March 31, 1997 and a pro forma combined
statement of operations for the year ended December 31, 1996 were included in
the Company's Form 8-K filed on July 15, 1997. Unaudited proforma financial
statements and related notes thereto which give effect to the merger as of June
30, 1997, and for the six months ended June 30, 1997 and the twelve months ended
December 31, 1996, are included herein following these financial statements.
6
Note D - STOCK REPURCHASE PROGRAM
On July 25, 1997, the Company announced that the Company's Board of Directors
has directed implementation of a share repurchase plan under which the Company
may repurchase, from time to time, up to 1,000,000 shares of the Company's
common stock. Shares acquired may be used for general corporate purposes.
Note E - INVENTORIES
Inventories are comprised of the following:
June 30, 1997 December 31, 1996
------------- -----------------
(In thousands)
Coal $29,114 $21,866
Repair Parts and Supplies 12,680 13,368
-------- --------
$41,794 $35,234
======= =======
Note F - DEBT
Debt consists of the following:
June 30, 1997 December 31, 1996
------------- -----------------
(In thousands)
Indebtedness to banks under revolving credit
agreement, expiring in 1999 $ 10,000 $147,000
Demand note, variable interest rate (interest rate
at June 30, 1997 - 6.6%) 122,000 -
7.79% senior unsecured notes, payable annually
through January 31, 2003 42,860 50,000
9.85% senior unsecured notes, paid in 1997 - 8,000
Obligations, interest rates of 7.15% to 9%,
payable through 2009, collateralized by
underlying properties 7,331 7,695
------- --------
$182,191 $212,695
======== ========
The Company had an unsecured revolving credit agreement with a group of banks
which provided for borrowings of up to $200 million. On July 1, 1997,
concurrently with the Merger, the Company entered into a new $500 million
revolving credit agreement and terminated the
7
$200 million facility on July 2, 1997. The new revolving credit agreement has a
five year term, and the rate of interest on borrowings under this agreement is,
at the Company's option, a money-market rate determined by a competitive bid
process, the PNC Bank base rate or a rate based on LIBOR. The Company is
currently borrowing under the LIBOR option. The demand note was entered into as
a temporary line of credit until the $500 million revolving credit agreement
took effect.
Note G - CHANGE IN ESTIMATE AND NON-RECURRING REVENUES AND EXPENSES
During the quarter ended June 30, 1997, the Company recorded a $4.2 million
reduction in workers' compensation reserves (including $3.5 million in cost of
coal sales and $.7 million in selling, general and administrative expenses) due
to better than anticipated safety performance. This favorable adjustment was
offset, in part, by a $1.5 million charge to cost of coal sales for the
impoundment failure in October 1996 at Lone Mountain Processing and a $1.5
million charge to other expenses for a settlement of a lawsuit with the Utah
Division of State Lands and Forestry.
In addition, year-to-date results reflect a $3.3 million decrease in the
reclamation and mine closure reserve at the Company's Illinois operation due to
a change in permit requirements.
Note H - CONTINGENCIES
The Company is a party to numerous claims and lawsuits with respect to various
matters. The Company provides for costs related to contingencies, including
environmental matters, when a loss is probable and the amount is reasonably
determinable. The Company estimates that its probable aggregate loss as a result
of such claims is $1.9 million (included in Other Noncurrent Liabilities) as of
June 30, 1997. The Company estimates that its reasonably possible aggregate
losses from all currently pending litigation could be as much as $1.0 million
(before taxes) in excess of the probable loss previously recognized. After
conferring with counsel, it is the opinion of management that the ultimate
resolution of these claims, to the extent not previously provided for, will not
have a material adverse effect on the consolidated financial position, results
of operations, or liquidity of the Company.
In May 1997, the Company made a payment of $3.3 million to the State of Utah in
final settlement of the matter of Trail Mountain Coal Company v. The Utah
Division of State Lands and Forestry (Trail Mountain lawsuit). The $3.3 million
payment was $1.5 million more than the $1.8 million the Company had reserved as
of March 31, 1997, as the probable loss associated with this lawsuit. The
Company recorded an expense of $1.5 million in the second quarter of 1997
related to the settlement.
On October 24, 1996, the rock strata overlaying an old, abandoned underground
mine adjacent to the coal-refuse impoundment used by the Company's Lone Mountain
mine failed, resulting in an accidental discharge of approximately 6.3 million
gallons of water and fine coal slurry into a tributary of the Powell River in
Lee County, Virginia. This discharge resulted in the death of approximately
11,500 fish, according to estimates of the Virginia Department of Game in Inland
Fisheries.
8
Following the discharge, personnel at Lone Mountain began working with agencies
of the Commonwealth of Virginia and the Untied States to identify the long-term
effects, if any, to fish, other organisms and the aquatic habitat of the Powell
River system. Small quantities of sediment were removed from stream beds,
although the majority of material has been resuspended and carried downstream.
Lone Mountain has committed to monitor and evaluate the stream conditions for
two years in order to accurately determine the effects of the discharge.
On January 29, 1997, the Director of the State Water Control Board and the
Department of Mines, Minerals and Energy of the Commonwealth of Virginia filed
suit in Lee County Virginia Circuit Court against Lone Mountain alleging
violations of effluent limitations and reporting violations under Lone
Mountain's NPDES permits. Lone Mountain and the Commonwealth of Virginia have
entered into a settlement agreement to resolve all matters arising out of the
discharge. Pursuant to the settlement agreement, Lone Mountain will pay the
Commonwealth approximately $1.4 million. In return two notices of violation and
a show cause order were vacated.
The proposed settlement agreement was published on June 9, 1997, and a public
comment period of 30 days commenced. The Virginia Coalfield Regional Tourism
Development Authority has sought to intervene in the lawsuit and has objected to
the settlement only with respect to the proposed expenditures of the settlement
fund. No other terms of the settlement have been challenged. In a hearing
conducted on August 13, 1997, the Circuit Court of Lee County ordered the
Tourism Authority to prepare any pleadings necessary to present the issues it
plans to present to the court for decision. The Commonwealth and Lone Mountain
must respond to those pleadings by September 12, 1997. Thereafter, the court
will either accept the legal challenge to the settlement agreement and schedule
further hearings, or will dismiss the challenge and enter the settlement as a
final order of the court. Upon entry by the court, the settlement will discharge
all civil claims alleging into the state's civil action of January 29, 1997.
At the request of the U.S. Environmental Protection Agency and the U.S. Fish &
Wildlife Service, the United States Attorney for the Western District of
Virginia has undertaken a criminal investigation of the incident. The
conclusions of this investigation are not expected until 1998. On March 19,
1997, Lone Mountain received a subpoena to produce documents and to testify
before a federal grand jury. The subpoena seeks the production of documents
related to the design and approval of the impoundment. All documents relevant to
the subpoena have been identified. The final delivery of documents is expected
in August, 1997. During the six months ended June 30, 1997, the Company recorded
expenses related to the Lone Mountain impoundment totaling $4.6 million,
including a provision for the $1.4 million settlement described above, and for
costs to reconstruct the impoundment.
9
Note I - EARNINGS PER SHARE
In February 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 128, Earnings per Share (SFAS 128). The
Company is required to adopt SFAS 128 on December 31, 1997, and at that time,
will present recomputed earnings per share (EPS) for all prior periods using the
methodology specified by SFAS 128. Although the Company has not yet determined
the full effect of SFAS 128, it believes that basic EPS as computed under SFAS
128 will not be significantly different from primary EPS as computed under the
prior accounting rules.
10
UNAUDITED PRO FORMA FINANCIAL INFORMATION
The following unaudited pro forma financial statements give effect to the
July 1, 1997 Merger of the Company and Ashland Coal (the Merger), the issuance
of shares of Company common stock to the stockholders of Ashland Coal and the
substitution of options to purchase Company common stock for Ashland Coal
options pursuant to the Arch Coal, Inc. 1997 Stock Incentive Plan (Incentive
Plan). The unaudited pro forma balance sheet is based on the respective balance
sheets of the Company and Ashland Coal and has been prepared to reflect the
Merger as of June 30, 1997. The unaudited pro forma statements of income are
based upon the respective statements of income of the Company and Ashland Coal
and combine the results of operations of the Company and Ashland Coal for the
six months ended June 30, 1997 and for the twelve months ended December 31,
1996, as if the Merger had been consummated on January 1, 1997, and January 1,
1996, respectively. The unaudited pro forma financial statements do not reflect
any cost savings or other synergies that may result from the Merger. In the
opinion of the management of the Company, all adjustments necessary to present
pro forma financial statements have been made.
The unaudited pro forma financial statements do not purport to be
indicative of the results of operations or financial position that would have
occurred had the Merger occurred as of the beginning of the period or as of the
date indicated or of the financial position or results of operations that may be
obtained in the future.
The Merger will be accounted for under the purchase method of accounting.
Accordingly, the cost to acquire Ashland Coal will be allocated to the assets
acquired and liabilities assumed according to their respective fair values. The
final allocation of such cost is dependent upon certain valuations that have not
progressed to a stage where there is sufficient information to make a final
allocation in the accompanying pro forma financial statements. Accordingly, the
cost allocation adjustments are preliminary and have been made solely for the
purpose of preparing such pro forma financial statements.
Adjustments to the preliminary allocation likely would result in changes
to amounts assigned to coal reserves, plant and equipment and coal supply
agreements and accordingly could impact depreciation, depletion and amortization
charged to future periods. Although not expected to be material, the likely
impact of the final allocation is not reasonably known.
11
Arch Coal, Inc.
UNAUDITED PRO FORMA COMBINED BALANCE SHEET
June 30, 1997
(In thousands)
Arch
Mineral Ashland Purchase
Corporation Coal Accounting Pro
Historical Historical Adjustments Forma
------------- ---------- ----------- ------
ASSETS
- ------
CURRENT ASSETS
Cash and cash equivalents $ 16,322 $ 4,236 $ -- $ 20,558
Trade accounts receivable 74,625 52,803 -- 127,428
Other receivables 3,849 2,334 -- 6,183
Inventories 41,794 45,931 -- 87,725
Prepaid royalties 3,337 16,534 -- 19,871
Deferred income taxes 14,500 1,325 -- 15,825
Prepaid expenses and other
assets 5,072 4,208 -- 9,280
----- ----- ------ -----
Total current assets 159,499 127,371 -- 286,870
------- ------- ------ -------
PROPERTY, PLANT AND EQUIPMENT,
NET 552,798 558,363 36,526 (1) 1,147,687
------- ------- ------ ---------
OTHER ASSETS
Prepaid royalties 3,723 69,144 (59,008)(1) 13,859
Coal supply agreements less
accumulated amortization 79,170 25,573 96,325 (1) 201,068
Deferred income taxes 78,520 -- (41,237)(2) 37,283
Receivables and other assets 9,994 13,498 (10,046)(1) 13,446
----- ------ ------- ------
171,407 108,215 (13,966) 265,656
------- ------- ------- -------
Total assets $ 883,704 $ 793,949 $ 22,560 $ 1,700,213
=========== =========== =========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
CURRENT LIABILITIES
Accounts payable $ 56,383 $ 37,589 $ -- $ 93,972
Accrued expenses 74,732 27,513 4,500 (3) 106,745
Current portion of
long-term debt -- 25,762 -- 25,762
----- ------ ----- ------
Total current
liabilities 131,115 90,864 4,500 226,479
LONG-TERM DEBT 182,191 128,610 20,100 (4) 330,901
ACCRUED POSTRETIREMENT
BENEFITS OTHER THAN PENSIONS 231,323 84,434 (28,567)(5) 287,190
ACCRUED RECLAMATION AND MINE
CLOSURE 100,490 12,462 -- 112,952
ACCRUED WORKERS' COMPENSATION 65,299 23,263 -- 88,562
DEFERRED INCOME TAXES -- 12,690 (12,690)(2) --
OTHER NONCURRENT LIABILITIES 25,019 19,022 (933)(6) 43,108
------ ------ ------- ------
STOCKHOLDERS' EQUITY 735,437 371,345 (17,590) 1,089,192
------- ------- ------- ---------
Convertible preferred stock -- 67,841 (67,841)(7) --
Common stock 209 138 49 (8) 396
Paid-in capital 8,392 110,042 352,525 (9) 470,959
Retained earnings 139,666 250,074 (250,074)(10) 139,666
Less: treasury common
stock at cost -- (5,491) 5,491 (11) --
------ ------ ----- ------
Total stockholders
equity 148,267 422,604 40,150 611,021
------- ------- ------ -------
Total liabilities and
stockholders' equity $ 883,704 $ 793,949 $ 22,560 $ 1,700,213
=========== ========== ========== ===========
See the accompanying notes.
12
NOTES TO UNAUDITED PRO FORMA COMBINED BALANCE SHEET
JUNE 30, 1997
(in thousands, except per share data)
The purchase price of Ashland Coal and allocation of purchase price are as
follows:
Ashland Coal common stock outstanding at June 30, 1997
(including Ashland Coal preferred stock, as if
converted in the Merger) 18,643
Purchase price per share $ 24.50(12)
--------
Purchase price of Ashland Coal $456,754
Fair value of options 6,000
Transaction related fees 4,500
--------
Total purchase price $467,254
========
Historical net book value of Ashland Coal at June 30, 1997 $422,604
Adjustments for valuing Ashland Coal assets and liabilities:
Prepaid royalties (59,008)
Deferred income taxes (28,547)
Other assets (10,046)
Coal supply agreements 96,325
Property, plant and equipment 36,526
Long-term debt (current and noncurrent) (20,100)
Accrued postretirement benefits other than pensions 28,567
Other long-term liabilities 933
--------
Total purchase price $467,254
========
1) To adjust prepaid royalties, property, plant and equipment, coal supply
agreements and other long-term assets, including interest rate swap
agreements to their estimated fair value. A substantial portion of the
excess purchase price has been allocated to coal reserves principally
because of higher productivities and technological advances that occurred
since the acquisition of the coal reserves combined with the expectation of
increased values of compliance and low-sulfur coal due to the Clean Air Act
Amendments. The value assigned to coal supply agreements is associated with
contracts signed in earlier years when spot market prices were higher versus
the current spot market prices.
2) To record deferred income taxes for the book and tax differences of the
purchase accounting adjustments, and to reflect the reclassification of
deferred income tax liability to deferred income tax asset.
3) To record transaction related fees.
4) To adjust long-term debt to estimated fair value based on current interest
rates.
5) To adjust the liability for postretirement benefits other than pensions to
equal the accumulated projected benefit obligation.
6) To eliminate the deferred gain on sale and leaseback of assets ($2,119) and
to increase the pension liability ($1,186) to equal the projected benefit
obligation in excess of plan assets.
7) To reflect the conversion of preferred stock to common stock.
8) To reflect the elimination of $138 of Ashland Coal common tock and the
addition of common stock issued by the Company (18,643 shares at $.01 per
share).
13
9) To reflect the elimination of $110,042 of Ashland Coal paid-in capital and
the addition of paid-in capital resulting from the common stock and options
issued by the Company totaling $462,567.
10) To eliminate retained earnings.
11) To eliminate treasury stock.
12) Represents the average market price of Ashland Coal common stock for several
days before and after March 25, 1997, the date the parties agreed to the
purchase price.
14
ARCH COAL, INC.
UNAUDITED PRO FORMA COMBINED STATEMENTS OF INCOME
SIX MONTHS ENDED JUNE 30, 1997
(In thousands, except per share data)
Arch
Mineral Ashland Purchase
Corporation Coal Accounting Pro Forma
Historical Historical Adjustments Combined
------------ ----------- ----------- -----------
REVENUES
Coal sales
Other revenues $ 383,286 $ 315,801 $ -- $ 699,087
10,290 7,038 -- 17,328
------ ----- ----- ------
393,576 322,839 $ -- 716,415
COSTS AND EXPENSES
Cost of coal sales 340,925 268,851 1,174 (1) 610,950
Selling, general and
administrative expenses 8,197 12,423 -- 20,620
Amortization of coal supply
agreements 4,200 2,139 6,966 (2) 13,305
Other expenses 7,645 5,831 -- 13,476
----- ----- ----- ------
360,967 289,244 8,140 658,351
------- ------- ----- -------
Income from operations 32,609 33,595 (8,140) 58,064
Interest Expense, Net:
Interest expense (6,792) (8,168) 2,478 (3) (12,482)
Interest income 535 166 -- 701
--- --- ----- ---
(6,257) (8,002) 2,478 (11,781)
------ ------ ----- -------
Income before income taxes 26,352 25,593 (5,662) 46,283
Provision (Benefit) for income taxes 4,200 3,415 (2,208) (4) 5,407 (5)
----- ----- ------ -----
Net Income 22,152 22,178 (3,454) 40,876
Dividends on preferred stock -- (1,400) 1,400 (6) --
---- ------ ----- ----
Income applicable to common stock $ 22,152 $ 20,778 $ (2,054) $ 40,876
========= ========= ========= =========
Earnings per common share
Primary $ 1.06 $ 1.20 $ 1.03
======= ========= =========
Fully diluted $ 1.06 $ 1.17 $ 1.03
======= ========= =========
Average common shares outstanding $20,948 $ 18,105 (7) $ 39,660 (8)
======= ========= =========
See the accompanying notes.
15
ARCH COAL, INC.
UNAUDITED PRO FORMA COMBINED STATEMENTS OF INCOME
TWEVE MONTHS ENDED DECEMBER 31, 1996
(In thousands, except per share data)
Arch
Mineral Ashland Purchase
Corporation Coal Accounting Pro Forma
Historical Historical Adjustments Combined
------------ ----------- ------------- -----------
REVENUES
Coal sales $ 750,123 $ 565,174 $ -- $1,315,297
Other revenues 25,682 12,030 -- 37,712
-------- -------- ----- ----------
775,805 577,204 -- 1,353,009
COSTS AND EXPENSES
Cost of coal sales 667,878 508,960 2,346 (1) 1,179,184
Selling, general and
administrative expenses 20,435 23,078 -- 43,513
Amortization of coal supply
agreements 12,604 3,786 13,933 (2) 30,323
Other expenses 18,776 9,559 -- 28,335
-------- ------- ------- ---------
719,693 545,383 16,279 1,281,355
-------- ------- ------- ---------
Income from operations 56,112 31,821 (16,279) 71,654
Interest Expense, Net:
Interest expense (18,783) (17,905) 4,957 (3) (31,731)
Interest income 1,191 417 -- 1,608
------- -------- ------ --------
(17,592) (17,488) 4,957 (30,123)
------- -------- ------ --------
Income before income taxes 38,520 14,333 (11,322) 41,531
Provision (Benefit) for income taxes 5,500 (2,180) (4,415) (4) (1,095) (5)
----- ------ ------ ------
Net Income 33,020 16,513 (6,907) 42,626
Dividends on preferred stock -- (2,810) 2,810 (6) --
------ ------ ----- ----
Income applicable to common stock $ 33,020 $ 13,703 $ (4,097) $ 42,626
========= ======== ======== ==========
Earnings per common share
Primary $ 1.58 $ 0.87 $ 1.07
========= ======== ==========
Fully diluted $ 1.58 $ 0.86 $ 1.07
========= ======== ==========
Average common shares outstanding 20,948 18,105 (7) 39,660 (8)
====== ====== ========
See the accompanying notes.
16
NOTES TO UNAUDITED PRO FORMA COMBINED STATEMENTS OF INCOME
1) To record net charges associated with adjusting the fair value of prepaid
royalties, property, plant and equipment, and other assets. Additions to
property, plant and equipment, including coal reserves, is assumed to be
depreciated or depleted over 15 years.
2) To record net charges associated with adjusting the fair value of coal
supply agreements with an average life of approximately seven years.
3) To record the reduction in interest expense on $152.9 million of fixed
long-term debt to reflect current market interest rates (6.75% current rate
versus average 9.75% stated rate) and a reduction in amortization of
deferred debt issuance cost.
4) To record the tax effect of 39% of the pro forma adjustments. The tax rate
of 39% represents the combined federal and state statutory rates.
5) The effective tax rate is substantially less than 39% primarily due to
benefits derived from percentage depletion.
6) To eliminate dividends related to the Ashland Coal preferred stock.
7) Assumes conversion of preferred stock at a rate of 18,346 per share.
8) Shares outstanding include 20,948 of Company shares outstanding as adjusted
for the stock split, 18,643 shares issued to acquire Ashland Coal assuming
conversion of preferred stock at a rate of 20,500 per share and 69 shares
related to stock options that are dilutive.
17
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Reference is made to the "Contingencies," "Certain Risk Factors" and "Factors
Routinely Affecting Results of Operations" sections below in this Management's
Discussion and Analysis for discussion of important factors that could cause
actual results to differ from the projections, expectations, and other
non-historical information contained herein.
Merger with Ashland Coal
On July 1, 1997, the Company acquired Ashland Coal in the Merger. The Merger was
accounted for as a purchase, and resulted in Ashland Coal becoming a
wholly-owned subsidiary of the Company. Pursuant to the Merger, holders of
Ashland Coal common stock received one share of Company common stock for each
share of Ashland Coal common stock held by them, and each holder of outstanding
Ashland Coal Class B and C preferred stock received 20,500 shares of Company
common stock for each share of preferred stock held by them. A total of
18,660,052 shares of Company common stock was issued in the Merger.
At the time of the Merger, Ashland Coal was engaged in the mining, processing
and marketing of low-sulfur bituminous coal primarily in the eastern United
States. Its independent operating subsidiaries included Coal-Mac, Inc., Hobet
Mining, Inc. (Hobet), Mingo Logan Coal Company (Mingo Logan) and Tri-State
Terminals, Inc. Ashland Coal produced 20.5 million tons of coal in 1996 and at
December 31, 1996, controlled approximately 615 million tons of proven and
probable low-sulfur coal reserves in southern West Virginia and eastern
Kentucky.
Prior to the Merger, Ashland Inc. owned 50% of the voting stock of the Company
and stock representing approximately 57% of the voting power of Ashland Coal.
Ashland Inc. currently owns approximately 54% of the Company's outstanding
common stock. In addition, various trusts for the benefit of descendants of H.
L. and Lyda Hunt and various corporations owned by trusts for the benefit of
descendants of H. L. and Lyda Hunt own approximately 25% of the Company's
outstanding stock, Carboex International, Ltd. owns approximately 5% of the
Company's outstanding stock, and the balance of the Company's common stock is
owned by the public.
Results of Operations
Quarter Ended June 30, 1997, Compared
to Quarter Ended June 30, 1996
Net income for the quarter ended June 30, 1997 was $11.7 million, compared to
net income of $5.2 million for the quarter ended June 30, 1996. Results for the
quarter ended June 30, 1997 included three unusual adjustments resulting in a
favorable impact to earnings of $1.2 million ($.7 million after tax). The
adjustments included a $4.2 million favorable adjustment to workers'
compensation reserves due to better than anticipated safety performance offset,
in part, by non-recurring charges of $1.5 million associated with the
impoundment discharge at Lone Mountain which occurred in the fourth quarter of
1996, and $1.5 million for the settlement of the Trail Mountain lawsuit.
18
Gross profit on coal sales (selling price less cost of sales) on a per ton basis
increased $.37 per ton from the second quarter of 1996. The increase was
primarily due to lower cost at the Company's Lone Mountain operation which
experienced adverse geologic conditions in the comparable period in 1996,
including mining through a sandstone channel.
Selling, general, and administrative expenses decreased $1.4 million due
principally to a $.7 million adjustment related to reducing the workers'
compensation reserve and a $.5 million reduction in employee benefit costs.
Other revenue increased $.4 million from the quarter ended June 30, 1996 due to
increased royalty income. This increase was offset, in part, by reduced
transloading income from dock operations.
Amortization of coal supply agreements decreased $.9 million from the comparable
period in 1996, due principally to certain sales contract being fully amortized
at the end of 1996.
The increase in other expenses was associated with a charge of $1.5 million in a
final settlement of the Trail Mountain lawsuit.
Interest expense decreased $1.5 million due to lower debt levels, generally and
the paydown of higher-cost fixed debt.
The Company's income tax rate for the quarter was lower than the comparable
period in 1996 because the company had lowered its 1997 estimated annual
effective tax rate from 20 percent in the quarter ended March 31, 1997 to the
current estimate of 16 percent. The estimated annual effective tax rate was
lowered because of new estimates for 1997 profitability and percentage
depletion. The effective tax rate is sensitive to changes in profitability
because of the effects of percentage depletion.
EBITDA (income from operations before the effects of changes in accounting
principles and extraordinary items, net interest expense, income taxes,
depreciation, depletion and amortization) was $45.9 million for the quarter
ended June 30, 1997 compared to $36.4 million for the same quarter to a year
ago. EBITDA is a widely accepted financial indicator of a company's ability to
incur and service debt. EBITDA should not be considered in isolation or as an
alternative to net income, operating income, cash flows from operations or as a
measure of a company's profitability, liquidity or performance under generally
accepted accounting principles. This measure of EBITDA may not be comparable to
similar measures reported by other companies.
19
Six Months Ended June 30, 1997 Compared
to Six Months Ended June 30, 1996
Net income was $22.2 million for the six months ended June 30, 1997 compared to
net income of $12.8 million for the six months ended June 30, 1996. The six
month period included several adjustments that netted to a favorable pre-tax
impact to earnings of $1.4 million after-tax. These adjustments included a $4.2
million decrease to the workers' compensation reserve due to better than
anticipated safety performance, a $3.3 million decrease in the accrual for
reclamation and mine closure at its Illinois operations due to a change in
permit requirements, largely offset by non-recurring charges of $4.6 million
associated with the impoundment discharge at Lone Mountain and $1.5 million for
the settlement of the Trail Mountain lawsuit.
Gross profit on coal sales (selling price less cost of sales) on a per ton basis
increased $.09 per ton due primarily to lower costs at the Company's Lone
Mountain operation which experienced adverse geologic conditions in the
comparable period of 1996, and higher production from the Arch of Illinois
operations, offset in part by higher ratios and higher operating costs at
Cumberland River Coal Company's Pardee operation and Catenary Coal Company's
Samples operation.
Other revenues increased $.9 million primarily the same factors that applied to
the increase of other revenues in the second quarter.
Selling, general and administrative expenses decreased $1.1 million due
principally to an adjustment to the workers' compensation reserve and a
reduction in employee benefit costs and lower legal and professional charges.
Amortization of coal supply agreements decreased $1.6 million due primarily to a
sales contract being fully amortized at the end of 1996 and the rescheduling of
certain other shipments.
Interest expense declined $3.0 million due to lower debt levels generally and
the payment of higher-cost fixed debt.
The Company's income tax expense approximates 1996 levels despite higher pre-tax
income. The lower estimated effective tax rate for 1997 is due to a higher
estimate of percentage depletion relative to pre-tax income.
EBITDA for the six months ended June 30, 1997 was $90.4 million as compared to
$76.0 million for the six months ended June 30, 1996.
20
Balance Sheets
Inventories were $6.6 million higher at June 30, 1997, than at December 31,
1996. This increase is primarily related to an increase in coal inventory levels
resulting from unseasonably cool spring and early summer weather and in
anticipation of the scheduled two week miners' vacation in July.
Accounts payable at June 30, 1997 were $13.7 million higher than at December 31,
1996 because of increased production levels and normal seasonal fluctuations and
$12.5 million in payables related to the Kayford James reserve acquisition.
Long-term debt decreased $30.5 million from the December 31, 1996 level due to
scheduled payments of the senior notes and a $15 million reduction in the 1994
Revolving Credit Agreement.
The balance of accrued workers compensation has declined $5.6 million since
December 31, 1996 primarily due to a favorable adjustment of $4.2 million due to
a better than anticipated safety performance.
Outlook
The Merger was effective July 1, 1997, and, as a consequence, the Company
anticipates recording a one-time charge in the third quarter related to the
Merger, which charge will include severance costs and the write down of
duplicate facilities. Although the Company anticipates significant synergies
will begin to accrue as a result of the Merger in the second half of 1997 and in
1998, several events are anticipated that will materially and adversely affect
the Company's results in the second half of 1997 and in the first half of 1998
when such results are compared to the pro forma combined results of the Company
and Ashland Coal in the first half of 1997.
The most significant event is the expiration of the Company's long-term coal
supply contract with Georgia Power in December 1997. The Company is currently
supplying 1.9 million tons of low-sulfur coal per year under this contract from
its Lone Mountain and Cumberland River operations and from third parties. The
prices for coal shipped under this contract are significantly above the current
open market price of such coal. For the six months ended June 30, 1997, 5.5% of
the Company's pro forma combined revenues and 13% of its pro forma combined
operating income (prior to purchase accounting adjustments) related to sales
under this contract, and the impact of its expiration may be disproportionate to
the percentage of total production represented by the tonnage delivered under
the contract. After expiration of the current Georgia Power contract, the
Company expects to continue to supply a significant amount of similar quality
coal to Georgia Power at less favorable prices.
Another significant event is the anticipated depletion of the longwall reserve
base at Apogee Coal Company's Arch of Kentucky Mine No. 37 in the third quarter
of 1997. Production from Mine No. 37 accounted for $10.1 million or
approximately 15.2% of the Company's pro forma combined operating income (prior
to purchase accounting adjustments) in the first six months of 1997. After
21
exhaustion of the longwall reserves, the decrease in operating profit will be
mitigated to some degree by the continued operation of two continuous miner
sections and may be further offset by the development of an underground mine in
the Darby seam that is in close proximity to the Cave Branch Preparation Plant
(currently used to process Mine No. 37 coal). Upon the exhaustion of the
longwall reserves, the Company does not expect any impairment of assets used to
mine those reserves as the estimated useful life of the related assets expires
at the time the reserves are depleted.
Other adverse developments anticipated in the second half of 1997 include
increased costs at the Hobet 21 mine as a result of maintenance on the dragline
at that operation. This maintenance, originally scheduled in the third quarter
of 1998, is expected to take the dragline out of operation for approximately 45
days. In addition, the dragline at Hobet's Dal-Tex mining complex is moving into
an area of relatively higher overburden ratios than experienced in the first
half of 1997, which move will result in reduced production and may result in
higher cost per ton.
In the second half of 1997, $5.4 million of the original $50 million
unrecognized net gain realized in 1993 upon changes in discount rates, black
lung benefit cost rates, rebates and other assumptions used in the calculation
of pneumoconiosis (black lung) liabilities will be credited against cost of
goods sold. This gain will be fully amortized by the end of 1997.
Results in the second half of 1997 should be favorably affected by increased
income from the Company's Ark Land subsidiary's ongoing third-party leasing
efforts and sales of surplus property, and by reduced interest expense as a
result of lower debt levels in general and the refinancing of long-term debt at
more favorable rates.
Other operational factors are expected to improve results in the longer term.
The poor roof conditions experienced at Lone Mountain's Huff Creek mine in 1996
and the first half of 1997 caused by over mining in the Darby Fork Mine are
improving. Beginning in the second quarter of 1997, the Company made certain
revisions to its mining plan to align mine works in the Huff Creek mine to
accommodate in-seam stresses and to better coordinate the mine plan with the
Darby Fork mine plan. As a result of these changes, the Company expects the roof
conditions at the Huff Creek mine to improve substantially beginning in the
third quarter of 1997. Nevertheless, if the adverse geologic conditions continue
longer than expected, or worsen, production from the mine could be reduced or
curtailed, production and yield could continue to be adversely affected, and
costs could continue to be high or increase to the point that continued
operation of the mine is uneconomic.
Similarly, the geologic conditions at Lone Mountain's Darby Fork Mine (in the
form of sandstone intrusions in the coal seam which resulted in lower
productivity, lower yields and lower productivity levels during 1996 and in the
first half of 1997) are also improving. The Company believes that its
exploration efforts have accurately identified and located the sandstone
intrusions, and that the adverse geologic conditions will abate in the fourth
quarter of 1997, at which time productivity, yield, and production levels should
improve dramatically. Nevertheless, like Huff Creek, should these adverse
geologic conditions continue longer than expected, or worsen, production from
the mine could be reduced or curtailed, productivity and yield could continue to
be adversely affected, and cost could continue to be high or increase to the
point that continued operation of the mine is uneconomic.
In April 1997, theCompany completed an acquisition of certain surface mineable
reserves adjacent to its Samples mine. The acquisition included 9.6 million tons
of lower-ratio and higher-quality
22
surface mineable coal than coal currently being mined at the Samples mine. As a
result, operating costs at the Samples mine are expected to decrease in 1998
compared to the first half of 1997.
Further, in the first half of 1997, production from the Archveyor mining system
at Arch of Wyoming was adversely affected by a fire and the consequent delay in
deployment of a new, more technologically advanced continuous miner purchased by
the Company. In 1998, the Company believes Archveyor production will
significantly increase compared to 1997, and that as a consequence operating
income will also increase.
A second unit of underground mining equipment was deployed at Pardee's Band Mill
mine at the end of March 1997. Production levels and costs are expected to
improve in 1998 when compared to expected 1997 levels due to a full year's
production and increased productivity from deployment of the second equipment
section.
Mining costs at Arch of West Virginia's Wylo mine also are expected to
significantly improve in 1998 compared to those expected in 1997, and overburden
ratios and mining costs at Arch of West Virginia's Ruffner mine are expected to
improve in 1999 when compared to 1997 and 1998 costs.
Finally, changes in transportation rates could also significantly influence the
Company's 1998 and 1999 results. CSX Corporation (CSX) and Norfolk Southern
Corporation (NS) are major railroads in the eastern United States which together
transport most of the coal sold by the Company. CSX and NS agreed to acquire
Conrail Inc. (Conrail), another major railroad, whose primary service area is
the Northeastern United States, and have divided Conrail's assets between them.
Costs of the reconstituted CSX and NS may be somewhat lower than the costs of
those railroads prior to the acquisition. If lower costs are realized and
freight rates are lowered as a consequence, the coal of some producers could
become less costly on a delivered basis and therefore gain competitive advantage
in some markets. It is not possible to predict with certainty the effects of the
division of Conrail on interregional competition and, specifically, the effects
on the Company.
In 1995, the Financial Accounting Standards Board issued Statement of Financial
Accounting Standards (SFAS) No. 123, "Accounting for Stock-Based Compensation."
SFAS No. 123 encourages, but does not require, companies to recognize
compensation expense related to the grants of stock or stock options to
employees under plans such as the Company's Stock Incentive Plan. Companies
choosing not to adopt SFAS No. 123 will continue to account for such grants
using the accounting prescribed by Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees" (APB25), but will be required to make
certain disclosures about their plans in their year-end financial statements,
including pro forma net income and earnings per share under the new method. The
Company has elected to continue to follow APB25 for expense recognition and to
make the disclosures required by SFAS No. 123. Accordingly, SFAS No. 123 will
have no effect on the Company's earnings or financial position.
23
Liquidity and Capital Resources
The following is a summary of cash provided by or used in each of the indicated
types of activities during the six months ended June 30, 1997 and 1996:
1997 1996
----------- ----------
(In thousands)
Cash provided by (used in):
Operating activities $72,313 $63,804
Investing activities (34,692) (40,846)
Financing activities (35,015) (30,184)
Cash provided by operating activities increased in the first six months of 1997
from the level in the same period of 1996 due primarily to recording an option
payable for an acquisition of surface mineable reserves adjacent to the Samples
Mine, more than offset by increases in coal inventories and tax payments related
to prior year audits.
The decrease in cash used for investing activities in the first six months of
1997 when compared to the same period in 1996 primarily reflects reduced capital
expenditures at the Lone Mountain operations ($3.9 million) relating primarily
to the conveyor development in 1996; and at the Pardee operation ($2.9 million)
relating to Band Mill mine development in 1996 and the design and fabrication of
the Conant Archveyor. Acquisition expenditures for 1996 included the $14.2
million Carbon Basin reserve, while the expenditures for 1997 included the
Kayford James reserve acquisition for $17.0 million.
Cash used in financing activities reflects comparable net reductions in debt
levels and an increase in dividend payments of $4.5 million.
The Company has historically satisfied its working capital requirements, its
capital expenditures (excluding major acquisitions) and scheduled debt
repayments from its operating cash flow. Cash requirements for the acquisition
of new business operations have generally been funded through a combination of
cash generated from operating activities, utilization of the Company's revolving
credit facility and the issuance of long-term obligations. The Company believes
that cash generated from operations will continue to be sufficient to meet its
working capital requirements, planned or anticipated capital expenditures
(excluding major acquisitions) and scheduled debt repayments. The Company had an
unsecured revolving credit agreement with a group of banks which provided for
borrowings of up to $200 million. In conjunction with the Merger, the Company
entered into a new $500 million revolving credit agreement and terminated the
$200 million facility. The new revolving credit agreement has a five year term.
On August 1, 1997, the Company redeemed previously issued senior notes by
Ashland Coal with a principal balance of $152.9 million for $170.7 million
including accrued interest. The redemption amount included a make-whole
provision based upon current market rates with similar maturities. The note
redemptions were financed with proceeds from the Company's new $500 million
revolving credit facility.
24
Contingencies
Reclamation
The Federal Surface Mining Control and Reclamation Act of 1977 and similar state
statutes require that mine property be restored in accordance with specified
standards and an approved reclamation plan. The Company accrues for the costs of
final mine closure reclamation over the estimated useful mining life of the
property. These costs relate to reclaiming the pit and support acreage at
surface mines and sealing portals at deep mines. Other costs common to both
types of mining are related to reclaiming refuse and slurry ponds. The Company
accrues for current mine disturbance which will be reclaimed prior to final mine
closure.
The establishment of the final mine closure reclamation liability and the
current disturbance is based upon permit requirements and requires various
estimates and assumptions, principally associated with costs and productivities.
The Company accrued $3.5 million and $6.1 million for the six months ended June
30, 1997 and for the twelve months ended December 31, 1996, respectively for
current and final mine closure reclamation. Cash payments for final mine closure
reclamation and current disturbances approximated $3.2 million and $9.8 million
for the six months ended June 30, 1997 and for the twelve months ended December
31, 1996, respectively.
The Company reviews its entire environmental liability annually and makes
necessary adjustments, including permit changes and revisions to costs and
productivity's to reflect current experience. These recosting adjustments are
recorded to cost of coal sales. Favorable adjustments total $3.3 million and
$4.5 million for the six months ended June 30, 1997 and for the twelve months
ended December 31, 1996, respectively. The Company's management believes it is
making adequate provisions for all expected reclamation and other costs
associated with mine closures.
Mine closing costs for operations as of June 30, 1997, in the aggregate, are
estimated to be approximately $98 million. At June 30, 1997 and December 31,
1996, the accrual for closing costs, which is included in accrued reclamation
and mine closure was $93.0 million and $90.3 million, respectively.
Legal Contingencies
The Company is a party to numerous claims and lawsuits with respect to various
matters. The Company provides for costs related to contingencies, including
environmental matters, when a loss is probable and the amount is reasonably
determinable. The Company estimates that its probable aggregate loss as a result
of such claims is $1.9 million (included in Other Noncurrent Liabilities) as of
June 30, 1997. The Company estimates that its reasonably possible aggregate
losses from all currently pending litigation could be as much as $1.0 million
(before taxes) in excess of the probable loss previously recognized. After
conferring with counsel, it is the opinion of management that the ultimate
resolution of these claims, to the extent not previously provided for, will not
have a material adverse effect on the consolidated financial position, results
of operations, or liquidity of the Company.
In May 1997, the Company made a payment of $3.3 million to the State of Utah in
final settlement of the Trail Mountain lawsuit. The $3.3 million payment was
$1.5 million more than the $1.8 million the Company had reserved as of March 31,
1997, as the probable loss associated with this lawsuit. The Company recorded an
expense of $1.5 million in the second quarter of 1997 related to the settlement.
25
On October 24, 1996, the rock strata overlaying an old, abandoned underground
mine adjacent to the coal-refuse impoundment used by the Company's Lone Mountain
mine failed, resulting in an accidental discharge of approximately 6.3 million
gallons of water and fine coal slurry into a tributary of the Powell River in
Lee County, Virginia. This discharge resulted in the death of approximately
11,500 fish, according to estimates of the Virginia Department of Game in Inland
Fisheries. Following the discharge, personnel at Lone Mountain began working
with agencies of the Commonwealth of Virginia and the United States to identify
the long-term effects, if any, to fish, other organisms and the aquatic habitat
of the Powell River system. Small quantities of sediment were removed from
stream beds, although the majority of material has been resuspended and carried
downstream. Lone Mountain has committed to monitor and evaluate the stream
conditions for two years in order to accurately determine the effects of the
discharge.
On January 29, 1997, the Director of the State Water Control Board and the
Department of Mines, Minerals and Energy of the Commonwealth of Virginia filed
suit in Lee County Virginia Circuit Court against Lone Mountain alleging
violations of effluent limitations and reporting violations under Lone
Mountain's NPDES permits. Lone Mountain and the Commonwealth of Virginia have
entered into a settlement agreement to resolve all matters arising out of the
discharge. Pursuant to the settlement agreement, Lone Mountain will pay the
Commonwealth approximately $1.4 million. In return two notices of violation and
a show cause order were vacated.
The proposed settlement agreement was published on June 9, 1997, and a public
comment period of 30 days commenced. The Virginia Coalfield Regional Tourism
Development Authority has sought to intervene in the lawsuit, and has objected
to the settlement only with respect to the proposed expenditures of the
settlement fund. No other terms of the settlement have been challenged. In a
hearing conducted on August 13, 1997, the Circuit Court of Lee County ordered
the Tourism Authority to prepare any pleadings necessary to present the issues
it plans to present to the court for decision. The Commonwealth and Lone
Mountain must respond to those pleadings by September 12, 1997. Thereafter, the
court will either accept the legal challenge to the settlement agreement and
schedule further hearings, or will dismiss the challenge and enter the
settlement as a final order of the court. Upon entry by the court, the
settlement will discharge all civil claims alleging into the state's civil
action of January 29, 1997.
At the request of the U.S. Environmental Protection Agency and the U.S. Fish &
Wildlife Service, the United States Attorney for the Western District of
Virginia has undertaken a criminal investigation of the incident. The
conclusions of this investigation are not expected until 1998. On March 19,
1997, Lone Mountain received a subpoena to produce documents and to testify
before a federal grand jury. The subpoena seeks the production of documents
related to the design and approval of the impoundment. All documents relevant to
the subpoena have been identified. The final delivery of documents is expected
in August, 1997. During the six months ended June 30, 1997, the Company recorded
expenses related to the Lone Mountain impoundment totaling $4.6 million,
including a provision for the $1.4 million settlement described above, and for
costs to reconstruct the impoundment.
The Company's federal income tax returns for the years 1992 through 1994 are
currently under review by the Internal Revenue Service (IRS). The IRS has
completed its examinations of the Company's federal income tax returns for the
years ended 1987, 1988 and 1989 and the proposed adjustments which relate
principally to business acquisitions, asset dispositions, corporate
reorganizations, percentage depletion and investment tax credits during those
years. As a result, the IRS has proposed additional taxes aggregating $50
million plus interest to the date of payment.
26
After an analysis of the proposed adjustments by management with tax counsel,
the Company paid $8.0 million in 1994 to the IRS and filed a protest with the
IRS contesting certain adjustments. Management believes that the Company has
adequately provided for any income taxes and related interest which may
ultimately be paid on contested issues. On April 30, 1997, the Company made an
additional $8 million deposit to the IRS which was charged against a previously
established reserve.
Certain Risk Factors
Credit risk - The Company markets its coal principally to electric utilities in
the United States. As a group, electric utilities generally are stable, well
capitalized entities with favorable credit ratings. Credit is extended based on
an evaluation of each customer's financial condition, and collateral is not
generally required. Credit losses have consistently been minimal.
Price risk - Selling prices for the Company's products are determined by
long-term contracts and the spot market. Selling prices in many of the Company's
long-term contracts are subject to adjustment, including changes in market
conditions. Falling market prices raise the price risk under these contracts.
Spot prices fluctuate primarily because of changes in demand for and supply of
coal. Demand for coal in the short term is primarily driven by changes in demand
for electricity in the areas serviced by the utilities purchasing the Company's
coal. Demand for electricity in turn depends on the level of economic activity
and other factors such as prolonged temperature extremes. The supply of coal in
the spot market has historically been most affected by excess productive
capacity in the industry and short-term disruptions, frequently labor-related.
The coal industry is highly competitive, and Arch Coal competes with a large
number of other coal producers. Factors such as the availability of sulfur
dioxide emissions allowances issued by the EPA, utility deregulation, and new
clean air regulations have had, or will have, the effect of further intensifying
competition between producers in the eastern United States, and producers in
other regions, including other countries. Producers in some of those regions,
because of geological conditions, local labor costs, or access to inexpensive
transportation modes, are able to produce and deliver coal into some markets at
a lower cost than the Company. These competitive factors have an impact on the
Company's pricing.
Arch Coal's operating subsidiaries purchase substantial amounts of power, fuel,
and supplies, generally under purchase orders at current market prices or
purchase agreements of relatively short duration.
The employees of Apogee's and Hobet's operations are covered by the National
Bituminous Coal Wage Agreement of 1993 (Wage Agreement), which provides for
certain wage rates and benefits. Employees of other operating subsidiaries are
not covered by a union contract but are compensated at rates representative of
prevailing wage rates in the local area. Among factors influencing such wage
rates is the Wage Agreement.
Although the Company cannot predict changes in its costs of production and coal
prices with certainty, Arch Coal believes that in the current economic
environment of low to moderate inflation,
27
the price adjustment provisions in its long-term contracts will largely offset
changes in the costs of providing coal under those contracts, except for those
costs related to changes in productivity. Further, because levels of general
price inflation are closely linked to levels of economic activity, it is
expected that changes in costs of producing coal for the spot market may be
offset in part by changes in spot coal prices. The Company attempts to limit
exposure to depressed spot market prices which result from industry over
capacity by entering into long-term coal supply agreements, which ordinarily
provide for prices in excess of spot market prices. In the event of a disruption
of supply, the Company might, depending on the level of its sales commitments,
benefit from higher spot prices if its own mines were not affected by the
disruption.
Interest rate risk - Arch Coal has significant debt which is linked to
short-term interest rates. If interest rates rise, Arch Coal's costs relative to
those obligations would also rise. Because an increase in interest rates is
usually an outgrowth of a higher level of economic activity and because
increased economic activity would likely lead to a higher demand for electricity
and consequently to higher spot prices for coal, Arch Coal believes that the
negative effects of higher interest rates on Arch Coal's earnings could be
partially offset, depending on the level of its sales commitments at the time,
by higher spot prices.
Factors Routinely Affecting Results of Operations
The Company sells a substantial portion of its coal production pursuant to
long-term coal supply agreements, and as a consequence may experience
fluctuations in operating results in the future, both on an annual and quarterly
basis, as a result of expiration or termination of, or sales price
redeterminations or suspensions of deliveries under, such coal supply
agreements. In addition, price adjustment provisions permit a periodic increase
or decrease in the contract price to reflect increases and decreases in
production costs, changes in specified price indices or items such as taxes or
royalties. Price reopener provisions provide for an upward or downward
adjustment in the contract price based on market factors, and from time to time
the Company has renegotiated contracts after execution to extend contract term
or to accommodate changing market conditions. The contracts also typically
include stringent minimum and maximum coal quality specifications and penalty or
termination provisions for failure to meet such specifications, force majeure
provisions allowing suspension of performance or termination by the parties
during the duration of certain events beyond the control of the affected party,
and some long-term contracts contain provisions that permit the utility to
terminate the contract if changes in the law make it illegal or uneconomic for
the utility to consume the Company's coal. Imposition of new nitrous oxide
emissions limits in
28
connection with Phase II of the Clean Air Act in 2000 could result in affected
utilities seeking to terminate or modify long-term contracts citing such
termination provisions. If the parties to any long-term contracts with the
Company were to modify, suspend or terminate those contracts, the Company could
be adversely affected to the extent that it is unable to find alternative
customers at the same or better level of profitability.
From time to time, disputes with customers may arise under long-term contracts
relating to, among other things, coal quality, pricing and quantity. The Company
may thus become involved in arbitration and legal proceedings regarding its
long-term contracts. There can be no assurance that the Company will be able to
resolve such disputes in a satisfactory manner.
The Company's customers frequently combine various qualities of coal, nuclear,
natural gas and other energy sources in their generating operations, and,
accordingly, their demand for coal of the kind produced by the Company varies
depending on price and transportation, regulatory, and other factors.
The Company's coal production and sales are subject to a variety of operational,
geologic, transportation, and weather-related factors that routinely cause
production to fluctuate. Operational factors affecting production include
anticipated and unanticipated events. For example, at Mingo Logan's longwall
mine, the longwall equipment must be dismantled and moved to a new area of the
mine whenever the coal reserves in a segment of the mine, called a panel, are
exhausted. The size of a panel varies, and therefore, the frequency of moves can
also vary. Unanticipated events, such as the unavailability of essential
equipment because of breakdown or unscheduled maintenance, could adversely
affect production.
Permits are sometimes delayed by unanticipated regulatory requests or processing
delays. Timely completion of improvement projects and equipment relocation's
depend to a large degree on availability of labor and equipment, timely issuance
of permits, and the weather. Sales can be adversely affected by fluctuations in
production and by transportation delays arising from equipment unavailability
and weather-related events, such as flooding.
Geologic conditions within mines are not uniform. Overburden ratios at the
surface mines vary, as do roof and floor conditions and seam thickness in
underground mines. These variations can be either positive or negative for
production. Weather conditions can also have a significant effect on the
Company's production, depending on the severity and duration of the condition.
For example, extremely cold weather combined with substantial snow and ice
accumulations may impede surface operations directly and all operations
indirectly by making it difficult for workers and suppliers to reach the mine
sites.
The results of the third quarter of each year are normally adversely affected by
lower production and resultant higher costs because of scheduled vacation
periods. In addition, costs are typically somewhat higher during vacation
periods because of maintenance activity carried on during those periods. These
adverse effects on the third quarter may make the third quarter not comparable
to the other quarters and not indicative of results to be expected for the full
year.
The Apogee and Hobet operations are a party to the Wage Agreement. From time to
time in the past, strikes and work stoppages have adversely affected production
at Apogee's and Hobet's
29
mining complexes. Any future strike or work stoppage that affected these
operations for a prolonged period would have a significant adverse effect on the
Company's results of operations.
Any one or a combination of changing demand; fluctuating selling prices; routine
operational, geologic, transportation and weather-related factors; unexpected
regulatory changes or results of litigation; or labor disruptions may occur at
times or in a manner that causes current and projected results of operations to
deviate from projections and expectations. Any event disrupting substantially
all production at any of the Company's principal mines for a prolonged period
would have a significant adverse effect on the Company's current and projected
results of operations. Decreases in production from anticipated levels usually
lead to increased mining costs and decreased net income.
30
Part II - Other Information
Item 1. LEGAL PROCEEDINGS
The third through seventh paragraphs of the Legal Contingencies subsection of
the Contingencies section of Management's Discussion and Analysis of Financial
Condition and Results of Operations in this report are incorporated herein by
reference.
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
(a) On April 4, 1997, the Company's shareholders acted by written consent
in accordance with Section 228 if the General Corporation Law of the State of
Delaware.
(c) By written consent of the shareholders representing 98.75% of the
Company's voting securities, the shareholders:
(1) approved an amendment to the Company's Restated Certificate of
Incorporation increasing the number of shares authorized to be issued to
100,000,000 par value $0.01 per share and reclassifying each existing issued and
outstanding share of Company common stock $1.00 par value into 338.0857 shares
common stock par value $0.01;
(2) adopted a Restated Certificate of Incorporation to be effective
as of the effective time of the Merger; and
(3) adopted and approved, effective as of the effective time of the
Merger, the Arch Coal, Inc. 1997 Stock Incentive Plan and the reservation for
issuance thereunder of 6,000,000 shares of Company common stock.
Item 6. EXHIBITS AND REPORTS ON FORM 8-K
(a)
2.1 Agreement and Plan of Merger dated as of April 4, 1997, among the
Company, Ashland Coal and AMC Merger Corporation (incorporated herein
by reference to Exhibit 2.1 to the Registration Statement of Arch
Mineral Corporation on Form S-4, registration 333-28149 (S-4)).
3.1 Restated Certificate of Incorporation of Arch Coal, Inc.
(incorporated herein by reference to Exhibit 3.1 to the S-4).
3.2 Restated and Amended By Laws of Arch Coal, Inc. (incorporated herein
by reference to Exhibit 3.4 to the S-4).
4.1 Stockholders Agreement, dated as of April 4, 1997, among Carboex
International, Ltd., Ashland Inc. and Arch Mineral Corporation
(incorporated herein as reference to Exhibit 4.1 to the S-4).
31
4.2 Registration Rights Agreement, dated as of April 4, 1997, among Arch
Mineral Corporation, Ashland Inc., Carboex International, Ltd. and the
entities listed on Schedules I and II thereto (incorporated herein by
reference to Exhibit 4.2 to the S-4).
4.3 Agreement Relating to Nonvoting Observer, executed as of April 4,
1997, among Carboex International, Ltd., Ashland Inc., Ashland Coal,
Inc. and Arch Mineral Corporation (incorporated herein by reference to
Exhibit 4.3 to the S-4).
4.4 Agreement for Termination of the Arch Mineral Corporation Voting
Agreement and for Nomination of Directors, dated as of April 4, 1997,
among Hunt Coal Corporation, Petro-Hunt Corporation, each of the
trusts listed on Schedule I thereto, Ashland Inc. and Arch Mineral
Corporation (incorporated herein by reference to Exhibit 4.4 to the
S-4).
4.5 Credit Agreement dated as of July 1, 1997, by and among Arch Coal,
Inc., the banks party thereto, PNC Bank, National Association, as
Administrative and Syndication Agent and Morgan Guaranty Trust Company
of New York, as Documentation and Syndication Agent (incorporated
herein by Reference to Exhibit 4.1 to the Current Report of Arch Coal,
Inc. on Form 8-K filed July 15, 1997).
27 Financial Data Schedule (filed herewith).
32
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
ARCH COAL, INC.
(Registrant)
Date: August 13, 1997 /s/ James P. Pye
-------------------
James P. Pye
Controller (Chief Accounting
Officer)
Date: August 13, 1997 /s/ Jeffry N. Quinn
--------------------
Jeffry N. Quinn
Senior Vice President, General
Counsel and Secretary
33
Arch Coal, Inc.
Form 10-Q for Quarter Ended June 30, 1997
INDEX TO EXHIBITS
2.1 Agreement and Plan of Merger dated as of April 4, 1997, among the
Company, Ashland Coal and AMC Merger Corporation (incorporated herein
by reference to Exhibit 2.1 to the Registration Statement of Arch
Mineral Corporation on Form S-4, registration 333-28149 (S-4)).
3.1 Restated Certificate of Incorporation of Arch Coal, Inc.
(incorporated herein by reference to Exhibit 3.1 to the S-4).
3.2 Restated and Amended By Laws of Arch Coal, Inc. (incorporated herein
by reference to Exhibit 3.4 to the S-4).
4.1 Stockholders Agreement, dated as of April 4, 1997, among Carboex
International, Ltd., Ashland Inc. and Arch Mineral Corporation
(incorporated herein as reference to Exhibit 4.1 to the S-4).
4.2 Registration Rights Agreement, dated as of April 4, 1997, among Arch
Mineral Corporation, Ashland Inc., Carboex International, Ltd. and the
entities listed on Schedules I and II thereto (incorporated herein by
reference to Exhibit 4.2 to the S-4).
4.3 Agreement Relating to Nonvoting Observer, executed as of April 4,
1997, among Carboex International, Ltd., Ashland Inc., Ashland Coal,
Inc. and Arch Mineral Corporation (incorporated herein by reference to
Exhibit 4.3 to the S-4).
4.4 Agreement for Termination of the Arch Mineral Corporation Voting
Agreement and for Nomination of Directors, dated as of April 4, 1997,
among Hunt Coal Corporation, Petro-Hunt Corporation, each of the
trusts listed on Schedule I thereto, Ashland Inc. and Arch Mineral
Corporation (incorporated herein by reference to Exhibit 4.4 to the
S-4).
4.5 Credit Agreement dated as of July 1, 1997, by and among Arch Coal,
Inc., the banks party thereto, PNC Bank, National Association, as
Administrative and Syndication Agent and Morgan Guaranty Trust Company
of New York, as Documentation and Syndication Agent (incorporated
herein by Reference to Exhibit 4.1 to the Current Report of Arch Coal,
Inc. on Form 8-K filed July 15, 1997).
27 Financial Data Schedule (filed herewith).
34
5
1,000
6-MOS
DEC-31-1997
JUN-30-1997
16322
0
78474
0
41794
159499
1182224
629426
883704
131115
0
0
0
209
148058
883704
383286
393576
340925
360967
0
0
6792
26352
4200
22152
0
0
0
22152
1.06
1.06
