• geologic, equipment and operational risks associated with mining;

• the outcome of commercial negotiations involving sales contracts or other transactions;

• customer performance and credit risks;

• supplier and contract miner performance, and the availability and cost of key equipment and commodities;

• availability and costs of transportation;

• our ability to replace proven and probable coal reserves;

• labor availability and relations;

• the effects of mergers, acquisitions and divestitures, including our ability to successfully integrate mergers and acquisitions;

• our ability to respond to changing customer preferences;

• availability and costs of credit, surety bonds and letters of credit;

• our dependence on Peabody for a substantial portion of our revenues;

• price volatility and demand, particularly in higher margin products;

• reductions of purchases by major customers;

• failure to comply with debt covenants;

• regulatory and court decisions including, but not limited to, those impacting permits issued pursuant to the Clean Water Act;

• environmental laws and regulations including those affecting our operations and those affecting our customers' coal usage;

• developments in greenhouse gas emission regulation and treatment, including any development of commercially successful carbon capture and storage techniques;

• coal mining laws and regulations;

• the outcome of pending or future litigation;

• changes in general economic conditions, including coal and power market conditions;

• weather patterns affecting energy demand;

• competition in our industry;

• changes in postretirement benefit obligations;

• changes to contribution requirements to multi-employer benefit funds;

• availability and costs of competing energy resources;

• worldwide economic and political conditions;

• interest rate fluctuation;

• inflationary trends, including those impacting materials used in our business;

• economic strength and political stability of countries in which we serve customers;

• downturns in consumer and company spending;

• wars and acts of terrorism or sabotage;

• impact of pandemic illness; and

• other factors, including those discussed in Legal Proceedings set forth in Item 3 of our Annual Report on Form 10-K and Part II, Item 1 of this report.

These factors should not be construed as exhaustive and should be read in conjunction with the other cautionary statements that are included in our Annual Report on Form 10-K. If one or more of these or other risks or uncertainties materialize, or if our underlying assumptions prove to be incorrect, actual results may vary materially from what we projected. Consequently, actual events and results may vary significantly from those included in or contemplated or implied by our forward-looking statements. We do not undertake any obligation to update the forward-looking statements, except as required by federal securities laws.
Overview
Effective October 31, 2007, Peabody Energy Corporation (Peabody) spun-off the Patriot group by distributing all of our common stock to the stockholders of Peabody as a dividend. We entered into various agreements with Peabody containing key provisions relating to the separation of our business. See our Annual Report on Form 10-K for more information about the spin-off and our operations.
On April 2, 2008, Patriot entered into an agreement to acquire Magnum Coal Company (Magnum). Magnum was one of the largest coal producers in Appalachia, operating 11 mines and 7 preparation plants with more than 60% of its production from surface mines and controlling more than 600 million tons of proven and probable coal reserves. On July 23, 2008, Patriot consummated the acquisition of Magnum. Magnum stockholders received 23,803,312 shares of newly-issued Patriot common stock and cash in lieu of fractional shares. The fair value of $50.57 per share of Patriot common stock issued to the Magnum shareholders was based on the average of Patriot stock price for the five business days surrounding and including April 2, 2008. The total purchase price was $738.4 million, including the assumption of $148.6 million of long term debt, $11.8 million of which related to capital lease obligations.
The acquisition was accounted for by Patriot using the purchase method of accounting. Under this method of accounting, the purchase price was allocated to the fair value of the net assets acquired. Magnum's results were consolidated beginning July 23, 2008 and are included in the Appalachian Mining Operations segment. As of September 30, 2008, the accounting for the acquisition is preliminary.
We are a leading producer of thermal coal in the eastern United States, with operations and coal reserves in Appalachia and the Illinois Basin. We are also a leading U.S. producer of metallurgical quality coal. We and our predecessor companies have operated in these regions for more than 50 years. In 2007, we sold 22.1 million tons of coal, of which 77% was sold to domestic electric utilities and 23% was sold to domestic and international steel producers. During the first nine months of 2008, we sold 19.1 million tons of coal, of which 80% was sold to domestic electric utilities and other international customers and 20% was sold to domestic and international steel producers. We control approximately 1.9 billion tons of proven and probable coal reserves. Our proven and probable coal reserves include premium coking coal and medium- and high-Btu thermal coal, with low, medium and high sulfur content.
Our operations consist of 16 mining complexes, of which 15 are active mining complexes that include company-operated mines, contractor-operated mines and coal preparation facilities. One of our mining complexes is located in northern West Virginia, 12 are located in southern West Virginia and three are located in western Kentucky. We ship coal to electric utilities, industrial users and metallurgical coal customers via one company-owned loading facility, third-party loading facilities and multiple rail and river transportation routes.
Our mining operations and coal reserves are as follows:
• Appalachia. In southern West Virginia, we have 11 active mining complexes located in Boone, Lincoln, Logan and Kanawha counties, and in northern West Virginia, we have one complex located in Monongalia County. We are developing a complex located in Kanawha and Clay Counties, which is scheduled to commence operations in 2009. In September 2008, we announced plans to idle our Jupiter mining complex by the end of 2008. In Appalachia, we sold 14.4 million and 13.3 million tons of coal in the year ended December 31, 2007 and the nine months ended September 30, 2008, respectively. As of December 31, 2007, we controlled 586 million tons of proven and probable coal reserves in

Appalachia, of which 283 million tons were assigned to current operations. As a result of the Magnum acquisition, we now control over 600 million additional tons of proven and probable coal reserves in Appalachia.
• Illinois Basin. In the Illinois Basin, we have three complexes located in Union and Henderson counties in western Kentucky. In the Illinois Basin, we sold 7.7 million and 5.8 million tons of coal in the year ended December 31, 2007 and the nine months ended September 30, 2008, respectively. As of December 31, 2007, we controlled 676 million tons of proven and probable coal reserves in the Illinois Basin, of which 131 million tons were assigned to current operations.
Stock Split
Effective August 11, 2008, Patriot implemented a 2-for-1 stock split effected in the form of a 100% stock dividend. All share and per share amounts in this Quarterly Report on Form 10-Q reflect this stock split, unless specifically noted otherwise.
Magnum Transaction Financing
In connection with the Magnum acquisition, on May 28, 2008, we completed a private offering of $200 million in aggregate principal amount of 3.25% Convertible Senior Notes due 2013 (the notes). The proceeds from the notes were held in escrow until the consummation of the Magnum acquisition. See Liquidity and Capital Resources - Private Convertible Notes Issuance for more details. On July 23, 2008, Patriot terminated Magnum's credit facility and utilized the proceeds from the notes to repay $135.5 million of principal and $1.0 million of accrued interest under Magnum's credit facility. In conjunction with the acquisition, Patriot issued $41.9 million of additional letters of credit related to Magnum operations.
As of September 30, 2008, Arch Coal, Inc. (Arch) held surety bonds related to properties acquired by Patriot in the Magnum acquisition. As a result of the acquisition, Patriot is required to post letters of credit in Arch's favor for the amount of the accrued reclamation liabilities no later than February 2010. Basis of Presentation Related to the Spin-off from Peabody The statement of operations for the three and nine months ended September 30, 2007 and cash flows for the nine months ended September 30, 2007 and related discussions below primarily relate to our historical results prior to the spin-off from Peabody. These results may not necessarily reflect what our results of operations and cash flows will be in the future or would have been as a stand-alone company. Upon the completion of the spin-off, our capital structure changed significantly. At the spin-off date, we entered into various operational agreements with Peabody, including certain on-going agreements that enhance both our financial position and cash flows. Such agreements include the assumption by Peabody of certain retiree healthcare liabilities and the repricing of a major coal supply agreement to be more reflective of the then current market pricing for similar quality coal.
The unaudited condensed consolidated financial statements presented herein include allocations of Peabody expenses, assets and liabilities through the date of the spin-off, including the following items:
Selling and Administrative Expenses
For the periods prior to the spin-off, our historical selling and administrative expenses were based on an allocation of Peabody general corporate expenses to all of its mining operations, both foreign and domestic, based on principal activity, headcount, tons sold or revenues as appropriate. The allocated expenses generally reflected service costs for marketing and sales, general accounting, legal, finance and treasury, public relations, human resources, environmental, engineering and internal audit. These allocated expenses were not necessarily indicative of the costs we would have incurred as a stand-alone company.
Interest Expense
For the periods prior to the spin-off, our historical interest expense primarily related to fees for letters of credit and surety bonds used to guarantee our reclamation, workers' compensation, retiree healthcare, and lease obligations as well as interest expense related to an intercompany note with Peabody. Our capital structure changed following the spin-off from Peabody, and effective October 31, 2007, we entered into a four-year revolving credit facility. See Liquidity and Capital Resources - Credit Facility for more information about our credit facility. The intercompany demand note totaling $62.0 million with Peabody was forgiven at spin-off.

Results of Operations
Adjusted EBITDA
The discussion of our results of operations below includes references to and analysis of our Appalachia and Illinois Basin Segments' Adjusted EBITDA results. Adjusted EBITDA is defined as net income (loss) before deducting interest income and expense; income taxes; minority interests; asset retirement obligation expense; depreciation, depletion and amortization; and net sales contract accretion excluding back-to-back coal purchase and sales contracts. The net contract accretion on the back-to-back coal purchase and sale contracts reflects the net accretion related to certain coal purchase and sales contracts existing prior to July 23, 2008, whereby Magnum purchased coal from third parties to fulfill tonnage commitments on sales contracts. Segment Adjusted EBITDA is used by management primarily as a measure of our segments' operating performance. Because Segment Adjusted EBITDA is not calculated identically by all companies, our calculation may not be comparable to similarly titled measures of other companies. Adjusted EBITDA is reconciled to its most comparable measure, under generally accepted accounting principles, in Note 10 to our unaudited condensed consolidated financial statements. Segment Adjusted EBITDA excludes selling, general and administrative expenses, past mining obligation expense and gain on disposal or exchange of assets and is reconciled to its most comparable measure below under Net Income (Loss).
Three and Nine Months Ended September 30, 2008 Compared to September 30, 2007 Tons Sold and Revenues

                             Three Months Ended                                                        Nine Months Ended
                               September 30,                  Increase (Decrease)                        September 30,                     Increase (Decrease)
                            2008           2007             Tons/$              %                     2008                2007             Tons/$            %
                                                                               (Dollars and tons in thousands)
Tons Sold:
Appalachia                    6,365          4,120              2,245              54.5 %                   13,268         11,344              1,924         17.0 %
Illinois Basin                1,805          1,868                (63 )           (3.4) %                    5,848          5,738                110          1.9 %

Total Tons Sold               8,170          5,988              2,182              36.4 %                   19,116         17,082              2,034         11.9 %


Revenue:
Appalachia Mining
Operations                $ 419,079      $ 230,172       $    188,907              82.1 %      $           884,978      $ 628,605       $    256,373         40.8 %
Illinois Basin Mining
Operations                   67,092         61,663              5,429               8.8 %                  208,763        187,737             21,026         11.2 %
Appalachia Other              3,412          1,466              1,946             132.7 %                   19,856          2,843             17,013        598.4 %

Total Revenues            $ 489,583      $ 293,301       $    196,282              66.9 %      $         1,113,597      $ 819,185       $    294,412         35.9 %


Average sales price
per ton sold:
Appalachia                $   65.84      $   55.87       $       9.97              17.8 %      $             66.70      $   55.41       $      11.29         20.4 %
Illinois Basin                37.17          33.01               4.16              12.6 %                    35.70          32.72               2.98          9.1 %

Revenues in the Appalachia segment were higher in the three and nine months ended September 30, 2008 compared to the same period in 2007 primarily related to $199.7 million of revenue from the newly-acquired Magnum operations. Compared to the prior year, revenues were also impacted by higher average sales prices, partially offset by lower sales volumes.
Average sales prices increased at all of our mining complexes reflecting higher sales contract pricing, including the repricing of a major coal supply agreement with Peabody as part of the spin-off, as well as higher spot sales prices. The Appalachia coal markets experienced a major increase in spot coal prices, generally driven by increases in international coal prices and supply/demand imbalance.

In the three months ended September 30, 2008, sales volumes in the Appalachia segment were higher compared to the same period in 2007 primarily related to 3.3 million tons from the newly-acquired Magnum operations, partially offset by lower sales volumes at certain mines. Sales volumes were adversely impacted during the quarter due to a longwall move at our Federal mine, the Harris mine longwall completing its final panel in May 2008, adverse geologic conditions, labor shortages at various mines, and increased Federal Mine Safety and Health Act of 1977 (MSHA) inspections. Adverse geologic conditions included hard cutting and soft floor conditions at our Federal complex, slowing progress along the longwall panel. Certain of the newly-acquired Magnum operations were negatively impacted by labor shortages, delays in permitting and adverse geologic conditions at several mines, primarily related to sandstone intrusions.
In the nine months ended September 30, 2008, sales volumes in the Appalachia segment were higher compared to the same period in 2007 primarily related to the 3.3 million tons from the newly-acquired Magnum operations, partially offset by lower sales volumes at certain mines. Sales volumes were reduced due to production shortfalls at our Federal complex stemming from two roof falls in the first quarter and a longwall move and the adverse geologic conditions discussed above in the third quarter. Sales volumes were also lower than the prior year due to the Harris mine longwall completing its final panel in the second quarter.
Revenues in the Illinois Basin segment were higher for the three and nine months ended September 30, 2008 compared to the prior year primarily due to higher average sales prices. Average sales prices increased reflecting higher sales contract pricing, including the repricing of a major contract, and higher spot sales in 2008. Sales volumes were lower in the three months ended September 30, 2008 primarily related to a roof fall at one of our mines.
Other Appalachia revenues were higher in the three and nine months ended September 30, 2008 compared to the same period in 2007. In addition to royalty income, other revenues for the nine months ended September 30, 2008 included a structured settlement on a property transaction, a settlement for past due coal royalties, which had previously been fully reserved due to the uncertainty of collection, and gains on the sale of purchased coal in the first quarter. Segment Adjusted EBITDA

                        Three Months Ended                                          Nine Months Ended
                           September 30,             Increase (Decrease)              September 30,             Increase (Decrease)
                         2008          2007             $              %            2008          2007             $             %
                                                                   (Dollars in thousands)
Appalachia Mining
Operations and
Other                 $   35,301     $ 31,485      $     3,816         12.1 %     $ 140,395     $ 76,070      $    64,325         84.6 %
Illinois Basin
Mining Operations          1,058        3,128           (2,070 )      (66.2 )%        9,156       11,160           (2,004 )     (18.0) %

Segment Adjusted
EBITDA                $   36,359     $ 34,613      $     1,746          5.0 %     $ 149,551     $ 87,230      $    62,321         71.4 %

Segment Adjusted EBITDA for Appalachia was higher in the three months ended September 30, 2008 from the prior year primarily due to the contribution from the newly-acquired Magnum operations and higher average sales prices, partially offset by lower sales volumes at certain mines and higher costs primarily related to contract mining. Contract mining costs increased due to higher materials and supply costs related to adverse geologic conditions and higher fuel and explosives costs as well as increased wages and benefits to address labor shortages that the entire region is experiencing.
Segment Adjusted EBITDA for Appalachia was higher in the nine months ended September 30, 2008 from the prior year primarily due to higher sales prices and, to a lesser extent, the contribution from the newly-acquired Magnum operations, partially offset by lower sales volumes and higher operating costs. Higher operating costs primarily related to start-up costs as we ramped up production at our Big Mountain and Kanawha Eagle complexes as well as higher contract mining costs primarily related to higher materials and supply and labor costs.
Segment Adjusted EBITDA for Appalachia also increased for the nine months ended September 30, 2008 from the prior year due to the gains on the sale of purchased coal in the first quarter and the structured settlements referenced above in the second quarter.

Segment Adjusted EBITDA for the Illinois Basin decreased in the three and nine months ended September 30, 2008 from the prior year primarily due to higher materials and supply costs from increased roofbolting, higher labor costs and higher fuel, explosives and steel costs, partially offset by higher average sales prices.

Net Income (Loss)

                           Three Months Ended                                                   Nine Months Ended
                              September 30,                  Increase (Decrease)                  September 30,                   Increase (Decrease)
                          2008             2007               $                %              2008             2007                $                %
                                                                             (Dollars in thousands)
Segment Adjusted
EBITDA                 $   36,359       $   34,613       $     1,746             5.0 %     $  149,551       $    87,230       $    62,321            71.4 %
Corporate and
Other:
Past mining
obligations               (31,516 )        (38,791 )           7,275            18.8 %        (75,259 )        (115,513 )          40,254            34.8 %
Net gain on
disposal or
exchange of assets            491            1,670            (1,179 )         (70.6 )%         7,021            82,696           (75,675 )         (91.5 )%
Selling and
administrative
expenses                   (7,533 )        (10,544 )           3,011            28.6 %        (25,310 )         (32,342 )           7,032            21.7 %

Total Corporate and
Other                     (38,558 )        (47,665 )           9,107            19.1 %        (93,548 )         (65,159 )         (28,389 )         (43.6 )%
Depreciation,
depletion and
amortization              (42,215 )        (23,130 )         (19,085 )         (82.5 )%       (81,730 )         (64,048 )         (17,682 )         (27.6 )%
Sales contract
accretion, net            121,859                -           121,859             n/a          121,859                 -           121,859             n/a
Asset retirement
obligation expense         (5,051 )         (3,641 )          (1,410 )         (38.7 )%       (11,726 )         (12,936 )           1,210             9.4 %
Interest expense           (5,626 )         (1,716 )          (3,910 )        (227.9 )%       (13,164 )          (6,504 )          (6,660 )        (102.4 )%
Interest income             3,588            3,527                61             1.7 %         10,458             8,293             2,165            26.1 %

Income
(loss) before
income taxes and
minority interests         70,356          (38,012 )         108,368             n/a           81,700           (53,124 )         134,824             n/a
Income tax benefit          2,595                -             2,595             n/a                -                 -                 -             n/a
Minority interests              -           (1,439 )           1,439             n/a                -            (4,092 )           4,092             n/a

Net income (loss)      $   72,951       $  (39,451 )     $   112,402             n/a       $   81,700       $   (57,216 )     $   138,916             n/a

Past mining obligations were lower in the three and nine months ended September 30, 2008 than the corresponding period in the prior year primarily due to the retention by Peabody of a portion of the retiree healthcare liability at spin-off and a higher discount rate associated with the 2008 expenses. The newly-acquired Magnum operations had past mining obligations of $8.2 million in the quarter, primarily related to retiree healthcare liabilities.
Net gain on disposal or exchange of assets was lower in the three and nine months ended September 30, 2008 compared to the prior year. In the nine months ended September 30, 2008, net gain on disposal or exchange of assets included a $6.3 million gain on the exchange/sale of certain leasehold mineral interests. The nine months ended September 30, 2007 included coal reserve transactions that resulted in gains of $78.5 million. Property sales in 2007 are not indicative of the level we expect on an ongoing basis.
Our historical selling and administrative expenses for the three and nine months ended September 30, 2007 were based on an allocation of Peabody general corporate expenses to all of its mining operations, both foreign and domestic. Selling and administrative expenses for the three and nine months ended September 30, 2008 represent our actual expenses incurred as a stand-alone company.
Depreciation, depletion and amortization increased in the three and nine months ended September 30, 2008 compared to the prior year primarily due to the Magnum acquisition.
Net sales contract accretion resulted from the below market coal sale and purchase contracts acquired in the Magnum acquisition and recorded at preliminarily-determined fair values in purchase accounting. The net liability generated from applying fair value to these contracts will be accreted over the . . .