• geologic, equipment and operational risks associated with mining;

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

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

• reductions of purchases or deferral of deliveries by major customers;

• customer performance and credit risks;

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

• 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;

• coal mining laws and regulations;

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

• downturns in consumer and company spending;

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

• availability and costs of transportation;

• worldwide economic and political conditions;

• labor availability and relations;

• our ability to replace proven and probable coal reserves;

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

• our ability to respond to changing customer preferences;

• our dependence on Peabody Energy for a significant portion of our revenues;

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

• failure to comply with debt covenants;

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

• the outcome of pending or future litigation;

• 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;

• interest rate fluctuation;

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

• wars and acts of terrorism or sabotage;

• impact of pandemic illness; and

• other factors, including those discussed in Legal Proceedings set forth in Part I, Item 3 of our 2008 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 2008 Annual Report on Form 10-K and in this report. 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
We are a leading producer of thermal coal in the eastern United States, with operations and coal reserves in Appalachia and the Illinois Basin, our operating segments. We are also a leading U.S. producer of metallurgical quality coal. Our principal business is the mining, preparation and sale of thermal coal, also known as steam coal, for sale primarily to electric utilities and metallurgical coal, for sale to steel mills and independent coke producers. In the first three months of 2009, we sold 8.5 million tons of coal, of which 84% was sold to domestic electric utilities and 16% was sold to domestic and global steel producers. In 2008, we sold 28.5 million tons of coal, of which 79% was sold to electric utilities and 21% was sold to domestic and global steel producers. We control approximately 1.8 billion tons of proven and probable coal reserves. Our proven and probable coal reserves include metallurgical coal and medium and high Btu thermal coal, with low, medium and high sulfur content.
Our operations consist of fifteen mining complexes, which include company-operated mines, contractor-operated mines and coal preparation facilities. The Appalachia and Illinois Basin segments consist of our operations in West Virginia and Kentucky, respectively. We ship coal to electric utilities, industrial users and metallurgical coal customers via various company-owned and third-party loading facilities and multiple rail and river transportation routes.
Effective July 23, 2008, we acquired Magnum Coal Company (Magnum). Magnum was one of the largest coal producers in Appalachia, operating eight mining complexes with production from surface and underground mines and controlling more than 600 million tons of proven and probable coal reserves. Upon the completion of the acquisition, we performed a strategic review of all our operations, resulting in the decision to cease operations at two Magnum mining complexes. The Jupiter complex ceased operations in December 2008 and the Remington complex ceased operations in March 2009.
Our mining operations and coal reserves are as follows:
• Appalachia. In southern West Virginia, we have ten 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. In Appalachia, we sold 6.7 million and 20.6 million tons of coal in the three months ended March 31, 2009 and the year ended December 31, 2008, respectively. As of December 31, 2008, we controlled 1.18 billion tons of proven and probable coal reserves in Appalachia, of which 468 million tons were assigned to current operations.
• 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 1.8 million and 7.9 million tons of coal in the three months ended March 31, 2009 and the year ended December 31, 2008, respectively. As of December 31, 2008, we controlled 655 million tons of proven and probable coal reserves in the Illinois Basin, of which 136 million tons were assigned to current operations.

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; 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 9 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 Months Ended March 31, 2009 Compared to March 31, 2008 Summary
Our 2009 results were impacted by the inclusion of our recently acquired Magnum operations. Results of the Magnum operations are included in our consolidated results of operations beginning July 23, 2008, the date of the acquisition. Our 2009 Segment Adjusted EBITDA also reflected higher average sales prices as compared to 2008. Our 2009 net income was impacted by the issuance of $200 million of 3.25% convertible senior notes in May 2008, which resulted in higher interest expense in 2009 compared to 2008.

   Tons Sold and Revenues

                                                               Three Months Ended March 31,             Increase (Decrease)
                                                                2009                    2008             Tons/$           %
                                                                (Dollars and tons in thousands, except per ton amounts)
Tons Sold:
Appalachia Mining Operations                                         6,639                  3,180            3,459       108.8 %
Illinois Basin Mining Operations                                     1,819                  1,905              (86 )      (4.5 )%

Total Tons Sold                                                      8,458                  5,085            3,373        66.3 %


Revenue:
Appalachia Mining Operations                              $        453,456         $      212,762     $    240,694       113.1 %
Illinois Basin Mining Operations                                    69,382                 66,339            3,043         4.6 %
Appalachia Other                                                     6,098                  5,233              865        16.5 %

Total Revenues                                            $        528,936         $      284,334     $    244,602        86.0 %


Average sales price per ton sold:
Appalachia                                                $          68.30         $        66.91     $       1.39         2.1 %
Illinois Basin                                                       38.14                  34.82             3.32         9.5 %

Revenues in the Appalachia segment were higher in the three months ended March 31, 2009 compared to the same period in 2008 primarily related to $192.6 million of revenue from the Magnum operations and higher average sales prices at several mining complexes.

Sales volumes in the Appalachia segment increased in 2009, primarily from the 3.3 million tons sold from the acquired Magnum operations. Additionally, sales volumes were slightly higher during the first quarter of 2009 due primarily to improved volumes at our Federal mining complex, which experienced two roof falls during the first quarter of 2008. This increase was partially offset by lower production at our Harris mine. This mine depleted longwall production in the first quarter of 2008, converting to continuous miner operations beginning in the second quarter of 2008 and into 2009. Additionally, production was lower compared to the prior year due to hard cutting and other difficult geologic conditions at several mining complexes.
Revenues in the Illinois Basin segment were higher for the three months ended March 31, 2009 compared to the prior year primarily due to higher average sales prices. Sales volumes were lower in the three months ended March 31, 2009 primarily related to unfavorable weather conditions.

 Segment Adjusted EBITDA

                              Three Months Ended March 31,           Increase (Decrease)
                                2009                 2008               $              %
                                                    (Dollars in thousands)
 Appalachia                $       69,487       $       41,998     $    27,489         65.5 %
 Illinois Basin                     3,041                5,339          (2,298 )      (43.0 )%

 Segment Adjusted EBITDA   $       72,528       $       47,337     $    25,191         53.2 %

Segment Adjusted EBITDA for Appalachia was higher in the three months ended March 31, 2009 primarily due to the contribution from the Magnum operations and higher average sales prices, partially offset by higher costs related to contract mining, which was driven by contract increases in mid- to late 2008.
Segment Adjusted EBITDA for the Illinois Basin decreased in the three months ended March 31, 2009 from the prior year primarily due to higher costs related to mining in new sections at two of our complexes, higher labor rates in 2009 due to increases established in 2008, and lower production volumes attributable to severe winter storms. These decreases were partially offset by higher average sales prices and lower diesel fuel costs.

 Net Income (Loss)

                                                           Three Months Ended March 31,             Increase (Decrease)
                                                             2009                 2008                 $             %
                                                                                  (Dollars in thousands)
Segment Adjusted EBITDA                                 $       72,528       $       47,337       $    25,191         53.2 %
Corporate and Other:
Past mining obligation expense                                 (37,800 )            (22,121 )         (15,679 )      (70.9 )%
Net gain on disposal or exchange of assets                          30                  194              (164 )      (84.5 )%
Selling and administrative expenses                            (12,886 )             (8,289 )          (4,597 )      (55.5 )%

Total Corporate and Other                                      (50,656 )            (30,216 )         (20,440 )      (67.6 )%
Depreciation, depletion and amortization                       (54,979 )            (18,610 )         (36,369 )     (195.4 )%
Sales contract accretion                                        76,807                    -            76,807          n/a
Asset retirement obligation expense                             (6,451 )             (3,416 )          (3,035 )      (88.8 )%
Interest expense                                                (8,593 )             (2,322 )          (6,271 )     (270.1 )%
Interest income                                                  3,487                3,249               238          7.3 %

Income (loss) before income taxes                               32,143               (3,978 )          36,121          n/a
Income tax benefit                                                   -                  912              (912 )        n/a

Net income (loss)                                       $       32,143       $       (3,066 )     $    35,209          n/a

Past mining obligations were higher in the three months ended March 31, 2009 than the corresponding period in the prior year primarily due to the addition of Magnum operations. Past mining obligations at Magnum operations in the quarter primarily consisted of retiree healthcare liabilities.
Selling and administrative expenses increased for the three months ended March 31, 2009 as compared to the corresponding period in the prior year primarily due to the addition of Magnum operations.
Depreciation, depletion and amortization increased in the three months ended March 31, 2009 compared to the prior year primarily due to the acquisition of Magnum.
Net sales contract accretion resulted from the below market coal sale and purchase contracts acquired in the Magnum transaction and recorded at preliminarily-determined fair value in purchase accounting. The net liability generated from applying fair value to these contracts is being accreted over the life of the contracts as the coal is shipped.
Asset retirement obligation expense increased in the three months ended March 31, 2009 primarily due to the acquisition of Magnum.
Interest expense increased in the three months ended March 31, 2009 primarily due to interest and amortized debt issuance costs related to our convertible notes, which includes expense recorded due to the implementation of new authoritative guidance. See Liquidity and Capital Resources for details concerning our outstanding debt and credit facility.
For the three months ended March 31, 2009, no income tax provision was recorded due to our anticipated tax net operating loss for the year ending December 31, 2009 and the full valuation allowance recorded against deferred tax assets. The primary difference between book and taxable income for 2009 is the treatment of the net sales contract accretion on the below market purchase and sales contracts acquired with Magnum, with such amounts being included in the computation of book income but excluded from the computation of taxable income. For the three months ended March 31, 2008, we reported an income tax benefit of $0.9 million based on the forecasted effective tax rate for 2008. Outlook
Market
During the first quarter of 2009, global economic activity remained weak. Reduced U.S. industrial activity led to a 2.9 percent decline in electricity consumption. Lower natural gas prices caused further declines in coal demand, as some utilities chose to burn natural gas in preference to coal.
Demand for steel continued at a reduced level through the first quarter of 2009. Utilization at U.S. steel mills fluctuated from 40 to 45 percent during the first quarter, after peaking at 85 to 90 percent in 2008. Globally, blast furnace iron production decreased 17 percent in the first quarter compared to the first quarter of 2008, but remained flat compared to the fourth quarter of 2008. As a result, domestic and global demand for metallurgical coals has stabilized, although at significantly lower levels than during the first nine months of 2008.
Because of lower coal-fueled generation, at the end of the first quarter, eastern U.S. utility coal inventories were approximately 6 million tons higher than a year ago. Due to the reduced demand and higher inventory levels, traded U.S. thermal coal prices decreased nearly 10 percent during the first quarter.
Coal production has decreased in response to weak demand and lower prices. In total, we believe 2009 U.S. production will be reduced by 80 to 100 million tons from 2008 levels. This supply response should position the coal sector for stronger pricing as the global economy improves. Government stimulus plans should lead the recovery, particularly as infrastructure projects are initiated, thereby increasing demand for industrial goods. Low-cost electricity fueled by coal is essential to the global economy.

Patriot Operations
As discussed more fully under Item 1A. Risk Factors in this report and in our 2008 Annual Report on Form 10-K, our results of operations in the near-term could be negatively impacted by unforeseen adverse geologic conditions or equipment problems at mining locations; customer performance and credit risks; the availability and costs of credit, surety bonds and letters of credit; the economic recession; reductions of purchases or deferral of deliveries by major customers; coal mining laws and regulations; the inability of contract miners to fulfill delivery terms of their contracts; delays in obtaining required permits for new mining operations; and the unavailability of transportation for coal shipments. On a long-term basis, our results of operations could be impacted by our ability to secure or acquire high-quality coal reserves; our ability to attract and retain skilled employees and contract miners; our ability to find replacement buyers for coal under contracts with comparable terms to existing contracts; rising prices of key supplies, mining equipment and commodities; and the passage of new or expanded regulations that could limit our ability to mine, increase our mining costs, or limit our customers' ability to utilize coal as fuel for electricity generation. If upward pressure on costs exceeds our ability to realize sales increases, or if we experience unanticipated operating or transportation difficulties, our operating margins would be negatively impacted. Management has continued to focus on controlling costs, optimizing performance and responding quickly to market changes.
In light of the Magnum acquisition, we performed a comprehensive strategic review of our mining complexes and their relative cost structures. As a result, we idled our Jupiter mining complex effective December 31, 2008 and the Remington complex effective March 31, 2009.
Early in 2009, we implemented a Management Action Plan in response to the weakened coal markets. In January 2009, we announced the idling of our Black Oak mine. On April 2, 2009, we announced additional contract mine suspensions, the deferral of the opening of the Blue Creek complex and the cancellation of certain shifts at various mining complexes.
Both our Federal and Panther longwall operations experienced improved performance in the first quarter of 2009. Our Federal longwall operation improved significantly over the first quarter of 2008, when it experienced two roof falls. The Panther longwall operation improved as the quarter progressed, with first quarter 2009 production more than 35 percent higher than fourth quarter 2008. Early in the third quarter of 2009, we anticipate moving to the next Panther longwall panel and replacing worn equipment, which we expect will improve production levels.
As of March 31, 2009, substantially all of our expected 2009 production was committed, including approximately 0.2 million committed international metallurgical tons not yet priced. However, certain thermal and metallurgical customers have approached us requesting shipment deferrals on currently committed tons. These requests are being evaluated to determine if a mutually acceptable outcome can be achieved.
Of expected 2010 volumes, up to 5.0 million tons of metallurgical coal and up to 8.0 million tons of thermal coal remained unpriced as of March 31, 2009. We will continue to evaluate 2010 production levels as the year progresses.
Actual events and results may vary significantly from those included in or contemplated or implied by the forward-looking statements under Outlook. The guidance provided under the caption Outlook should be read in conjunction with the section entitled Cautionary Notice Regarding Forward Looking Statements and Item 1A. Risk Factors included in this report. For additional information regarding the risks and uncertainties that affect our business, see Item 1A. Risk Factors in our 2008 Annual Report on Form 10-K. Liquidity and Capital Resources
Our primary sources of cash include sales of our coal production to customers, sales of non-core assets and financing transactions. Our primary uses of cash include our cash costs of coal production, capital expenditures, interest costs and costs related to past mining obligations. Our ability to service our debt (interest and principal) and acquire new productive assets or businesses is dependent upon our ability to continue to generate cash from the primary sources noted above in excess of the primary uses. We expect to fund all of our capital expenditure requirements with cash generated from operations or borrowed funds as necessary.
Net cash used in operating activities was $19.2 million for the three months ended March 31, 2009, compared to $4.8 million in the same period of 2008. The increase in cash used in operating activities primarily related to changes in working capital of $19.8 million, primarily due to higher saleable coal inventory and increased accounts receivable.

Net cash used in investing activities was $18.1 million for the three months ended March 31, 2009, compared to $13.3 million in the same period of 2008. The increase in cash used reflected an increase in capital expenditures of $7.0 million and additional advance mining royalties of $1.6 million, offset by additional proceeds from the sale of assets of $3.8 million.
Net cash provided by financing activities was $40.6 million for the three months ended March 31, 2009, compared to $21.6 million in the same period of 2008. The increase in cash provided was primarily due to increased short-term borrowings.
Credit Facility
On October 31, 2007, we entered into a $500 million, four-year revolving credit facility, which includes a $50 million swingline sub-facility and a letter of credit sub-facility. This facility is available for working capital requirements, capital expenditures and other corporate purposes. As of March 31, 2009, the balance of outstanding letters of credit issued against the credit facility totaled $343 million. Outstanding short-term borrowings on this facility were $65 million as of March 31, 2009. Availability under the credit facility as of March 31, 2009 was $92 million. At March 31, 2009, we were in compliance with the covenants of our amended credit facility.
Private Convertible Notes Issuance
On May 28, 2008, Patriot completed a private offering of $200 million in aggregate principal amount of 3.25% Convertible Senior Notes due 2013. Also in May 2008, the Financial Accounting Standards Board (FASB) issued Staff Position (FSP) APB 14-1, "Accounting for Convertible Debt Instruments That May Be Settled in Cash upon Conversion (Including Partial Cash Settlement)" (FSP APB 14-1). FSP APB 14-1 changes the accounting for our convertible notes, specifying that issuers of convertible debt instruments that may settle in cash upon conversion must bifurcate the proceeds from the debt issuance between debt and equity components in a manner that reflects the entity's nonconvertible debt borrowing rate when interest cost is recognized in subsequent periods. The equity . . .