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CLD > SEC Filings for CLD > Form 10-Q on 26-Oct-2012All Recent SEC Filings

Show all filings for CLOUD PEAK ENERGY INC.

Form 10-Q for CLOUD PEAK ENERGY INC.


26-Oct-2012

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.

Explanatory Note

Cloud Peak Energy Resources LLC ("CPE Resources") is the sole direct subsidiary of Cloud Peak Energy Inc. ("CPE Inc."), providing 100% of CPE Inc.'s total consolidated revenue for the three and nine months ended September 30, 2012 and constituting nearly 100% of CPE Inc.'s total consolidated assets as of September 30, 2012.

Unless the context indicates otherwise, the terms "Cloud Peak Energy," the "Company," "we," "us," and "our" refer to both CPE Inc. and CPE Resources and their subsidiaries. Discussions or areas of this report that either apply only to CPE Inc. or CPE Resources are clearly noted in such sections.

This Item 2 may contain forward-looking statements that involve substantial risks and uncertainties. When considering these forward-looking statements you should keep in mind the cautionary statements in this report and our other Securities and Exchange Commission ("SEC") filings, including Risk Factors in Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2011 ("2011 Form 10-K"). Please see "Cautionary Notice Regarding Forward-Looking Statements" elsewhere in this document.

This Item 2 is intended to help the reader understand our results of operations and financial condition. This discussion should be read in conjunction with our unaudited condensed consolidated financial statements in Item 1 of this report and our other SEC filings, including our audited consolidated financial statements in Item 8 of our 2011 Form 10-K.

Overview

We are one of the largest producers of coal in the United States ("U.S.") and in the Powder River Basin ("PRB"), based on 2011 coal sales. As of December 31, 2011, we controlled approximately 1.37 billion tons of proven and probable coal reserves. We operate some of the safest mines in the coal industry. According to Mine Safety and Health Administration ("MSHA") data, in 2011, we had one of the lowest employee all injury incident rates among the largest U.S. coal producing companies. We currently operate solely in the PRB, the lowest cost region of the major coal producing regions in the U.S., and operate two of the four largest coal mines in the U.S. Our operations include three wholly-owned surface coal mines, two of which, the Antelope mine and the Cordero Rojo mine, are in Wyoming and one of which, the Spring Creek mine, is in Montana. We also own rights to substantial undeveloped coal and complimentary surface assets in the Northern PRB, further building our long-term position to serve Asian export and domestic customers. We also own a 50% non-operating interest in a fourth surface coal mine in Montana, the Decker mine. We produce subbituminous thermal coal with low sulfur content and sell our coal primarily to domestic and foreign electric utilities.

On June 29, 2012, we completed our acquisition of the Youngs Creek Mining Company, LLC ("Youngs Creek") joint venture and other related coal and surface assets, including CX Ranch, from Chevron U.S.A. Inc. ("Chevron") and CONSOL Energy Inc. ("CONSOL") for $300 million. We utilized available cash on hand to fund the acquisition. We believe the location of the coal and surface lands, as well as the quality of the acquired coal, position us well for future growth in our Asian exports as additional terminal capacity becomes available. As Youngs Creek is an undeveloped greenfield surface mine project, there are no revenues or income related to the acquired properties. Future development timing and production levels are expected to depend largely on the availability of additional export terminal capacity on the West Coast and continued strong Asian demand for thermal coal.

Decker Mine

We hold a 50% non-operating interest in the Decker mine in Montana. The other 50% mine owner has responsibility for the day-to-day operations of the Decker mine. We account for our pro-rata share of assets and liabilities in our undivided interest in the joint venture using the proportionate consolidation method, whereby our share of assets, liabilities, revenues and expenses are included in the appropriate classification in our consolidated financial statements.


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Core Business Operations



Our key business drivers include the following:



          the volume of coal sold domestically and internationally;



          the price for which we sell our coal;



          the costs of mining, including labor, repairs and maintenance, fuel,
explosives, depreciation of capital equipment, and depletion of coal leases;



          the costs for logistic services and rail and port charges for coal
sales on a delivered basis; and



          capital expenditures to acquire property, plant and equipment.

The volume of coal that we sell in any given year is driven by the amount of global and domestic demand for coal-generated electric power. Demand for coal-generated electric power may be affected by many factors including weather patterns, natural gas prices, coal-fired generating capacity and utilization, environmental and legal challenges, political and regulatory factors, energy policies, international and domestic economic conditions, and other factors discussed in this Item 2 and in our 2011 Form 10-K.

The price at which we sell our coal is a function of the demand relative to the supply for coal, domestically and internationally. As the demand within a region increases, prices are also subject to increase. Significant increases in demand can allow our coal to compete in new markets. We typically enter into multi-year contracts with our customers which helps mitigate the risks associated with any short-term imbalance in supply and demand. In addition, international demand has increased, enabling us to increase exports of coal during the past few years. We enter into coal forward contracts that are scheduled to settle at various dates between 2012 and 2015 to hedge a portion of our export coal sales.

We typically seek to enter each year with expected production effectively fully sold. This strategy helps us deliver our expected tonnages and run our mines at predictable production rates, which helps us control operating costs.

As is common in the PRB, coal seams at our existing mines naturally deepen, resulting in additional overburden to be removed at additional cost. In line with the worldwide mining industry, we have experienced increased operating costs for mining equipment, diesel fuel and supplies, and employee wages and salaries. Changes in the cost of commodities related to our production process, such as diesel fuel, will result in changes in the cost of coal production. During the second quarter of 2012, we commenced the use of costless collars to help manage certain exposures to diesel fuel prices.

For some of our coal sales, including our sales to Asian customers, we arrange and pay for logistic services, rail and/or port charges. Our costs for transportation are affected by volume and negotiated freight rates.

We incur significant capital expenditures to update or expand our mining equipment, surface land holdings and coal deposits. In line with the worldwide mining industry, generally the cost of capital equipment and lead times are increasing. In addition, in recent years, the costs of acquiring federal coal leases and associated surface rights have increased. As we mine these more expensive leases in the future, our depletion costs will increase.

Current Considerations

The hot summer increased coal burn and gas prices, which led to strong shipments and initial reductions in stockpiles of coal held by utilities. Stockpiles, while still high, are within the five-year average. The outlook for coal demand for the rest of the year will depend on the intensity and timing of the winter season and the price of natural gas.

The operations successfully controlled their costs this quarter helped by the increased shipment rates. For the third quarter 2012, the average cost of product sold was $9.14 per ton compared to $9.17 per ton in the third quarter of 2011. These cost controls along with increased realized price per ton of $13.28 compared to $12.91 in 2011, resulted in a margin expansion to $4.14 per ton from $3.74 per ton in the third quarter 2011.

As reported last quarter a small number of our customers had contacted us to request shipment deferrals. At this time, we have renegotiated 1.7 million tons, mostly to 2013, and continue discussions with a small number of customers about additional deferrals.


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On August 8, 2011, the U.S. Environmental Protection Agency ("EPA") published the Cross-State Air Pollution Rule ("CSAPR") intended to replace the Clean Air Interstate Rule ("CAIR"). CSAPR was expected to take effect on January 1, 2012 and was intended to reduce pollutants from upwind states by requiring 28 states to reduce power plant emissions of sulfur dioxide and nitrogen oxide. On August 21, 2012, the U.S. Court of Appeals issued a split ruling that vacated CSAPR, remanding it back to the EPA and leaving CAIR in effect until the EPA revises CSAPR. On October 5, 2012, the EPA filed a petition for an en banc rehearing of the August 21, 2012 ruling, and a court decision on that petition is pending.

On July 20, 2012, the EPA announced that it is reviewing pollution limits for new power plants under the Mercury and Air Toxics Standards ("MATS"). MATS imposes maximum achievable control technology emission limits on hazardous air emissions from new and existing coal- and oil-fired electric generating plants, as well as revised new source performance standards for nitrogen oxides, sulfur dioxides and particulate matter from such plants. In addition, on April 13, 2012, the EPA published for comment proposed new source performance standards for emissions of carbon dioxide for new and modified fossil fuel-fired electric utility generating units. The standards, if promulgated along the lines proposed, would pose significant challenges for the construction of any new coal-fired electric utility generating units in the U.S. without the use of carbon capture and storage technologies and could result in a decrease in U.S. demand for steam coal. It is possible that any final rules issued by the EPA in this area will be challenged.

Adjusted EBITDA and Adjusted EPS (CPE Inc. only)

The discussion of our results of operations below includes the non-GAAP financial measures of (1) Adjusted EBITDA and (2) Adjusted Earnings Per Share ("Adjusted EPS"). Adjusted EBITDA and Adjusted EPS are intended to provide additional information only and do not have any standard meaning prescribed by generally accepted accounting principles in the United States of America ("U.S. GAAP"). A quantitative reconciliation of historical net income to Adjusted EBITDA and EPS (as defined below) to Adjusted EPS is found within this Item 2.

EBITDA represents net income before (1) interest income (expense) net,
(2) income tax provision, (3) depreciation and depletion, (4) amortization, and
(5) accretion. Adjusted EBITDA represents EBITDA as further adjusted for specifically identified items that management believes do not directly reflect our core operations. The specifically identified items are the impacts, as applicable, of: (1) the Tax Receivable Agreement including tax impacts of CPE Inc.'s 2009 initial public offering ("IPO") and 2010 Secondary Offering,
(2) adjustments for derivative financial instruments including unrealized mark-to-market amounts and cash settlements realized, and (3) our significant broker contract that expired in the first quarter of 2010.

Adjusted EPS represents diluted earnings (loss) per common share ("EPS") adjusted to exclude the estimated per share impact of the same specifically identified items used to calculate Adjusted EBITDA and described above, adjusted at the statutory tax rate of 36%.

Because not all companies use identical calculations, our presentations of Adjusted EBITDA and Adjusted EPS may not be comparable to other similarly titled measures of other companies. Moreover, our presentation of Adjusted EBITDA is different than EBITDA as defined in our debt financing agreements.

See Item 6 of our 2011 Form 10-K for additional information regarding Adjusted EBITDA and Adjusted EPS and their limitations compared to U.S. GAAP financial measures.

Three Months Ended September 30, 2012 Compared to Three Months Ended September 30, 2011

Summary



The following table summarizes key results (in millions):



                       Three Months Ended
                         September 30,             Change
                        2012         2011     Amount    Percent
Total revenue        $    425.9    $  407.0   $  18.9       4.6
Net income                 85.3        24.6      60.7     246.7
Adjusted EBITDA(1)        108.4        87.9      20.5      23.3
Adjusted EPS(1)      $     0.80    $   0.61   $  0.19      30.5
Asian export tons           1.5         1.4       0.1       7.5
Total tons sold            25.1        25.2      (0.2 )    (0.6 )



(1) Non-GAAP measure; please see definition above and reconciliation below.


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Adjusted EBITDA and Adjusted EPS (CPE Inc. only)



The following tables present a reconciliation of net income to Adjusted EBITDA
and diluted earnings (loss) per common share to Adjusted EPS (in millions,
except per share amounts):



                                        Three Months Ended
                                          September 30,
                                         2012         2011
Net income                            $      85.3    $  24.6
Interest income                              (0.2 )     (0.1 )
Interest expense                             11.7        6.8
Income tax expense                           13.6       52.2
Depreciation and depletion                   24.7       24.3
Accretion                                     3.3        3.0
EBITDA                                      138.3      110.8
Tax agreement benefit(1)                    (29.0 )    (22.9 )
Derivative financial instruments(2)          (0.9 )        -
Expired significant broker contract             -          -
Adjusted EBITDA                       $     108.4    $  87.9




--------------------------------------------------------------------------------
(1)               Changes to related deferred taxes are included in income tax
expense.

(2)               Derivative financial instruments including unrealized

mark-to-market amounts and cash settlements realized.

                                                             Three Months Ended
                                                               September 30,
                                                           2012             2011
Diluted earnings per common share                      $        1.39    $        0.41
Tax agreement expense including tax impacts of IPO
and Secondary Offering                                         (0.58 )           0.20
Derivative financial instruments(1)                            (0.01 )              -
Expired significant broker contract                                -                -
Adjusted EPS                                           $        0.80    $        0.61
Weighted-average dilutive shares outstanding (in
millions)                                                       61.1             60.6



(1) Derivative financial instruments including unrealized mark-to-market amounts and cash settlements realized.

Results of Operations

"Owned and operated mines" refers to our three surface coal mines and excludes our 50% non-operating interest in the Decker mine. We include our share of results from operations at the Decker mine along with broker coal sales and services for both domestic and export sale transportation and delivery as "Other operations."

Revenues



The following table presents revenues (in millions except per ton amounts):



                                Three Months Ended
                                  September 30,             Change
                                 2012         2011     Amount    Percent
Owned and operated mines
Revenue                       $    323.7    $  314.6   $   9.2       2.9
Realized price per ton sold   $    13.28    $  12.91   $  0.37       2.9
Tons sold                           24.4        24.4         -         -

Other operations
Revenue                       $    102.2    $   92.4   $   9.8      10.6


Table of Contents

The increase in revenue from our owned and operated mines was the result of an increase to our realized price per ton sold in 2012 compared to 2011. This increase is the result of prices committed and fixed in earlier years. Since the fourth quarter of 2011, coal prices have fallen due to a warm winter and low natural gas prices. This will negatively impact our future realized prices.

Revenues from other operations increased primarily as a result of higher realized prices on the Asian export tons sold. Coal sold on a delivered basis, both domestic and export sales, have delivered pricing terms that include logistic services and rail and port charges. We arranged and paid for the logistic services and rail and port charges and charged our customers for providing this service. This increase was offset by fewer broker coal sales in 2012 as compared to 2011. Revenues from the Decker mine were not significantly different between the respective periods.

Cost of Product Sold



The following table presents cost of product sold (in millions except per ton
amounts):



                              Three Months Ended
                                September 30,             Change
                               2012         2011     Amount    Percent
Owned and operated mines
Cost of product sold        $    222.9    $  223.5   $  (0.7 )    (0.3 )
Average cost per ton sold   $     9.14    $   9.17   $ (0.03 )    (0.4 )

Other operations
Cost of product sold        $     79.1    $   83.0   $  (3.9 )    (4.7 )

Cost of product sold decreased slightly as a result of lower diesel consumption, explosives and outside services expenditures, partially offset by higher labor and tire costs.

Cost of product sold from other operations decreased primarily due to lower rail and port charges incurred and lower broker costs.

Operating Income

The following table presents operating income (in millions):

Three Months Ended September 30, Change 2012 2011 Amount Percent Operating income $ 81.6 $ 60.2 $ 21.5 35.7

The increase in operating income was primarily due to the higher revenues and lower costs noted above. These were partially offset by higher selling, general and administrative costs due to additional labor related costs including health insurance and stock-based compensation, and additional governmental affairs and community relations expenditures.

Other Income (Expense)



The following table presents other income (expense) (in millions):



                                  Three Months Ended
                                    September 30,             Change
                                   2012         2011     Amount    Percent
Other income (CPE Inc.)         $      17.2    $  16.1   $   1.1       6.9

Other expense (CPE Resources)   $     (11.8 )  $  (6.8 ) $  (5.0 )    73.6

Other income for CPE Inc. was primarily impacted by a reduction in our tax agreement liability. In the third quarter of each year, we update our estimates of the undiscounted liability over the remaining lives of our mines owed to Rio Tinto


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Energy America, Inc. ("Rio Tinto") under the Tax Receivable Agreement. In the three months ended September 30, 2012, this resulted in a $29.0 million benefit as compared to a $22.9 million benefit for the three months ended September 30, 2011. See Note 7 of notes to unaudited condensed consolidated financial statements in Item 1. In addition, other income was partially offset by a $4.9 million increase in interest expense due to a reduction in the amount of interest capitalized in the current period.

Other expense for CPE Resources increased due to a $4.9 million increase in interest expense caused by a reduction in the amount of interest capitalized in the current period.

Income Tax Provision



The following table presents income tax provision (in millions):



                                                 Three Months Ended
                                                   September 30,             Change
                                                  2012         2011     Amount    Percent
Income tax benefit (expense) (CPE Inc.)        $    (13.6 )  $  (52.2 ) $  38.6     (73.9 )
Effective tax rate (CPE Inc.)                        13.8 %      68.4 %   (54.7 )   (79.9 )

Income tax benefit (expense) (CPE Resources)   $     (3.2 )  $  (45.3 ) $  42.1     (93.0 )
Effective tax rate (CPE Resources)                    4.5 %      84.8 %   (80.3 )   (94.7 )

Our statutory income tax rate, including state income taxes, is 36%. The difference between the statutory income tax rate and our effective tax rate for the three months ended September 30, 2012 and 2011 is due primarily to changes in our deferred tax valuation allowance resulting from the third quarter annual calculation of our estimate of future taxable income.

Nine Months Ended September 30, 2012 Compared to Nine Months Ended September 30, 2011

Summary



The following table summarizes key results (in millions):



                       Nine Months Ended
                         September 30,            Change
                       2012        2011      Amount    Percent
Total revenue        $ 1,141.9   $ 1,151.2   $  (9.2 )    (0.8 )
Net income               145.6       146.0      (0.4 )    (0.3 )
Adjusted EBITDA(1)       249.8       258.8      (9.0 )    (3.5 )
Adjusted EPS(1)      $    1.62   $    1.78   $ (0.16 )    (9.2 )
Asian export tons          3.5         3.7      (0.2 )    (5.0 )
Total tons sold           68.7        72.8      (4.0 )    (5.6 )



(1) Non-GAAP measure; please see definition in Adjusted EBITDA and Adjusted EPS section above and reconciliation below.


Table of Contents

Adjusted EBITDA and Adjusted EPS (CPE Inc. only)



The following tables present a reconciliation of net income to Adjusted EBITDA
and diluted earnings (loss) per common share to Adjusted EPS (in millions,
except per share amounts):



                                        Nine Months Ended
                                          September 30,
                                         2012        2011
Net income                            $    145.6    $ 146.0
Interest income                             (0.9 )     (0.5 )
Interest expense                            25.5       27.5
Income tax expense (benefit)                47.5       (2.0 )
Depreciation and depletion                  70.3       58.5
Accretion                                    9.3        9.4
EBITDA                                     297.2      238.9
Tax agreement expense(1)                   (29.0 )     19.9
Derivative financial instruments(2)        (18.5 )        -
Expired significant broker contract            -          -
Adjusted EBITDA                       $    249.8    $ 258.8




--------------------------------------------------------------------------------
(1)               Changes to related deferred taxes are included in income tax
expense.

(2)               Derivative financial instruments including unrealized

mark-to-market amounts and cash settlements realized.

                                                             Nine Months Ended
                                                               September 30,
                                                           2012             2011
Diluted earnings per common share                      $        2.39    $        2.41
Tax agreement expense including tax impacts of IPO
and Secondary Offering                                         (0.58 )          (0.63 )
Derivative financial instruments(1)                            (0.19 )              -
Expired significant broker contract                                -                -
Adjusted EPS                                           $        1.62    $        1.78
Weighted-average dilutive shares outstanding (in
millions)                                                       60.9             60.6



(1) Derivative financial instruments including unrealized mark-to-market amounts and cash settlements realized.

Results of Operations

"Owned and operated mines" refers to our three surface coal mines and excludes our 50% non-operating interest in the Decker mine. We include our share of results from operations at the Decker mine along with broker coal sales and services for both domestic and export sale transportation and delivery as "Other operations."

Revenues



The following table presents revenues (in millions except per ton amounts):



                                Nine Months Ended
                                  September 30,            Change
                                 2012        2011     Amount    Percent
Owned and operated mines
Revenue                       $    887.0    $ 907.3   $ (20.4 )    (2.2 )
Realized price per ton sold   $    13.24    $ 12.88   $  0.36       2.8
Tons sold                           67.0       70.5      (3.4 )    (4.9 )

Other operations
Revenue                       $    254.9    $ 243.9   $  11.0       4.5


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