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ACI > SEC Filings for ACI > Form 10-K on 28-Feb-2014All Recent SEC Filings

Show all filings for ARCH COAL INC

Form 10-K for ARCH COAL INC


28-Feb-2014

Annual Report


ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

Overview

The weakness in global coal markets continued throughout 2013, impacting our results primarily due to lower metallurgical coal pricing and lower metallurgical coal sales volumes in our Appalachian segment. Both metallurgical coal and international thermal coal markets remain oversupplied, which will continue to impact our operations in 2014. We exported 11.4 million tons in 2013, compared to approximately 13.6 million tons in 2012. We expect our export shipments to decline in 2014. We expect that international demand for metallurgical and thermal coal will continue to grow in 2014. As global coal growth projects cease and reserves deplete, we expect that excess supply will be absorbed by growing international demand for coal, ultimately leading to more balanced markets over time.

At the same time, trends relating to the domestic thermal coal markets are improving. According to internal estimates, U.S. coal consumption for power generation rose by more than 35 million tons in 2013, while U.S. coal production of 984 million tons reached its lowest level since the early 1990's. As a result, U.S. power generator coal stockpiles built during 2012 fell meaningfully over the course of the year. The cold weather across much of the country in the winter of 2013/2014 should contribute further to the liquidation of these stockpiles. In addition, natural gas prices have increased compared with prior year, which we believe ensures that most domestic coal is competitively priced for power generation. Thermal coal market recovery has not been even amongst the coal basins, primarily due to a higher-cost Appalachian coal basin. We recorded fixed asset impairment charges related to certain mining and other operations in the Appalachia region of approximately $126.4 million and goodwill impairment charges of $265.4 million during 2013. See "Results of operations" for further discussion.

Management has continued to focus on capital spending reductions, cost containment and efficiency efforts and working capital and liquidity management to improve cash flows and prepare the company to capitalize on opportunities when coal markets recover.

As part of a strategy to divest non-core thermal coal assets, on August 16, 2013, we sold Canyon Fuel Company, LLC ("Canyon Fuel") to Bowie Resources, LLC for $422.7 million. Canyon Fuel operated the Sufco and Skyline longwall mining complexes and the Dugout Canyon continuous miner operation in Utah. We recognized a gain on the sale of Canyon Fuel, net of tax, of $77.0 million. See Note 3 to the consolidated financial statements, "Discontinued Operations," for further information.


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Operational Performance

    The following table shows operating results of continuing coal operations
for the years ended December 31, 2013, 2012, and 2011. The "other" category
includes the results of our other bituminous thermal operations, our West Elk
mining complex in Colorado and our Viper mining complex in Illinois.

                                                     Year Ended December 31,
                                                  2013        2012        2011
      Powder River Basin
      Tons sold (in thousands)                    111,654     104,394     117,846
      Coal sales realization per ton sold(1)    $   12.44   $   13.61   $   13.62
      Cost per ton sold                         $   12.16   $   12.77   $   12.11
      Operating margin per ton sold(2)          $    0.28   $    0.84   $    1.51
      Adjusted EBITDA(3) (in thousands)         $ 209,211   $ 265,231   $ 370,423
      Appalachia
      Tons sold (in thousands)                     14,224      18,717      20,874
      Coal sales realization per ton sold(1)    $   73.07   $   85.42   $   84.52
      Cost per ton sold                         $   80.54   $   83.17   $   70.88
      Operating margin (loss) per ton sold(2)   $   (7.47 ) $    2.25   $   13.64
      Adjusted EBITDA(3) (in thousands)         $  84,201   $ 395,806   $ 468,806
      Other
      Tons sold (in thousands)                      8,422       8,820       6,952
      Coal sales realization per ton sold(1)    $   32.63   $   34.39   $   36.11
      Cost per ton sold                         $   27.49   $   26.99   $   28.98
      Operating margin per ton sold(2)          $    5.14   $    7.40   $    7.13
      Adjusted EBITDA(3) (in thousands)         $  97,489   $ 121,396   $  89,844


--------------------------------------------------------------------------------
    (1)


These per-ton measurements reflect classification adjustments to numbers reported under U.S. GAAP to reflect the results we achieved within our operating segments. Since other companies may calculate these per ton amounts differently, our calculation may not be comparable to similarly titled measures used by those companies.

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

(3)
Adjusted EBITDA is defined as net income or loss attributable to the segment before the effect of net interest expense, income taxes, depreciation, depletion and amortization and the amortization of acquired sales contracts. Adjusted EBITDA may also be adjusted for items that may not reflect the trend of future results.


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Segment Adjusted EBITDA is reconciled to net income (loss) at the end of this "Results of Operations" section.

                                                                   Year Ended December 31,
Reconciliation to amounts reported in statement of operations      2013        2012      2011
Transportation costs netted against per-ton realizations to
reflect netback price to the region
Powder River Basin                                               $    0.84    $  1.00   $ 0.36
Appalachia                                                       $    8.22    $ 11.18   $ 7.22
Other                                                            $   14.13    $ 17.00   $ 9.30
API-2 risk management position settlements included in
per-ton realizations not classified as coal sales revenues in
statement of operations
Appalachia                                                       $    0.74    $  0.78   $    -
Other                                                            $    2.61    $  2.64   $    -
Diesel risk management position settlements not classified as
cost of coal sales in statement of operations
Powder River Basin                                               $    0.10    $  0.09   $    -
Appalachia                                                       $    0.25    $  0.10   $    -

Powder River Basin-Segment Adjusted EBITDA decreased in 2013 when compared to 2012 due to continued weak coal market conditions, which resulted in lower per-ton realizations. The increase in coal consumption by electric generation facilities contributed to an increase of 7% in sales volumes. Per-ton costs decreased 5% in 2013 when compared with 2012 as a result of cost control efforts and the increase in sales volumes, as well as a decrease in production taxes and royalties that fluctuate with selling prices ($0.24 per ton).

Segment Adjusted EBITDA decreased in 2012 when compared to 2011, due to the lower sales volumes from the production curtailments in response to market conditions, and the resulting higher per-ton cash costs.

Appalachia-Segment Adjusted EBITDA decreased significantly in 2013 when compared to 2012 due to the weaker coal market conditions, which resulted in lower coal sales volumes and also lower average coal pricing. The decrease in pricing was particularly pronounced on metallurgical coal shipments. We sold 6.8 million tons of metallurgical-quality coal in 2013 compared to 7.5 million tons in 2012. Part of the volume differential in Appalachia was due to geologic issues at the Mountain Laurel mine, which we expect to continue through the first quarter of 2014. Per-ton costs have decreased, despite the significant decrease in sales volumes, as we closed higher-cost coal operations in 2012 in response to the challenging market conditions, which contributed approximately $5 to cost per ton in 2012. In addition, our cost containment and efficiency efforts contributed to lower costs in 2013, as did a decrease in production taxes and royalties that fluctuate with selling prices, which decreased $1.07 per ton in 2013 when compared with 2012.

Operating margins decreased in 2012 when compared with 2011 due to the impacts of lower production levels as a result of mine closures and other production rationalization, including an extended longwall move at the Mountain Laurel complex. The extended longwall move at the Mountain Laurel complex reflected our move to the current seam. We sold 7.5 million tons of metallurgical-quality coal in 2012 compared to 7.4 million tons in 2011. Reduced operating margins were offset by a benefit in Adjusted EBITDA from the $79.5 million decrease in a legal contingent liability acquired with ICG.

Other-EBITDA and margins were higher in 2012 as a result of lower production costs stemming from improved cost control, higher sales volumes from lower costs mines and and reductions to accruals for sales-sensitive costs. In 2013, margins and EBITDA were impacted by lower price realizations due to the weak thermal coal markets.


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Results of Operations

The following tables reflect the amounts as presented in our consolidated statements of operations. Individual line items exclude the results of Canyon Fuel, including the gain on the sale, as those amounts are presented as one line item, "Income from discontinued operations, including gain on sale-net of tax", in the consolidated statements of operations.

Year Ended December 31, 2013 Compared to Year Ended December 31, 2012

Summary. Our results during the year ended December 31, 2013, when compared to the year ended December 31, 2012, were impacted by weak market conditions and related impairment charges in both 2013 and 2012, in part offset by the gain on the sale of Canyon Fuel in 2013.

Revenues. Our revenues consist of coal sales and revenues from our ADDCAR subsidiary.

Coal sales. The following table compares information about coal sales during the year ended December 31, 2013 with the information for the year ended December 31, 2012:

                           Year Ended December 31,
                             2013           2012        Increase (Decrease)
                                           (In thousands)
            Coal sales    $  3,000,476   $ 3,747,971     $          (747,495 )
            Tons sold          134,300       131,931                   2,369

Coal sales decreased approximately 20% in 2013 compared with 2012 due to lower realized prices. Lower average realizations per ton sold, the result of the weak coal markets, including a decrease in export sales, and a lower percentage of higher-priced coal sales out of Appalachia, resulted in a decrease in coal sales revenues of approximately $456 million. The increase in sales volumes in our Powder River Basin segment ($99 million) was offset by the impact of lower volumes from Appalachia and other segments ($390 million).

Costs, expenses and other. The following table compares costs, expenses and other components of operating income for the year ended December 31, 2013 with the information for the year ended December 31, 2012:

                                         Year Ended December 31,         (Increase)
                                                                          Decrease
                                           2013           2012          in Net Loss
                                                    (Amounts in thousands)
Cost of sales (exclusive of items
shown separately below)                 $  2,663,136   $ 3,155,099     $        491,963
Depreciation, depletion and
amortization                                 426,442       492,211               65,769
Amortization of acquired sales
contracts, net                                (9,457 )     (25,189 )            (15,732 )
Change in fair value of coal
derivatives and coal trading
activities, net                                7,845       (16,590 )            (24,435 )
Coal derivative settlements,
non-hedging                                  (32,534 )     (43,990 )            (11,456 )
Asset impairment and mine closure
costs                                        220,879       539,182              318,303
Goodwill impairment                          265,423       330,680               65,257
Contract settlement resulting from
Patriot Coal bankruptcy                            -        58,335               58,335
Reduction in accrual related to
acquired litigation                                -       (79,532 )            (79,532 )
Selling, general and administrative
expenses                                     133,448       134,299                  851
Other operating expense (income),
net                                            2,316       (19,367 )            (21,683 )


Total costs, expenses and other         $  3,677,498   $ 4,525,138     $        847,640

Cost of sales. Our cost of sales decreased in 2013 from 2012 primarily due to lower average per-ton production costs ($409 million) , the result of a change in regional mix that reflects lower sales volumes from the Appalachia segment. In addition, transportation costs decreased $133 million in 2013 from 2012 due to a decrease


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in export shipments. The increase in sales volumes resulted in an increase of $42 million in cost of sales. These factors are discussed in detail in the "Operational performance" section.

Depreciation, depletion and amortization. When compared with 2012, depreciation, depletion and amortization costs decreased in 2013 due to asset impairments and the decreases in production in the Appalachia and other segments for the respective periods, including the impact of mine closures in 2012.

Change in fair value of coal derivatives and coal trading activities, net. The gains reflected in 2012 relate primarily to positions taken in 2012 in the API-2 market, the derivatives market for coal delivered into Europe. We entered into these positions taken in 2012 to manage price risk on physical export sales into Europe. As these positions are not accounted for as hedges, changes in the positions' fair value prior to settlement are recognized in this line on the consolidated statement of operations. When the positions settle, the realized gains and losses are reclassified to "Coal derivative settlements, non-hedging". The decrease from gains in 2012 to losses in 2013 is the result of a decrease in positions outstanding, due to settlements during the year.

Coal derivative settlements, non-hedging. These gains reflect the realized settlement income reclassified from the line "Change in fair value of coal derivatives and coal trading activities, net", and consist primarily of the realized gains on API-2 positions.

Asset impairment and mine closure costs. In response to market conditions, we recorded impairment charges in 2013 related to a Kentucky coal operation and our highwall mining equipment subsidiary. In addition, we recorded other-than-temporary impairment charges related to equity method investees. In 2012, we closed or idled five mining operations in response to market conditions. See further discussion in Note 5 ,"Impairment Charges and Mine Closure Costs", and Note 9, "Equity Method Investments and Membership Interests in Joint Ventures", to the consolidated financial statements.

Goodwill impairment. In 2012, we recognized an impairment charge of $115.8 million, the entire balance of goodwill allocated to our Black Thunder mining complex, due to expectations of lower thermal coal demand and its impact on near-term sales volumes and pricing, and $214.9 million related to two of four operating units that were allocated goodwill in the acquisition of ICG, due to a drop in near-term metallurgical coal prices. The remaining $265.4 million of goodwill from the ICG acquisition was impaired in the fourth quarter of 2013, as a result of continuing weakness in the metallurgical coal markets. See further discussion in "Critical Accounting Policies".

Contract settlement resulting from Patriot Coal bankruptcy. In the fourth quarter of 2012, Patriot Coal's rejection of their supply agreement with us was approved by the bankruptcy court. We then agreed to a settlement of a contract that had been supplied by Patriot Coal. We will make annual payments through 2017 under this obligation.

Reduction in accrual related to acquired litigation. As a result of a 2012 legal ruling in a lawsuit against former ICG subsidiaries, we changed our assessment of the probable loss related to the lawsuit. The suit is discussed in detail in Note 25 to the consolidated financial statements.

Selling, general and administrative expenses. Selling, general and administrative expenses in 2013 decreased slightly when compared with 2012, due to lower discretionary spending levels in 2013, which were partially offset by the impact of lower bonus and incentive plan costs in 2012 as certain performance targets were not achieved in 2012. Cost reductions in 2013 were achieved primarily through a decrease in industry group dues and fees of $6.4 million, and decreases in legal and other professional fees.

Other operating expense (income), net. When compared with 2012, liquidated damages on throughput commitments increased $9.4 million in 2013, commercial-related income decreased by $17.9 million, and gains on asset sales decreased from $11.8 million in 2012 to $4.6 million in 2013. These items were partially offset by a


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decrease in 2013 in unrealized losses relating to our diesel purchase and fuel surcharge risk management programs of $11.3 million.

Net interest expense. The following table summarizes our net interest expense for the year ended December 31, 2013 and compares it with the information for the year ended December 31, 2012:

                                     Year Ended December 31,      (Increase) Decrease
                                       2013            2012           in Net Loss
                                                     (In thousands)
  Interest expense                  $   (381,267 )  $ (317,615 )   $           (63,652 )
  Interest and investment income           6,603         5,473                   1,130


                                    $   (374,664 )  $ (312,142 )   $           (62,522 )

The increase in interest expense is due to an increase in our outstanding debt in 2013 when compared with 2012, primarily as a result of financing transactions completed during 2012, which resulted in a net increase in debt outstanding of over $1 billion.

Non-operating expense. The following table summarizes non-operating expense for the year ended December 31, 2013 and compares it with the information for the year ended December 31, 2012:

                                                            Year Ended
                                                           December 31,        Increase
                                                         2013        2012          $
                                                            (Amounts in thousands)
Net loss resulting from early retirement and
refinancing of debt                                    $ (42,921 ) $ (23,668 ) $ (19,253 )

Amounts reported as nonoperating consist of expenses resulting from financing activities, other than interest costs. In the fourth quarter of 2013, we retired our 8.75% senior notes due in 2016 and reduced the capacity of our revolving credit facility, in conjunction with a refinancing discussed in the "Liquidity" section. As a result, we paid a tender premium and wrote off unamortized discount and fees. During 2012, nonoperating expense consists primarily of the write-off of financing fees relating to decreases in our revolving credit facility capacity.

Income taxes. Our effective income tax rate is sensitive to changes in and the relationship between annual profitability and the deduction for percentage depletion.

                                              Year Ended
                                             December 31,
                                           2013         2012      Decrease
                                                  (In thousands)
            Benefit from income taxes     (335,498 )   (353,907 )   (18,409 )

In 2013 and 2012, our benefit was impacted by $70.3 million and $56.9 million, respectively, of non-deductible goodwill adjustments and $8.7 million and $31.8 million, respectively, to increase our valuation allowance against state and foreign tax carryforwards.

Income from discontinued operations, net of tax. Canyon Fuel's results and the $77.0 million gain from its sale in 2013, net of the related income tax impacts, are segregated from continuing operations.

                                                          Year Ended
                                                         December 31,
                                                       2013        2012     Increase
                                                              (In thousands)
   Income from discontinued operations, net of tax     103,396     55,228      48,168


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See Note 3 "Discontinued Operations", to the consolidated financial statements for further information.

Year Ended December 31, 2012 Compared to Year Ended December 31, 2011

Summary. Our results during 2012 when compared to 2011 were impacted substantially by weak market conditions which led us to rationalize supply through mine closures, idlings and production curtailments.

Revenues. Our revenues consist of coal sales and revenues from our ADDCAR subsidiary acquired with ICG.

The following table summarizes information about coal sales during the year ended December 31, 2012 and compares it with the information for the year ended December 31, 2011:

                           Year Ended December 31,
                             2012           2011        Increase (Decrease)
                                       (Amounts in thousands)
            Coal sales    $  3,747,971     3,877,749                (129,778 )
            Tons sold          131,931       145,672                 (13,741 )

Coal sales decreased 3% in 2012 from 2011, as we reduced production and closed mines in response to the weak market conditions. The impact of lower volumes (a decrease in coal sales of $342 million) was partially offset by higher coal sales realizations per ton (an increase of $212 million), as increased export activity resulted in higher selling prices. We have provided more information about the tons sold and the coal sales realizations per ton by operating segment under the heading "Operating segment results".

Costs, expenses and other. The following table summarizes costs, expenses and other components of operating income during the year ended December 31, 2012 and compares it with the information for the year ended December 31, 2011:

                                          Year Ended December 31,         Increase
                                                                         (Decrease)
                                            2012           2011         in Net Income
                                                    (Amounts in thousands)
Cost of sales (exclusive of items
shown separately below)                  $  3,155,099   $ 2,980,354     $      (174,745 )
Depreciation, depletion and
amortization                                  492,211       420,980             (71,231 )
Amortization of acquired sales
contracts, net                                (25,189 )     (22,069 )             3,120
Change in fair value of coal
derivatives and coal trading
activities, net                               (16,590 )      (2,907 )            13,683
Coal derivative settlements,
non-hedging                                   (43,990 )           7              43,997
Asset impairment and mine closure
costs                                         539,182         7,316            (531,866 )
Goodwill impairment                           330,680             -            (330,680 )
Contract settlement resulting from
Patriot Coal bankruptcy                        58,335             -             (58,335 )
Reduction in accrual related to
acquired litigation                           (79,532 )           -              79,532
Acquisition and transition costs                    -        47,360              47,360
Selling, general and administrative
expenses                                      134,299       119,056             (15,243 )
Other operating income, net                   (19,367 )     (10,119 )             9,248


Total costs, expenses and other          $  4,525,138   $ 3,539,978     $      (985,160 )

Cost of coal sales. Our cost of sales increased in 2012 from 2011 primarily from the impact of the acquisition of the ICG operations ($237.8 million) and an increase in transportation costs as a result of the increase in export shipments ($206.0 million). These factors were partially offset by the impact of lower thermal coal demand in all operating segments which resulted in our decision to close or idle mining operations and curtail production ($269.0 million).

Depreciation, depletion and amortization. When compared with 2011, higher depreciation, depletion and amortization costs in 2012 resulted primarily from the acquired ICG operations, partially offset by the impact of


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lower depreciation and amortization on assets amortized or depleted on the basis of tons produced, processed, or sold.

Amortization of acquired sales contracts, net. The fair values of acquired sales contracts are amortized over the tons of coal shipped during the term of the contracts. In 2011, amortization income of $41.5 million related to the contracts we acquired with the ICG operations was higher than what we recognized in 2012 due to the amortization of contracts whose term ended in 2011. Offsetting the amortization of the ICG contracts in 2011 was expense of $19.5 million related to contracts acquired with the Jacobs Ranch operations in the Powder River Basin in 2009.

Change in fair value of coal derivatives and coal trading activities, . . .

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