UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-Q

(Mark One)

þ		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the Quarterly Period Ended September 30, 2005

OR

o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                      to                     

ARCH COAL, INC.

Delaware (State or other jurisdiction of incorporation or organization)		43-0921172 (I.R.S. Employer Identification No.)

One CityPlace Drive, Suite 300, St. Louis, Missouri 63141
(Address of principal executive offices)(Zip Code)

Registrant’s telephone number, including area code: (314) 994-2700

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No o

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes þ No o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ

At November 8, 2005, there were 64,688,882 shares of registrant’s common stock outstanding.

 

 

INDEX

						PAGE
PART I. FINANCIAL INFORMATION
		Item 1. Financial Statements
				Condensed Consolidated Balance Sheets as of September 30, 2005 and December 31, 2004			1
				Condensed Consolidated Statements of Operations for the Three Months Ended September 30, 2005 and 2004 and the Nine Months Ended September 30, 2005 and 2004			2
				Condensed Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2005 and 2004			3
				Notes to Condensed Consolidated Financial Statements			4
		Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations					16
		Item 3. Quantitative and Qualitative Disclosures About Market Risk					41
		Item 4. Controls and Procedures					41
PART II. OTHER INFORMATION
		Item 1. Legal Proceedings					42
		Item 2. Changes in Securities, Use of Proceeds and Issues Purchasers of Equity Securities					42
		Item 3. Defaults Upon Senior Securities					42
		Item 4. Submission of Matters to a Vote of Security Holders					42
		Item 5. Other Information					42
		Item 6. Exhibits					42
Master Contribution Agreement
Certification of Principal Executive Officer Pursuant to Section 302
Certification of Principal Financial Officer Pursuant to Section 302
Certification of Principal Executive Officer Pursuant to 18 U.S.C. Section 1350
Certification of Principal Financial Officer Pursuant to 18 U.S.C. Section 1350

PART I — FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

ARCH COAL, INC. AND SUBSIDIARIES

		September 30,				December 31,
		2005				2004
		(Unaudited)
Assets
Current assets
Cash and cash equivalents		$	227,428			$	323,167
Trade receivables			252,031				180,902
Other receivables			30,377				34,407
Inventories			142,012				119,893
Prepaid royalties			8,341				12,995
Deferred income taxes			9,778				33,933
Other			24,512				25,560
Total current assets			694,479				730,857
Property, plant and equipment, net			2,117,463				2,033,200
Other assets
Prepaid royalties			103,741				87,285
Goodwill			40,032				37,381
Deferred income taxes			273,237				241,226
Other			116,950				126,586
Total other assets			533,960				492,478
Total assets		$	3,345,902			$	3,256,535
Liabilities and stockholders’ equity
Current liabilities
Accounts payable		$	183,526			$	148,014
Accrued expenses			213,009				217,216
Current portion of debt			3,124				9,824
Total current liabilities			399,659				375,054
Long-term debt			972,875				1,001,323
Accrued postretirement benefits other than pension			402,073				380,424
Asset retirement obligations			184,538				179,965
Accrued workers’ compensation			74,698				82,446
Other noncurrent liabilities			144,055				157,497
Total liabilities			2,177,898				2,176,709
Stockholders’ equity
Preferred stock			29				29
Common stock			647				631
Paid-in capital			1,343,082				1,280,513
Retained deficit			(157,979	)			(166,273	)
Unearned compensation			(3,140	)			(1,830	)
Treasury stock, at cost			(1,190	)			(5,047	)
Accumulated other comprehensive loss			(13,445	)			(28,197	)
Total stockholders’ equity			1,168,004				1,079,826
Total liabilities and stockholders’ equity		$	3,345,902			$	3,256,535

See notes to condensed consolidated financial statements.

ARCH COAL, INC. AND SUBSIDIARIES

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
		2005				2004				2005				2004
Revenues
Coal sales		$	654,716			$	527,776			$	1,888,978			$	1,354,043
Costs and expenses
Cost of coal sales			546,725				448,638				1,608,439				1,161,259
Depreciation, depletion and amortization			57,842				43,491				160,887				115,677
Selling, general and administrative expenses			20,285				12,729				60,540				39,358
Other operating expenses			15,150				13,746				40,695				26,243
			640,002				518,604				1,870,561				1,342,537
Other operating income
Income from equity investments			—				1,143				—				10,828
Gain on sale of units of Natural Resource Partners, LP			—				289				—				90,244
Other operating income			19,463				15,731				63,206				45,535
			19,463				17,163				63,206				146,607
Income from operations			34,177				26,335				81,623				158,113
Interest expense, net:
Interest expense			(17,994	)			(16,220	)			(55,454	)			(45,062	)
Interest income			2,109				1,110				5,635				2,723
			(15,885	)			(15,110	)			(49,819	)			(42,339	)
Other non-operating income (expense):
Expenses resulting from early debt extinguishment and termination of hedge accounting for interest rate swaps			(1,949	)			(2,066	)			(6,082	)			(6,199	)
Other			(1,567	)			461				(1,497	)			835
			(3,516	)			(1,605	)			(7,579	)			(5,364	)
Income before income taxes			14,776				9,620				24,225				110,410
(Benefit from) provision for income taxes			(4,150	)			(1,155	)			(4,750	)			18,545
Net income			18,926				10,775				28,975				91,865
Preferred stock dividends			(1,797	)			(1,797	)			(5,391	)			(5,391	)
Net income available to common shareholders		$	17,129			$	8,978			$	23,584			$	86,474
Earnings per common share
Basic earnings per common share		$	0.27			$	0.16			$	0.37			$	1.59
Diluted earnings per common share		$	0.26			$	0.16			$	0.37			$	1.48
Basic weighted average shares outstanding			63,858				54,874				63,382				54,431
Diluted weighted average shares outstanding			64,791				55,838				64,371				62,262
Dividends declared per share		$	0.0800			$	0.0800			$	0.2400			$	0.2175

See notes to condensed consolidated financial statements.

ARCH COAL, INC. AND SUBSIDIARIES

		Nine months Ended
		September 30,
		2005				2004
Operating activities
Net income		$	28,975			$	91,865
Adjustments to reconcile to cash provided by operating activities:
Depreciation, depletion and amortization			160,887				115,677
Prepaid royalties expensed			12,143				10,923
Accretion on asset retirement obligations			11,392				9,198
Net gain on disposition of assets			(29,882	)			(748	)
Gain on sale of units of Natural Resource Partners, LP			—				(90,244	)
Net distributions from equity investments			—				(10,828	)
Income from equity investments			—				17,678
Other nonoperating expense			7,579				5,364
Changes in:
Receivables			(66,799	)			(73,997	)
Inventories			(22,119	)			(5,324	)
Accounts payable and accrued expenses			30,965				(19,889	)
Income taxes			(1,511	)			(860	)
Accrued postretirement benefits other than pension			21,649				13,950
Asset retirement obligations			(6,819	)			(7,525	)
Accrued workers’ compensation benefits			(7,748	)			(1,030	)
Federal income tax receipts			14,701				—
Other			9,615				(14,404	)
Cash provided by operating activities			163,028				39,806
Investing activities
Payments for acquisitions, net of cash acquired			—				(381,905	)
Capital expenditures			(248,906	)			(243,566	)
Proceeds from sale of units of Natural Resource Partners, LP			—				105,365
Proceeds from dispositions of capital assets			30,183				1,279
Additions to prepaid royalties			(23,945	)			(27,171	)
Cash used in investing activities			(242,668	)			(545,998	)
Financing activities
Net proceeds from (payments on) revolver and lines of credit			(25,000	)			250,426
Net payments on long-term debt			(9,125	)			(6,300	)
Deferred financing costs			(2,631	)			(1,160	)
Dividends paid			(20,681	)			(17,249	)
Proceeds from issuance of common stock			41,338				30,732
Cash provided by (used in) financing activities			(16,099	)			256,449
Decrease in cash and cash equivalents			(95,739	)			(249,743	)
Cash and cash equivalents, beginning of period			323,167				254,541
Cash and cash equivalents, end of period		$	227,428			$	4,798

See notes to condensed consolidated financial statements.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Note A – General

The accompanying unaudited Condensed Consolidated Financial Statements have been prepared in accordance with generally accepted accounting principles for interim financial reporting and Securities and Exchange Commission regulations, but are subject to any year-end adjustments that may be necessary. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Results of operations for the period ended September 30, 2005 are not necessarily indicative of results to be expected for the year ending December 31, 2005. These financial statements should be read in conjunction with the audited financial statements and related notes thereto as of and for the year ended December 31, 2004 included in Arch Coal, Inc.’s Annual Report on Form 10-K as filed with the Securities and Exchange Commission.

Arch Coal, Inc. (the “Company”) is engaged in the production of steam and metallurgical coal from surface and deep mines throughout the United States, for sale to utility, industrial and export markets. The Company’s mines are primarily located in the Powder River Basin, Central Appalachia and Western Bituminous regions of the United States. All subsidiaries (except as noted below) are wholly owned. Intercompany transactions and accounts have been eliminated in consolidation.

The Company’s Wyoming, Colorado and Utah coal operations are included in a joint venture named Arch Western Resources, LLC (“Arch Western”). Arch Western is 99% owned by the Company and 1% owned by BP Amoco. The Company also acts as the managing member of Arch Western.

On July 31, 2004, the Company acquired the remaining 35% of Canyon Fuel Company, LLC (“Canyon Fuel”) that it did not already own. See Note C – “Business Combinations” for further discussion. Income from Canyon Fuel through July 31, 2004 is reflected in the Condensed Consolidated Statements of Operations as income from equity investments (see additional discussion in Note E – “Equity Investments”).

Note B – Recent Accounting Pronouncements

On March 30, 2005, the Financial Accounting Standards Board (“FASB”) ratified the consensus reached by the Emerging Issues Task Force (“EITF”) on issue No. 04-6, Accounting for Stripping Costs in the Mining Industry. This issue applies to stripping costs incurred in the production phase of a mine for the removal of overburden or waste materials for the purpose of obtaining access to coal that will be extracted. Under the new rule, stripping costs incurred during the production phase of the mine are variable production costs that are included in the cost of inventory produced and extracted during the period the stripping costs are incurred. Historically, the Company has associated stripping costs at its surface mining operations with the cost of tons of coal uncovered and has classified tons uncovered but not yet extracted as coal inventory (pit inventory). Pit inventory, reported as coal inventory in Note H, was $38.3 million at September 30, 2005. The guidance in this EITF consensus is effective for fiscal years beginning after December 15, 2005 for which the cumulative effect of adoption should be recognized as an adjustment to the beginning balance of retained earnings during the period. The Company expects to adopt the change as of January 1, 2006.

Note C – Business Combinations

Canyon Fuel 35% Acquisition

On July 31, 2004, the Company purchased the 35% interest in Canyon Fuel that it did not own from ITOCHU Corporation. The purchase price, including related costs and fees, of $112.2 million was funded with cash of $90.2 million and a five-year, $22.0 million non-interest bearing note. Net of cash acquired, the fair value of the transaction totaled $97.4 million. The Company owns substantially all of the ownership interests of Canyon Fuel and consolidates Canyon Fuel in its financial statements. Prior to July 31, 2004, the investment in Canyon Fuel was accounted for on the equity method. The results of operations of the Canyon Fuel mines are included in the Company’s Western Bituminous segment.

The purchase accounting allocation related to the acquisition has been recorded in the accompanying consolidated financial statements as of, and for the period subsequent to, July 31, 2004. The following table summarizes the fair values of the assets acquired and the liabilities assumed at the date of acquisition (dollars in thousands):

Accounts receivable		$	7,432
Materials and supplies			3,751
Coal inventory			7,434
Other current assets			6,466
Property, plant, equipment and mine development			125,881
Accounts payable and accrued expenses			(10,379	)
Coal supply agreements			(33,378	)
Other noncurrent assets and liabilities, net			(9,823	)
Total purchase price, net of cash received of $11.0 million		$	97,384

Amounts allocated to coal supply agreements noted in the table above represent the liability established for the net below-market coal supply agreements to be amortized over the remaining terms of the contracts. The liability is classified as an other noncurrent liability on the accompanying Condensed Consolidated Balance Sheet. The remaining amortization period on these acquired coal supply agreements ranges from three to 39 months.

Triton Acquisition

On August 20, 2004, the Company acquired (1) Vulcan Coal Holdings, L.L.C., which owns all of the common equity of Triton Coal Company, LLC (“Triton”), and (2) all of the preferred units of Triton, for a purchase price of $382.1 million, including transaction costs and working capital adjustments. In 2003, Triton was the nation’s sixth largest coal producer and operated two mines in the Powder River Basin: North Rochelle and Buckskin. Following the consummation of the transaction, the Company completed an agreement to sell Buckskin to Kiewit Mining Acquisition Company. The net sales price for this second transaction was $73.1 million. The total purchase price, including related costs and fees, was funded with cash on hand, including the proceeds from the Buckskin sale, $22.0 million in borrowings under the Company’s existing revolving credit facility and a $100.0 million term loan at its Arch Western Resources subsidiary. Upon acquisition, the Company integrated the North Rochelle mine with its existing Black Thunder mine in the Powder River Basin.

The purchase accounting allocations related to the acquisition have been recorded in the accompanying consolidated financial statements as of, and for the periods subsequent to August 20, 2004. The following table summarizes the fair values of the assets acquired and the liabilities assumed at the date of acquisition (dollars in thousands):

Accounts receivable		$	14,233
Materials and supplies			4,161
Coal inventory			4,875
Other current assets			2,200
Property, plant, equipment and mine development			325,194
Coal supply agreements			8,486
Goodwill			40,032
Accounts payable and accrued expenses			(72,326	)
Other noncurrent assets and liabilities, net			(22,135	)
Total purchase price, net of cash received of $0.4 million		$	304,720

Amounts allocated to coal supply agreements noted in the table above represent the value attributed to the net above-market coal supply agreements to be amortized over the remaining terms of the contracts. The remaining amortization period on these acquired coal supply agreements ranges from three to 15 months.

Pro Forma Financial Information

If Triton and Canyon Fuel had been included in the Company’s results of operations during the three months ended September 30, 2004, its unaudited pro forma revenues would have been $570.9 million, unaudited pro forma net income available to common shareholders would have been $2.4 million and unaudited pro forma basic and diluted earnings per share would both have been $0.04. If Triton and Canyon Fuel had been included in the Company’s results of operations during the nine months ended September 30, 2004, its unaudited pro forma revenues would have been $1,605.8 million, unaudited pro forma net income available to common shareholders would have been

$73.6 million and unaudited pro forma basic and diluted earnings per share would have been $1.35 and $1.18, respectively.

Note D – Stock-Based Compensation

These interim financial statements include the disclosure requirements of Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation (“FAS 123”), as amended by Statement of Financial Accounting Standards No. 148, Accounting for Stock-Based Compensation — Transition and Disclosure (“FAS 148”). With respect to accounting for its stock options, as permitted under FAS 123, the Company has retained the intrinsic value method prescribed by Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (“APB 25”), and related Interpretations. Had compensation expense for stock option grants been determined based on the fair value at the grant dates consistent with the method required by FAS 123, the Company’s net income available to common shareholders and earnings per common share would have been changed to the pro forma amounts as indicated in the following table:

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
		2005				2004				2005				2004
		(in thousands, except per share data)
Net income available to common shareholders, as reported		$	17,129			$	8,978			$	23,584			$	86,474
Add:
Stock-based employee compensation included in reported net income, net of related tax effects			101				495				8,718				1,342
Deduct:
Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects			(1,122	)			(1,829	)			(11,767	)			(5,474	)
Pro forma net income available to common shareholders		$	16,108			$	7,644			$	20,535			$	82,342
Earnings per share:
Basic earnings per share — as reported			0.27				0.16				0.37				1.59
Basic earnings per share — pro forma			0.25				0.14				0.32				1.51
Diluted earnings per share — as reported			0.26				0.16				0.37				1.48
Diluted earnings per share — pro forma			0.25				0.14				0.32				1.41

In December 2004, the FASB issued Statement of Financial Accounting Standards No. 123 (revised 2004), “Share-Based Payment” (“FAS 123R”), which requires all public companies to measure compensation cost in the income statement for all share-based payments (including employee stock options) at fair value for interim and annual periods. On April 14, 2005, the Securities and Exchange Commission (“SEC”) delayed the implementation of FAS 123R from its original implementation date by six months for most registrants, requiring all public companies to adopt FAS 123R no later than the beginning of the first fiscal year beginning after June 15, 2005. As such, the Company intends to adopt FAS 123R on January 1, 2006 using the modified-prospective method. FAS 123R also requires the benefits of tax deductions in excess of recognized compensation cost to be reported as a financing cash flow, rather than as an operating cash flow as required under current literature. This requirement will reduce net operating cash flows and increase net financing cash flows in periods after adoption. The Company does not expect a material impact on its results of operations after the date of adoption.

On January 14, 2004, the Company granted an award of 220,766 shares of performance-contingent phantom stock that vested in the event the Company’s stock price reached an average pre-established price over a period of 20 consecutive trading days within five years following the date of grant. On March 3, 2005, the price contingency discussed above was met, and the award was paid in a combination of Company stock ($7.3 million) and cash ($2.6 million). As such, the Company recognized a $9.9 million charge as a component of selling, general and administrative expense ($9.1 million) and cost of coal sales ($0.8 million) in the accompanying Condensed Consolidated Statements of Operations in the first quarter of 2005.

In the third quarter 2005, the Company’s Board of Directors approved a performance-contingent phantom stock plan for 11 of its executives. The plan allows for participants to earn up to 252,600 units to be paid out in both cash and stock upon simultaneous attainment of certain levels of stock price and EBITDA, as defined by the company. No expense related to this grant has been recognized as the Company is unable to assess the probability of achieving the

performance and market targets under APB25. The Company is continuing to determine the pro forma impact under FAS 123R, however, does not believe such impact will be material.

Note E – Equity Investments

At September 30, 2005, the Company no longer held equity investments. The Company purchased the remaining 35% interest in Canyon Fuel on July 31, 2004. Prior to July 31, 2004, the Company accounted for its investment in Canyon Fuel on the equity method. In addition, on March 10, 2004, the Company sold the majority of its interest in Natural Resource Partners, LP (“NRP”). Prior to March 10, 2004, the Company accounted for its investment in NRP on the equity method. Amounts recorded in the Condensed Consolidated Statements of Operations are as follows:

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
		2005				2004				2005				2004
						(in thousands)
Income from equity investments:
Income from investment in Canyon Fuel		$	—			$	1,143			$	—			$	8,410
Income from NRP			—				—				—				2,418
Income from equity investments as reported in the Condensed Consolidated Statements of Operations		$	—			$	1,143			$	—			$	10,828

Investment in Canyon Fuel

The following table presents unaudited summarized financial information for Canyon Fuel:

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
Condensed Income Statement Information		2005				2004				2005				2004
		(in thousands)
Revenues		$	—			$	20,186			$	—			$	142,893
Total costs and expenses			—				18,791				—				133,546
Net income before cumulative effect of accounting change		$	—			$	1,395			$	—			$	9,347
65% of Canyon Fuel net income before cumulative effect of accounting change		$	—			$	906			$	—			$	6,075
Effect of purchase adjustments			—				237				—				2,335
Arch Coal’s income from its equity investment in Canyon Fuel		$	—			$	1,143			$	—			$	8,410

Through July 31, 2004, the Company’s income from its equity investment in Canyon Fuel represented 65% of Canyon Fuel’s net income after adjusting for the effect of purchase adjustments related to its investment in Canyon Fuel. The Company’s investment in Canyon Fuel reflected purchase adjustments primarily related to the reduction in amounts assigned to sales contracts, mineral reserves and other property, plant and equipment. The purchase adjustments were amortized consistent with the underlying assets of the joint venture.

Investment in NRP

During 2004, the Company sold its remaining limited partnership units of NRP in three separate transactions occurring in March, June and October. Specifically during the nine months ended September 30, 2004, the Company sold the majority of its remaining limited partnership units of NRP for proceeds of approximately $105.4 million. The sale resulted in a gain of $90.2 million.

Note F – Employee Benefit Plans

Defined Benefit Pension and Other Postretirement Benefit Plans

The Company has non-contributory defined benefit pension plans covering certain of its salaried and non-union hourly employees. Benefits are generally based on the employee’s years of service and compensation. The Company funds the plans in an amount not less than the minimum statutory funding requirements nor more than the maximum amount that can be deducted for federal income tax purposes.

The Company also currently provides certain postretirement medical/life insurance coverage for eligible employees. Generally, covered employees who terminate employment after meeting eligibility requirements are eligible for postretirement coverage for themselves and their dependents. The salaried employee postretirement medical/life plans are contributory, with retiree contributions adjusted periodically, and contain other cost-sharing features such as deductibles and coinsurance. The postretirement medical plan for retirees who were members of the United Mine Workers of America (“UMWA”) is not contributory. The Company’s current funding policy is to fund the cost of all postretirement medical/life insurance benefits as they are paid.

Components of Net Periodic Benefit Cost

The following table details the components of pension and other postretirement benefit costs.

										Other postretirement
		Pension benefits								benefits
Three Months Ended September 30,		2005				2004				2005				2004
		(in thousands)
Service cost		$	2,304			$	2,396			$	1,364			$	1,089
Interest cost			2,416				3,009				7,967				7,461
Expected return on plan assets*			(3,334	)			(3,698	)			—				—
Other amortization and deferral			2,195				1,227				6,470				4,159
		$	3,581			$	2,934			$	15,801			$	12,709

										Other postretirement
		Pension benefits								benefits
Nine Months Ended September 30,		2005				2004				2005				2004
		(in thousands)
Service cost		$	8,303			$	6,311			$	3,906			$	2,989
Interest cost			9,112				8,616				23,663				22,185
Expected return on plan assets*			(11,579	)			(10,672	)			—				—
Other amortization and deferral			5,545				3,541				19,003				12,539
		$	11,381			$	7,796			$	46,572			$	37,713

Employer Contributions

The Company contributed 273,000 shares of treasury stock in August 2005. The Company has no minimum contribution required.

Note G – Other Comprehensive Income

Other comprehensive income items under FAS 130, Reporting Comprehensive Income, are transactions recorded in stockholders’ equity during the year, excluding net income and transactions with stockholders. The following table presents comprehensive income:

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
		2005				2004				2005				2004
						(in thousands)
Net income		$	18,926			$	10,775			$	28,975			$	91,865
Other comprehensive income, net of income taxes			6,211				1,904				14,752				7,594
Total comprehensive income		$	25,137			$	12,679			$	43,727			$	99,459

Other comprehensive income for the three and nine months ended September 30, 2005 and 2004 consists primarily of the reclassification of previously deferred mark-to-market adjustments from other comprehensive income to net income and mark-to-market adjustments related to the Company’s financial derivatives which still qualify as effective hedges.

Note H – Inventories

Inventories consist of the following:

		September 30,				December 31,
		2005				2004
		(in thousands)
Coal		$	80,308			$	76,009
Repair parts and supplies			61,704				43,884
		$	142,012			$	119,893

Note I – Debt

Debt consists of the following:

		September 30,				December 31,
		2005				2004
		(in thousands)
Indebtedness to banks under revolving credit agreement, expiring December 22, 2009		$	—			$	25,000
6.75% senior notes ($950.0 million face value) due July 1, 2013			960,589				961,613
Promissory note			15,405				17,523
Other			5				7,011
			975,999				1,011,147
Less current portion			3,124				9,824
Long-term debt		$	972,875			$	1,001,323

On December 22, 2004, the Company entered into a $700.0 million revolving credit facility that matures on December 22, 2009. The rate of interest on borrowings under the credit facility is a floating rate based on LIBOR. The Company’s credit facility is secured by substantially all of its assets as well as its ownership interests in substantially all of its subsidiaries, except its ownership interests in Arch Western and its subsidiaries. The credit facility replaced the Company’s existing $350.0 million revolving credit facility. At September 30, 2005, the Company had $106.2 million in letters of credit outstanding, resulting in $593.8 million of unused borrowings under the revolver. Financial covenant requirements may restrict the amount of unused capacity available to the Company for borrowings and letters of credit. As of September 30, 2005, the Company was not restricted by financial covenants.

On October 22, 2004, the Company issued $250.0 million of 6.75% Senior Notes due 2013 at a price of 104.75% of par. Interest on the notes is payable on January 1 and July 1 of each year, beginning on January 1, 2005. The senior notes were issued under an indenture dated June 25, 2003, under which the Company previously issued $700.0 million of 6.75% Senior Notes due 2013. The senior notes are guaranteed by Arch Western and certain of Arch Western’s subsidiaries and are secured by a security interest in loans made to Arch Coal by Arch Western. The terms of the senior notes contain restrictive covenants that limit Arch Western’s ability to, among other things, incur additional debt, sell or transfer assets, and make certain investments.

On July 31, 2004, the Company issued a five-year, $22.0 million non-interest bearing note to help fund the Canyon Fuel acquisition. At its issuance, the note was discounted to its present value using a rate of 7.0%. The promissory note is payable in quarterly installments of $1.0 million through July 2008 and $1.5 million from October 2008 through July 2009.

Note J – Contingencies

The Company is a party to numerous claims and lawsuits with respect to various matters. The Company provides for costs related to contingencies when a loss is probable and the amount is reasonably determinable. After conferring with counsel, it is the opinion of management that the ultimate resolution of these claims, to the extent not provided

for, will not have a material adverse effect on the consolidated financial position, results of operations or liquidity of the Company.

Note K – Transactions or Events Affecting Comparability of Reported Results

During the third quarter of 2005, the Company recognized a gain of $9.0 million on the sale of surface land rights at its Central Appalachian operations in West Virginia. The gain is reported as other operating income in the accompanying Condensed Consolidated Statements of Operations.

During the third quarter, contingencies relating to the outcome of certain lawsuits were resolved. The Company recorded a charge of $2.6 million during the third quarter to reflect its best estimate of the cost of the resolution of these lawsuits in cost of coal sales in the accompanying Condensed Consolidated Statements of Operations.

The change in market value of SO2 and coal derivatives was expense of $5.5 million and $7.5 million for the three months and nine months ended September 30, 2005, respectively, recorded in other operating income in the accompanying Condensed Consolidated Statements of Operations.

During the second quarter of 2005, the Company participated in a settlement from its insurance broker related to certain types of commissions previously paid and recognized a gain of $1.0 million. The gain is reflected in other operating income in the Condensed Consolidated Statements of Operations.

During the second quarter of 2005, the Company assigned its rights and obligations to an unused loadout facility to a third party resulting in a gain of $1.7 million. Of the $1.7 million gain recognized, $1.2 million was recorded as an increase to other operating income in the Condensed Consolidated Statements of Operations while $0.5 million was reflected as a reduction in cost of coal sales in the Condensed Consolidated Statements of Operations representing the elimination of the reclamation obligation associated with this facility.

During the second quarter of 2005, the State of Wyoming completed an audit related to severance taxes for the period of 1999 through 2001. The audit resulted in the Company being assessed additional taxes. The Company has recorded a liability of $4.5 million on its books related to the audit of which $2.6 million was recorded in cost of coal sales and interest associated with the assessment of $1.4 million was recorded as interest expense in the second quarter in the Condensed Consolidated Statements of Operations.

During the first quarter of 2005, the Company assigned its rights and obligations on several parcels of land to a third party resulting in a gain of $9.3 million. The gain is reflected in other operating income in the accompanying Condensed Consolidated Statements of Operations.

During the first quarter of 2005, the Company recognized a gain of $9.5 million resulting from various equipment sales. The gain is reported as other operating income in the accompanying Condensed Consolidated Statements of Operations.

During the third quarter of 2004, the Company was notified by the IRS that it would receive additional black lung excise tax refunds and related interest from black lung claims that were originally denied by the IRS in 2002. The Company recognized a gain of $2.8 million ($2.1 million of principal and $0.7 million of interest) related to the claims. The $2.1 million principal amount was recorded as a reduction of cost of coal sales, while the $0.7 million interest amount was recorded as interest income.

During the second quarter of 2004, the Office of Surface Mining completed an audit of certain of the Company’s federal reclamation fee filings for the period from 1998 through 2003. The audit resulted in the Company being assessed additional fees of $1.3 million and interest of $0.2 million. The additional fees were recorded as a component of cost of coal sales in the accompanying Condensed Consolidated Statements of Operations, while the interest portion has been reflected as interest expense.

During the first quarter of 2004, Canyon Fuel, while accounted for under the equity method, began the process of temporarily idling its Skyline Mine, and incurred severance costs of $3.2 million for the nine months ended September 30, 2004. The Company’s share of these costs totals $2.1 million, and is reflected in income from equity investments in the Condensed Consolidated Statements of Operations.

On June 25, 2003, the Company repaid the $675 million term loan of its Arch Western subsidiary with the proceeds from the offering of $700.0 million in senior notes. The Company had designated certain interest rate swaps as hedges of the variable rate interest payments due under the Arch Western term loans. Pursuant to the requirements of Statement of Financial Accounting Standards No. 133, Accounting for Derivative Instruments and Hedging Activities (“FAS 133”), historical mark-to-market adjustments related to these swaps through June 25, 2003 were deferred as a component of Accumulated Other Comprehensive Loss. Subsequent to the repayment of the term loans, these deferred amounts will be amortized as additional expense over the contractual terms of the swap agreements. For the three months ending September 30, 2005 and 2004, the Company recognized $1.9 million and $2.1 million of expense for the three months ended September 30, 2005 and 2004, respectively, related to the amortization of previously deferred mark-to-market adjustments. For the nine months ending September 30, 2005 and 2004, the Company recognized $6.1 million and $6.2 million of expense, respectively, related to the amortization of previously deferred mark-to-market adjustments.

Note L — Earnings Per Share

The following tables set forth the computation of basic and diluted earnings per common share from continuing operations.

		Three Months Ended September 30, 2005
		Numerator				Denominator				Per Share
		(Income)				(Shares)				Amount
Basic EPS:
Net income		$	18,926				63,858			$	0.30
Preferred stock dividends			(1,797	)							(0.03	)
Basic income available to common shareholders		$	17,129							$	0.27
Effect of dilutive securities:
Effect of common stock equivalents arising from stock options and restricted stock grants			—				933
Diluted EPS:
Diluted income available to common shareholders		$	17,129				64,791			$	0.26

		Three Months Ended September 30, 2004
		Numerator				Denominator				Per Share
		(Income)				(Shares)				Amount
Basic EPS:
Net income		$	10,775				54,874			$	0.19
Preferred stock dividends			(1,797	)							(0.03	)
Basic income available to common shareholders		$	8,978							$	0.16
Effect of dilutive securities:
Effect of common stock equivalents arising from stock options and restricted stock grants			—				964
Diluted EPS:
Diluted income available to common shareholders		$	8,978				55,838			$	0.16

		Nine Months Ended September 30, 2005
		Numerator				Denominator				Per Share
		(Income)				(Shares)				Amount
Basic EPS:
Net income		$	28,975				63,382			$	0.46
Preferred stock dividends			(5,391	)							(0.09	)
Basic income available to common shareholders		$	23,584							$	0.37
Effect of dilutive securities:
Effect of common stock equivalents arising from stock options and restricted stock grants			—				989
Diluted EPS:
Diluted income available to common shareholders		$	23,584				64,371			$	0.37

		Nine Months Ended September 30, 2004
		Numerator				Denominator				Per Share
		(Income)				(Shares)				Amount
Basic EPS:
Net income		$	91,865				54,431			$	1.69
Preferred stock dividends			(5,391	)							(0.10	)
Basic income available to common shareholders		$	86,474							$	1.59
Effect of dilutive securities:
Effect of common stock equivalents arising from stock options and restricted stock grants			—				935
Effect of common stock equivalents arising from convertible preferred stock			5,391				6,896
Diluted EPS:
Diluted income available to common shareholders		$	91,865				62,262			$	1.48

Note M – Guarantees

The Company holds a 17.5% general partnership interest in Dominion Terminal Associates (“DTA”), which operates a ground storage-to-vessel coal transloading facility in Newport News, Virginia. DTA leases the facility from Peninsula Ports Authority of Virginia (“PPAV”) for amounts sufficient to meet debt-service requirements. Financing is provided through $132.8 million of tax-exempt bonds issued by PPAV (of which the Company is responsible for 17.5%, or $23.2 million) that mature July 1, 2016. Under the terms of a throughput and handling agreement with DTA, each partner is charged its share of cash operating and debt-service costs in exchange for the right to use its share of the facility’s loading capacity and is required to make periodic cash advances to DTA to fund such costs. On a cumulative basis, costs exceeded cash advances by $14.8 million at September 30, 2005, which is included in other noncurrent liabilities. Future payments for fixed operating costs and debt service are estimated to approximate $2.7 million annually through 2015 and $26.0 million in 2016.

In connection with the Company’s acquisition of the coal operations of Atlantic Richfield Company (“ARCO”) and the simultaneous combination of the acquired ARCO operations and the Company’s Wyoming operations into the Arch Western joint venture, the Company agreed to indemnify another member of Arch Western against certain tax liabilities in the event that such liabilities arise as a result of certain actions taken prior to June 1, 2013, including the sale or other disposition of certain properties of Arch Western, the repurchase of certain equity interests in Arch Western by Arch Western or the reduction under certain circumstances of indebtedness incurred by Arch Western in connection with the acquisition. Depending on the time at which any such indemnification obligation were to arise, it could have a material adverse effect on the business, results of operations and financial condition of the Company.

Note N – Segment Information

The Company produces steam and metallurgical coal from surface and deep mines for sale to utility, industrial and export markets. The Company operates only in the United States, with mines in the major low-sulfur coal basins. The Company has three reportable business segments, which are based on the coal basins in which the Company operates. Coal quality, coal seam height, transportation methods and regulatory issues are generally consistent within

a basin. Accordingly, market and contract pricing have developed by coal basin. The Company manages its coal sales by coal basin, not by individual mine complex. Mine operations are evaluated based on their per-ton operating costs (defined as including all mining costs but excluding pass-through transportation expenses). The Company’s reportable segments are Powder River Basin (PRB), Central Appalachia (CAPP) and Western Bituminous (WBIT). The Company’s operations in the Powder River Basin are located in Wyoming and include one operating surface mine and one idle surface mine. The Company’s operations in Central Appalachia are located in southern West Virginia, eastern Kentucky, and Virginia and include 18 underground mines and nine surface mines. The Company’s Western Bituminous operations are located in southern Wyoming, Colorado and Utah and include four underground mines.

Operating segment results for the three and nine months ending September 30, 2005 and 2004 are presented below. Results for the operating segments include all direct costs of mining. Corporate, Other and Eliminations includes corporate overhead, land management, other support functions, and the elimination of intercompany transactions.

Three months ending September 30, 2005

																		Corporate,
																		Other and
(Amounts in thousands, except per ton amounts)						PRB				CAPP				WBIT				Eliminations				Consolidated
Coal sales						$	189,112			$	358,610			$	106,994			$	—			$	654,716
Income from operations							18,996				829				28,882				(14,530	)			34,177
Total assets							1,213,821				2,202,946				1,716,482				(1,787,347	)			3,345,902
Depreciation, depletion and amortization							27,230				18,383				11,855				374				57,842
Capital expenditures							13,330				68,793				23,295				4,130				109,548
Operating cost per ton							7.43				43.23				14.62				—				—

Three months ending September 30, 2004

																			Corporate,
																			Other and
(Amounts in thousands, except per ton amounts)						PRB				CAPP				WBIT				Eliminations				Consolidated
Coal sales						$	160,495			$	303,133			$	64,148			$	—			$	527,776
Income from equity investments							—				—				1,143				—				1,143
Income from operations							12,149				20,038				5,889				(11,741	)			26,335
Total assets							1,129,833				2,066,842				1,373,331				(1,631,879	)			2,938,127
Depreciation, depletion and amortization							21,145				15,224				6,850				273				43,492
Capital expenditures							13,692				28,375				8,326				124,041				174,434
Operating cost per ton							6.46				35.45				15.30				—				—

Nine months ending September 30, 2005

														Corporate,
														Other and
(Amounts in thousands, except per ton amounts)		PRB				CAPP				WBIT				Eliminations				Consolidated
Coal sales		$	559,901			$	1,019,340			$	309,737			$	—			$	1,888,978
Income (loss) from operations			62,574				(1,611	)			67,988				(47,328	)			81,623
Depreciation, depletion and amortization			79,666				51,387				28,875				959				160,887
Capital expenditures			30,331				162,614				48,258				7,703				248,906
Operating cost per ton			7.09				42.74				14.68				—				—

Nine months ending September 30, 2004

														Corporate,
														Other and
(Amounts in thousands, except per ton amounts)		PRB				CAPP				WBIT				Eliminations				Consolidated
Coal sales		$	397,951			$	837,901			$	118,191			$	—			$	1,354,043
Income from equity investments			—				—				8,410				2,418				10,828
Income from operations			42,910				39,818				17,346				58,039				158,113
Depreciation, depletion and amortization			52,651				47,090				14,783				1,153				115,677
Capital expenditures			41,275				62,541				11,356				128,394				243,566
Operating cost per ton			6.19				34.20				15.82				—				—

Reconciliation of segment income from operations to consolidated income before income taxes and cumulative effect of accounting change:

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
		2005				2004				2005				2004
		(in thousands)
Income from operations		$	34,177			$	26,335			$	81,623			$	158,113
Interest expense			(17,994	)			(16,220	)			(55,454	)			(45,062	)
Interest income			2,109				1,110				5,635				2,723
Other non-operating expense			(3,516	)			(1,605	)			(7,579	)			(5,364	)
Income before income taxes		$	14,776			$	9,620			$	24,225			$	110,410

Note O – Subsequent Events

Asset dispositions — Magnum Coal Company

On October 11, 2005, the Company and affiliates of ArcLight Capital Partners, LLC signed a definitive agreement to contribute certain mining operations and properties to a new company to be called Magnum Coal Company (“Magnum”) that would mine and market low-sulfur coal in the Central Appalachian region. Arch will contribute four of its active Central Appalacian mining operations and a total of 455 million tons of reserves to Magnum. These mining properties together had sales of 9.7 million tons through September 30, 2005.

The Company and the affiliates of ArcLight Capital will receive approximately 37.5% and 62.5%, respectively, of the ownership interest in Magnum. The transaction is contingent upon conclusion of a number of agreements, and there is no assurance that the transaction will be completed.

West Elk mine evacuation

On October 27, 2005, the Company conducted a precautionary evacuation of its West Elk mine after elevated readings of combustion-related gases were detected in an area of the mine where mining activities were completed, but final longwall equipment removal had not yet occurred. A portion of the equipment had already been moved to

another area of the mine where the Company intends to begin mining and the remainder is currently isolated from the affected area by permanent and temporary seals.

Once the mine is determined to be safe for re-entry, the longwall equipment can be moved and production can resume in the new area. While management does not anticipate an extended evacuation or significant impact on production or results of operations, we cannot currently estimate when production will resume.

Note P — Reclassifications

Certain amounts in the 2004 financial statements have been reclassified to conform to the classifications in the 2005 financial statements with no effect on previously reported net income or members’ equity.

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

FORWARD-LOOKING STATEMENTS

In this quarterly report, statements that are not reported financial results or other historical information are “forward-looking statements.” Forward-looking statements give current expectations or forecasts of future events and are not guarantees of future performance. They are based on our management’s expectations that involve a number of business risks and uncertainties, any of which could cause actual results to differ materially from those expressed in or implied by the forward-looking statements.

Forward-looking statements can be identified by the fact that they do not relate strictly to historic or current facts. They use words such as “anticipate,” “estimate,” “project,” “intend,” “plan,” “believe” and other words and terms of similar meaning in connection with any discussion of future operating or financial performance. In particular, these include statements relating to:

•		our expectation of continued growth in the demand for our coal by the domestic electric generation industry;
•		our belief that legislation and regulations relating to the Clean Air Act and other proposed environmental initiatives and the relatively higher costs of competing fuels will increase demand for our compliance and low sulfur coal;
•		our expectations regarding incentives to generators of electricity to minimize their fuel costs as a result of electric utility deregulation;
•		our expectation that we will continue to have adequate liquidity from cash flow from operations;
•		a variety of market, operational, geologic, permitting, labor, transportation and weather related factors;
•		our expectations regarding any synergies to be derived from the Triton acquisition; and
•		the other risks and uncertainties which are described below under “Contingencies” and “Certain Trends and Uncertainties,” including, but not limited to, the following:

	o		Due to the significant amount of our debt, a downturn in economic or industry conditions could materially affect our ability to meet our future financial and liquidity obligations.
	o		A reduction in consumption by the domestic electric generation industry may cause our profitability to decline.
	o		Extensive environmental laws and regulations could cause the volume of our sales to decline.
	o		The coal industry is highly regulated, which restricts our ability to conduct mining operations and may cause our profitability to decline.
	o		We may not be able to obtain or renew our surety bonds on acceptable terms.
	o		Unanticipated mining conditions may cause profitability to fluctuate.
	o		Deregulation of the electric utility industry may cause customers to be more price-sensitive, resulting in a potential decline in our profitability.
	o		Our profitability may be adversely affected by the status of our long-term coal supply contracts.
	o		Decreases in purchases of coal by our largest customers could adversely affect our revenues.
	o		An unavailability of coal reserves would cause our profitability to decline.

	o		Disruption in, or increased costs of, transportation services could adversely affect our profitability.
	o		Numerous uncertainties exist in estimating our economically recoverable coal reserves, and inaccuracies in our estimates could result in lower revenues, higher costs or decreased profitability.
	o		Title defects or loss of leasehold interests in our properties could result in unanticipated costs or an inability to mine these properties.
	o		All acquisitions involve a number of inherent risks, any of which could cause us not to realize the benefits anticipated to result.
	o		Changes in our credit ratings could adversely affect our costs and expenses.
	o		Some of our agreements impose significant potential indemnification obligations on us.
	o		Our expenditures for postretirement medical and pension benefits have increased in recent periods and could further increase in the future.
	o		Pending litigation involving third parties may impact our cash balance pension plan and the retirement account formula used in its administration.
	o		Any inability to comply with restrictions imposed by our credit facilities and other debt arrangements could result in a default under these agreements.
	o		Our estimated financial results may prove to be inaccurate.

We cannot guarantee that any forward-looking statements will be realized, although we believe that we have been prudent in our plans and assumptions. Achievement of future results is subject to risks, uncertainties and assumptions that may prove to be inaccurate. Should known or unknown risks or uncertainties materialize, or should underlying assumptions prove to be inaccurate, actual results could vary materially from those anticipated, estimated or projected.

We undertake no obligation to publicly update forward-looking statements, whether as a result of new information, future events or otherwise, except as may be required by law. You are advised, however, to consider any additional disclosures that we may make on related subjects in future filings with the SEC. You should understand that it is not possible to predict or identify all factors that could cause our actual results to differ. Consequently, you should not consider any such list to be a complete set of all potential risks or uncertainties.

RESULTS OF OPERATIONS

Items Affecting Comparability of Reported Results

The comparison of our operating results for the quarter-to-date and year-to-date periods ending September 30, 2005 and 2004 are affected by the following items:

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
(Dollar amounts in millions)		2005				2004				2005				2004
Income from operations
Gain on land, equipment and facility sales		$	9.8			$	—			$	31.6			$	—
Mark to market adjustments on SO2 and coal derivatives			(5.5	)			—				(7.5	)			—
Resolution of lawsuits			(2.6	)							(2.6	)
Insurance broker settlement			—				—				1.0				—
Wyoming severance tax assessment			—				—				(2.6	)			—
Long-term incentive compensation expense			—				—				(9.9	)			—
Gain on sale of NRP units			—				.3				—				90.2
Black lung excise tax refund			—				2.1				—				2.1
Severance costs			—				—				—				(2.1	)
Reclamation fee assessment			—				—				—				(1.3	)
Net impact on operating income			1.7				2.4				10.0				88.9
Other
Net interest on tax assessments/refunds			—				0.7				(1.4	)			0.5
Net impact on pre-tax income		$	1.7			$	3.1			$	8.6			$	89.4

Gain from land, equipment and facility sales

During the quarter and nine months ended September 30, 2005, we recognized gains of $9.8 million and $31.6 million, respectively, related to gains for land, equipment and facility sales. During the first quarter of 2005, we assigned our rights and obligations on several parcels of land to a third party resulting in a gain of $9.3 million. During the first quarter of 2005, we recognized a gain of $9.5 million resulting from various equipment sales. In the third quarter of 2005, we sold surface land resulting in a gain of $9.0 million and gains on miscellaneous property of $0.8 million. The gains are reflected in other operating income in the accompanying Condensed Consolidated Statements of Operations. During the second quarter of 2005, we assigned our rights and obligations to an unused loadout facility to a third party resulting in a gain of $1.7 million. Of the $1.7 million gain recognized, $1.2 million was recorded as an increase to other revenues in the Condensed Consolidated Statements of Operations while $0.5 million was reflected as a reduction in cost of coal sales in the Condensed Consolidated Statements of Operations representing the elimination of the reclamation obligation associated with this facility.

Mark to market adjustments on SO2 and coal derivatives

Amounts represent the amount recorded to reflect the change in fair market value during the period and are reflected in other operating income in the Condensed Consolidated Statements of Operations. These are discussed in more depth in the market risk disclosures included in “Liquidity and Capital Resources”.

Insurance broker settlement

During the second quarter of 2005, we participated in a settlement from our insurance broker related to certain types of commissions previously paid and recognized a gain of $1.0 million. The gain is reflected in other operating income in the Condensed Consolidated Statements of Operations.

Wyoming severance tax assessment

During the second quarter of 2005, the State of Wyoming completed an audit related to severance taxes for the period of 1999 through 2001. The audit resulted in additional taxes being assessed against us. We are reviewing the assessment and as of September 30, 2005, we have recorded a liability of $4.5 million on our books related to the audit. Of the $4.5 million recognized, $2.6 million was recorded during the second quarter of 2005 in cost of coal sales in the accompanying Condensed Consolidated Statements of Operations, while $1.4 million, representing

interest associated with the assessment, was recorded as interest expense in the second quarter of 2005 in the Condensed Consolidated Statements of Operations.

Long-term incentive compensation expense

During 2004, we granted an award of 220,766 shares of performance-contingent phantom stock that vested in the event the Company’s stock price reached an average pre-established price over a period of 20 consecutive trading days within five years following the date of grant. During the first quarter of 2005, the price contingency discussed above was met, and the award was paid in a combination of Company stock and cash. As such, we recognized a $9.9 million charge as a component of selling, general and administrative expense ($9.1 million) and cost of coal sales ($0.8 million) in the accompanying Condensed Consolidated Statements of Operations.

Gain on sale of NRP units

During the nine months ended September 30, 2004, we sold the majority of our remaining limited partnership units of Natural Resource Partners, LP (“NRP”) for proceeds of approximately $105.4 million. The sales resulted in a gain of $90.2 million.

Black lung excise tax refund

During the third quarter of 2004, the Company was notified by the IRS that it would receive additional black lung excise tax refunds and related interest from black lung claims that were originally denied by the IRS in 2002. The Company recognized a gain of $2.8 million ($2.1 million of principal and $0.7 million of interest) related to the claims. The $2.1 million principal amount was recorded as a reduction of cost of coal sales, while the $0.7 million interest amount was recorded as interest income.

Severance costs — Skyline Mine

During the first quarter of 2004, Canyon Fuel, our equity method investment, began the process of idling its Skyline Mine (the idling process was completed in May 2004), and incurred severance costs of $3.2 million for the nine months ended September 30, 2004. Our 65% share of these costs totals $2.1 million (which was prior to our purchase of the remaining 35% interest) for the nine months ended September 30, 2004, and is reflected in income from equity investments in the accompanying Condensed Consolidated Statements of Operations.

Reclamation fee assessment

During the nine months ended September 30, 2004, the Office of Surface Mining completed an audit of certain of our federal reclamation fee filings for the period from 1998 through 2003. The audit resulted in an assessment of additional fees of $1.3 million and interest of $0.2 million. The additional fees have been recorded as a component of cost of coal sales in the accompanying Condensed Consolidated Statements of Operations, while the interest portion has been reflected as interest expense.

Quarter Ended September 30, 2005 Compared to Quarter Ended September 30, 2004

Revenues

		Three Months Ended
		September 30,								Increase (Decrease)
		2005				2004				$				%
		(Amounts in thousands, except per ton data)
Coal sales		$	654,716			$	527,776			$	126,940				24.1	%
Tons sold			35,211				33,807				1,404				4.2	%
Coal sales realization per ton sold		$	18.59			$	15.61			$	2.98				19.1	%

Tons sold by operating segment

		Three Months Ended								Three Months Ended
		September 30, 2005								September 30, 2004
		tons				% of total				tons				% of total
						(Amounts in thousands)
Powder River Basin			22,536				64.0	%			22,646				67.0	%
Central Appalachia			7,976				22.7	%			7,616				22.5	%
Western Bituminous Region			4,699				13.3	%			3,545				10.5	%
Total operating regions			35,211				100.0	%			33,807				100.0	%

Coal sales. The increase in coal sales resulted from the combination of higher pricing, increased volumes and the acquisitions of Triton in the Powder River Basin on August 20, 2004 and the remaining 35% interest in Canyon Fuel in the Western Bituminous region on July 31, 2004.

Volumes increased 32.6% at our Western Bituminous region in addition to a 4.7% increase in volumes in Central Appalachia. Despite the acquisition of Triton in the Powder River Basin on August 20, 2004, volumes at our Powder River Basin operations declined 0.5% primarily due to lower purchased coal volumes during the third quarter of 2005. The Western Bituminous region benefited from the Canyon Fuel acquisition that was completed in the third quarter of 2004. Volumes in Central Appalachia were higher during the current quarter primarily from increased brokered activity. Transportation issues also affected sales volume in third quarter of 2004.

Per ton realizations increased due primarily to higher contract prices in all three regions. In the Powder River Basin, per ton realization increased 18.4%, as a result of increased base pricing and higher SO2 quality premiums resulting from higher SO2 emission allowance prices. The Central Appalachia region experienced an increase of 13.0%, as both contract and spot market prices were higher than in the third quarter of 2004. Additionally, we received higher sales prices on our metallurgical coal sales in the third quarter of 2005 as compared to the third quarter of 2004. The Western Bituminous region’s per ton realization increased 25.8%. In addition to higher contract pricing, per ton realizations in the Western Bituminous region were also affected by the acquisition of the remaining 35% interest in Canyon Fuel during the third quarter of 2004.

On a consolidated basis, the increase in per ton realizations was partially offset by the change in mix of sales volumes among our operating regions as noted in the table above. Central Appalachia has the highest average realization and Powder River Basin has the lowest average realization.

Costs and Expenses

		Three Months Ended
		September 30,								Increase (Decrease)
		2005				2004				$				%
		(Amounts in thousands)
Cost of coal sales		$	546,725			$	448,638			$	98,087				21.9	%
Depreciation, depletion and amortization			57,842				43,491				14,351				33.0	%
Selling, general and administrative expenses			20,285				12,729				7,556				59.4	%
Other operating expenses			15,150				13,746				1,404				10.2	%
		$	640,002			$	518,604			$	121,398				23.4	%

Cost of coal sales. The increase in the cost of coal sales resulted from the combination of higher costs, increased volumes and the acquisitions of Triton in the Powder River Basin on August 20, 2004 and the remaining 35% interest in Canyon Fuel in the Western Bituminous region on July 31, 2004. Specific factors contributing to the increase are as follows (note that specifically the increases discussed below for diesel fuel, explosives, utilities, operating supplies and repairs and maintenance costs are partially due to the acquisitions of Triton and Canyon Fuel during the third quarter of 2004):

	•		Production taxes and coal royalties (which are incurred as a percentage of coal sales realization) increased $25.2 million during the third quarter of 2005 compared to the same period in the prior year.
	•		Our Central Appalachia operations incurred higher costs related to additional processing necessary for coal sold in metallurgical markets as well as the move into less favorable geologic conditions at our Mingo Logan mine during the third quarter of 2005.
	•		The cost of purchased coal increased $17.2 million, reflecting a combination of increased purchase volumes and higher spot market prices that were prevalent during the third quarter of 2005 compared to the same period in 2004. During the third quarter of 2005, we utilized purchased coal to fulfill steam coal sales commitments in order to direct more of our produced coal into the metallurgical markets.

	•		Repairs and maintenance costs increased $5.2 million compared to the same period in the prior year.
	•		Costs for diesel fuel, explosives and utilities increased $6.5 million, $2.9 million and $1.7 million, respectively, compared to the same period in the prior year, resulting from increased volumes and cost.
	•		Costs for operating supplies increased $8.2 million due partially to increased steel prices during the current quarter compared to the prior year’s comparable quarter.