**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C.  20549**

 

**FORM 10-Q**

 
| **(Mark One)**                                                                                                                                                                                                                       | ** ** | ** **                                                                                               |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------|
| ** **                                                                                                                                                                                                                           | ** ** | ** **                                                                                               |
| **ý**                                                                                                                                                                                                                           | ** ** | **QUARTERLY  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**             |
| ** **                                                                                                                                                                                                                           |
| **For the Quarterly Period Ended March 31, 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                ** |

 

**CommissionFile Number 333-120979-49**

 

**Foundation Coal Corporation**

(Exact Name of Registrant as Specified in Its Charter)

 
| **Delaware**                                                                | ** ** | **26-0085077**                        |
|-----------------------------------------------------------------------------|------------|---------------------------------------|
| (State or Other Jurisdiction of  Incorporation or Organization)             |       | (I.R.S. Employer  Identification No.) |
|                                                                        |       |                                  |
| **999 Corporate Boulevard, Suite 300  Linthicum Heights, Maryland**         | ** ** | **21090**                             |
| (Address of Principal Executive Offices)                                    |       | (Zip Code)                            |
|                                                                        |       |                                  |
| **Registrant’s telephone number, including area code) (410) 689-7500** |

 

Indicate by check mark whetherthe Registrant (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during thepreceding 12 months (or for such shorter period that the registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days. Yes ý  No o

 

Indicate by check mark whetherthe Registrant is an accelerated filer (as defined in Rule 12b-2 of theExchange Act). Yes o  No ý

 

The Registrant’s common equityis not publicly traded. The common stock of the Registrant’s ultimate parent,Foundation Coal Holdings, Inc., began trading on the New York Stock Exchange onDecember 9, 2004. There were 44,627,047 shares of Foundation CoalHoldings, Inc. common stock outstanding on April 30, 2005. There were 100shares of Foundation Coal Corporation common stock outstanding onApril 30, 2005 which are not publicly traded and are all held by it’sparent FC 2 Corp. 

 

 

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**TABLEOF CONTENTS**

 
| ** **                       | ** **                                                                                                | **Page** |
|----------------------------------|-----------------------------------------------------------------------------------------------------------|----------|
| **PART I-FINANCIAL INFORMATION** |
| ** **                       |
| ITEM 1.                          | FINANCIAL STATEMENTS                                                                                      |     |
|                             | Statements of Consolidated Operations and  Comprehensive Income (Loss)                                    | 3        |
|                             | Consolidated Balance Sheets                                                                               | 4        |
|                             | Statements of Consolidated Cash Flows                                                                     | 5        |
|                             | Notes to Consolidated Financial Statements                                                                | 6        |
| ITEM 2.                          | MANAGEMENT’S  DISCUSSION AND ANALYSIS OF CONSOLIDATED FINANCIAL CONDITION AND RESULTS OF  OPERATIONS | 21       |
| ITEM 3.                          | QUANTITATIVE AND QUALITATIVE DISCLOSURES  ABOUT MARKET RISK                                               | 36       |
| ITEM 4.                          | CONTROLS AND PROCEDURES                                                                                   | 36       |
|                             |                                                                                                      |     |
| **PART II-OTHER INFORMATION**    |
| ** **                       | ** **                                                                                                |     |
| ITEM 1.                          | LEGAL PROCEEDINGS                                                                                         | 38       |
| ITEM 2.                          | UNREGISTERED SALES OF EQUITY SECURITIES AND  USE OF PROCEEDS                                              | 38       |
| ITEM 3.                          | DEFAULTS UPON SENIOR SECURITIES                                                                           | 38       |
| ITEM 4.                          | SUBMISSION OF MATTERS OF VOTE OF SECURITY  HOLDERS                                                        | 38       |
| ITEM 5.                          | OTHER INFORMATION                                                                                         | 38       |
| ITEM  6.                         | EXHIBITS                                                                                                  | 38       |

 

2

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**PARTI-FINANCIAL INFORMATION**

 

*Unless the context otherwise indicates, asused in this Form 10-Q the terms “we”, “our”, “us” and similar terms refer toFoundation Coal Corporation and its consolidated subsidiaries.*

 

**ITEM 1. FINANCIAL STATEMENTS**

 

**FoundationCoal Corporation and Subsidiaries (An Indirect Wholly Owned Subsidiary of Foundation Coal Holdings, Inc.)**

**Statements of Consolidated Operations and Comprehensive Income (Loss)**

**(Dollarsin thousands)**

**(Unaudited)**

** **
| ** **                                                                                       | ** ** | **Three Months Ended March 31,** | ** ** |
|--------------------------------------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                                                       | ** ** | **2005  Successor**              | ** ** | **2004  Predecessor** | ** ** |
|                                                                                             |       |                             |       |   |   |
| Revenues:                                                                                        |       |                             |       |   |   |
| Coal sales                                                                                       |       | $                                | 300,021    |   | $ | 221,979 |   |
| Other revenue                                                                                    |       | 5,485                            |       | 4,328 |   |
|                                                                                             |       | 305,506                          |       | 226,307 |   |
| Costs and expenses:                                                                              |       |                             |       |   |   |
| Cost of coal sales (excludes depreciation,  depletion and amortization)                          |       | 215,230                          |       | 197,160 |   |
| Selling, general and administrative expense  (excludes depreciation, depletion and amortization) |       | 11,431                           |       | 10,411 |   |
| Accretion on asset retirement obligation                                                         |       | 2,040                            |       | 1,723 |   |
| Depreciation, depletion and amortization                                                         |       | 54,800                           |       | 25,017 |   |
| Amortization of coal supply agreements                                                           |       | (23,379                          | )          | 3,966 |   |
| Income (loss) from operations                                                                    |       | 45,384                           |       | (11,970 | ) |
| Other income (expense):                                                                          |       |                             |       |   |   |
| Interest expense                                                                                 |       | (14,253                          | )          | (9,971 | ) |
| Loss on termination of hedge accounting for  interest rate swaps                                 |       | —                           |       | (48,772 | ) |
| Mark-to-market loss on interest rate swap                                                        |       | —                           |       | (3,166 | ) |
| Interest income                                                                                  |       | 122                              |       | 773 |   |
| Income (loss) before income tax (expense)  benefit                                               |       | 31,253                           |       | (73,106 | ) |
| Income tax (expense) benefit                                                                     |       | (12,211                          | )          | 27,012 |   |
| Income (loss) from continuing operations                                                         |       | 19,042                           |       | (46,094 | ) |
| Income from discontinued operations, net of  income tax expense of $1,636 in 2004                |       | —                           |       | 2,792 |   |
| Net income (loss)                                                                                |       | 19,042                           |       | (43,302 | ) |
| Components of comprehensive income:                                                              |       |                             |       |   |   |
| Unrealized gain on interest rate swap, net  of tax expense of $553 in 2005 and $16,890 in 2004   |       | 829                              |       | 28,820 |   |
| Comprehensive income (loss)                                                                      |       | $                                | 19,871     |   | $ | (14,482 | ) |
|                                                                                                  |            |                                  |            |  |  |  |  |  |  |

 

The accompanying notes are anintegral part of these financial statements.

 

3

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**FoundationCoal Corporation and Subsidiaries (An Indirect Wholly Owned Subsidiary of Foundation Coal Holdings, Inc.)Consolidated Balance Sheets**

**(Dollarsin thousands, except share and per share data)**

** **
| ** **                                                                                                               |   | **March 31,  2005** | ** ** | **December 31,  2004** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------|--------|---------------------|------------|------------------------|------------|
| ** **                                                                                                               |   | **(Unaudited)**     | ** ** | ** **             | ** ** |
| **ASSETS**                                                                                                               |   | ** **          | ** ** | ** **             | ** ** |
| ** **                                                                                                               |   | ** **          | ** ** | ** **             | ** ** |
| Current assets:                                                                                                          |   |                |       |                   |       |
| Cash and cash equivalents                                                                                                |   | $                   | 4,132      |                   | $          | 25,043 |   |
| Trade accounts receivable, net of allowance  ($217 in 2005 and 2004, respectively)                                       |   | 101,268             |       | 66,484                 |       |
| Inventories, net                                                                                                         |   | 58,311              |       | 39,718                 |       |
| Deferred income taxes                                                                                                    |   | 15,145              |       | 15,145                 |       |
| Other current assets                                                                                                     |   | 24,582              |       | 27,821                 |       |
|                                                                                                                     |   |                |       |                   |       |
| Total current assets                                                                                                     |   | 203,438             |       | 174,211                |       |
|                                                                                                                     |   |                |       |                   |       |
| Owned surface lands                                                                                                      |   | 28,274              |       | 29,171                 |       |
| Plant, equipment and mine development  costs, net                                                                        |   | 509,101             |       | 487,495                |       |
| Owned and leased mineral rights, net                                                                                     |   | 1,245,966           |       | 1,282,989              |       |
| Coal supply agreements, net                                                                                              |   | 76,947              |       | 84,508                 |       |
| Other noncurrent assets                                                                                                  |   | 40,818              |       | 41,586                 |       |
| Total assets                                                                                                             |   | $                   | 2,104,544  |                   | $          | 2,099,960 |   |
|                                                                                                                     |   |                |       |                   |       |
| **LIABILITIES**                                                                                                          |   | ** **          | ** ** | ** **             | ** ** |
| ** **                                                                                                               |   | ** **          | ** ** | ** **             | ** ** |
| Current liabilities:                                                                                                     |   |                |       |                   |       |
| Trade accounts payable                                                                                                   |   | $                   | 31,315     |                   | $          | 30,512 |   |
| Accrued expenses and other current  liabilities                                                                          |   | 159,263             |       | 155,541                |       |
|                                                                                                                     |   |                |       |                   |       |
| Total current liabilities                                                                                                |   | 190,578             |       | 186,053                |       |
|                                                                                                                     |   |                |       |                   |       |
| Long-term debt                                                                                                           |   | 685,000             |       | 685,000                |       |
| Deferred income taxes                                                                                                    |   | 138,204             |       | 133,828                |       |
| Coal supply agreements, net                                                                                              |   | 147,269             |       | 178,210                |       |
| Postretirement benefits                                                                                                  |   | 452,809             |       | 449,683                |       |
| Other noncurrent liabilities                                                                                             |   | 215,705             |       | 211,455                |       |
| Total liabilities                                                                                                        |   | 1,829,565           |       | 1,844,229              |       |
|                                                                                                                     |   |                |       |                   |       |
| *Commitments and contingencies (Note 17)*                                                                                |   |                |       |                   |       |
| * *                                                                                                                 |   |                |       |                   |       |
| **STOCKHOLDERS’  EQUITY**                                                                                           |   | ** **          | ** ** | ** **             | ** ** |
| ** **                                                                                                               |   | ** **          | ** ** | ** **             | ** ** |
| Common stock, $0.01 par value; 100 shares  authorized, issued and outstanding at March 31, 2005 and at December 31, 2004 |   | —              |       | —                 |       |
| Additional paid-in capital                                                                                               |   | 241,422             |       | 241,993                |       |
| Retained earnings                                                                                                        |   | 33,106              |       | 14,064                 |       |
| Unearned restricted stock compensation                                                                                   |   | (52                 | )          | —                 |       |
| Accumulated other comprehensive income  (loss)                                                                           |   | 503                 |       | (326                   | )          |
| Total stockholders’ equity                                                                                          |   | 274,979             |       | 255,731                |       |
| Total liabilities and stockholders’ equity                                                                          |   | $                   | 2,104,544  |                   | $          | 2,099,960 |   |

 

The accompanying notes are anintegral part of these financial statements.

 

4

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**FoundationCoal Corporation and Subsidiaries (An Indirect Wholly Owned Subsidiary of Foundation Coal Holdings, Inc.)Statements of ConsolidatedCash Flows**

**(Dollarsin thousands)**

**(Unaudited)**

** **
| ** **                                                                                | ** ** | **Three Months Ended March 31,** | ** ** |
|-------------------------------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                                                | ** ** | **2005  Successor**              | ** ** | **2004  Predecessor** | ** ** |
| **Operating activities:**                                                                 |       |                             |       |   |   |
| Net income (loss)                                                                         |       | $                                | 19,042     |   | $ | (43,302 | ) |
| Income from discontinued operations                                                       |       | —                           |       | (2,792 | ) |
| Income (loss) from continuing operations                                                  |       | 19,042                           |       | (46,094 | ) |
| Adjustments to reconcile net income (loss)  to net cash provided by operating activities: |       |                             |       |   |   |
| Accretion on asset retirement obligations                                                 |       | 2,040                            |       | 1,723 |   |
| Depreciation, depletion and amortization                                                  |       | 31,421                           |       | 28,983 |   |
| Amortization of deferred financing costs                                                  |       | 773                              |       | — |   |
| Gain on sale of assets                                                                    |       | —                           |       | (446 | ) |
| Non-cash restricted stock compensation                                                    |       | 308                              |       | — |   |
| Non-cash mark-to-market adjustment for  interest rate swap                                |       | —                           |       | 3,166 |   |
| Non-cash expense from termination of hedge  accounting for interest rate swap             |       | —                           |       | 48,772 |   |
| Deferred income taxes                                                                     |       | 3,824                            |       | (26,874 | ) |
| Changes in operating assets and  liabilities:                                             |       |                             |       |   |   |
| Trade accounts receivable                                                                 |       | (34,784                          | )          | (172 | ) |
| Inventories, net                                                                          |       | (18,593                          | )          | (4,507 | ) |
| Other current assets                                                                      |       | 3,429                            |       | 494 |   |
| Other noncurrent assets                                                                   |       | 8                                |       | 1,542 |   |
| Trade accounts payable                                                                    |       | 818                              |       | (170 | ) |
| Accrued expenses and other current  liabilities                                           |       | (1,457                           | )          | (10,691 | ) |
| Noncurrent liabilities and other                                                          |       | 4,435                            |       | 6,693 |   |
| Net cash provided by continuing operations                                                |       | 11,264                           |       | 2,419 |   |
| Net cash provided by discontinued  operations                                             |       | —                           |       | 9,570 |   |
| Net cash provided by operating activities                                                 |       | 11,264                           |       | 11,989 |   |
| **Investing activities:**                                                                 |       |                             |       |   |   |
| Purchases of property, plant and equipment                                                |       | (36,528                          | )          | (25,550 | ) |
| Proceeds from disposition of property,  plant and equipment                               |       | 4,353                            |       | 1,827 |   |
| Net cash used in continuing operations                                                    |       | (32,175                          | )          | (23,723 | ) |
| Net cash used in discontinued operations                                                  |       | —                           |       | (126 | ) |
| Net cash used in investing activities                                                     |       | (32,175                          | )          | (23,849 | ) |
| **Financing activities:**                                                                 |       |                             |       |   |   |
| Proceeds from revolving credit facility                                                   |       | 39,000                           |       | — |   |
| Repayment of revolving credit facility                                                    |       | (39,000                          | )          | — |   |
| Repayment of long-term debt                                                               |       | —                           |       | (17 | ) |
| Repayment of capital lease obligations                                                    |       | —                           |       | (821 | ) |
| Net decrease in cash on deposit with the  Predecessor                                     |       | —                           |       | 5,362 |   |
| Net cash provided by (used in) financing  activities                                      |       | —                           |       | 4,524 |   |
| Decrease in cash and cash equivalents                                                     |       | (20,911                          | )          | (7,336 | ) |
| Cash and cash equivalents at beginning of  period                                         |       | 25,043                           |       | 7,649 |   |
| Cash and cash equivalents at end of period                                                |       | $                                | 4,132      |   | $ | 313 |   |
| **Supplemental cash flow information:**                                                   |       |                             |       |   |   |
| Cash paid for interest                                                                    |       | $                                | 17,276     |   | $ | 19,332 |   |
| Cash paid for income taxes                                                                |       | $                                | 7,563      |   | $ | 3 |   |

 

The accompanying notes are anintegral part of these financial statements.

 

5

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**FoundationCoal Corporation and Subsidiaries (An Indirect Wholly Owned Subsidiary of Foundation Coal Holdings, Inc.)**

**Notes to Consolidated Financial Statements**

**(Unaudited,dollars in thousands)**

 

**(1) Basisof Presentation of Financial Statements**

 

The following interimconsolidated financial statements of Foundation Coal Corporation and Subsidiaries(“FCC” or the “Company”) are unaudited and prepared in accordance with therules and regulations of the Securities and Exchange Commission for Form 10-Q.Such rules and regulations allow the omission of certain information andfootnote disclosures normally included in financial statements prepared inaccordance with generally accepted accounting principles as long as thestatements are not misleading. In the opinion of management, these financialstatements reflect all normal and recurring adjustments necessary for a fairpresentation of the results of the periods presented. These interim consolidatedfinancial statements should be read in conjunction with the consolidatedfinancial statements of the Company included in its Annual Report on Form 10-Kfor the year ended December 31, 2004, filed March 31, 2005.

 

The Company’s consolidatedfinancial statements have been prepared in accordance with accountingprinciples generally accepted in the United States of America. The preparationof the Company’s consolidated financial statements requires management to makeestimates and assumptions that affect the reported amounts of assets andliabilities at the date of the consolidated financial statements and thereported amounts of revenues and expenses during the reporting period. The moresignificant areas requiring the use of management estimates and assumptionsrelate to coal reserves that are the basis for future cash flow estimates andunits-of-production depreciation, depletion and amortization calculations;environmental and reclamation obligations; asset impairments; post-employment,post-retirement and other employee benefit liabilities; valuation allowancesfor deferred taxes; reserves for contingencies and litigation; and the fairvalue and accounting treatment of certain financial instruments. Managementbases its estimates on historical experience and on various other assumptionsthat are believed to be reasonable under the circumstances. Accordingly, actualresults may differ significantly from these estimates.  In addition, different assumptions orconditions could reasonably be expected to yield different results.  The operating results for the three monthsended March 31, 2005 may not necessarily be indicative of the results to beexpected in future quarters for the year ended December 31, 2005.

 

FoundationCoal Holdings, Inc. and its indirect wholly owned subsidiary FCC wereformed to acquire the North American coal mining assets of RAG American CoalHolding, Inc., a wholly owned subsidiary of RAG Coal International AG (“RAG”),which acquisition closed on July 30, 2004 (the “acquisition”). The acquisition was accounted for usingthe purchase method of accounting whereby identifiable assets acquired andliabilities assumed were recorded at their fair market values as of the date ofacquisition. The Company has performed the preliminary purchase priceallocation based on the results of an independent appraisal performed by areputable consulting firm well known in the industry. Certain judgments andestimates by the Company regarding future cash flows from individual mine sitesand other plans are integral to the valuations performed by the valuationspecialists. The appraisal was completed during the first quarter of 2005 andthe results are being evaluated by management. The final purchase priceallocation, which management anticipates will be competed in the third quarterof 2005, is not expected to vary significantly from the preliminary allocation.

 

RAG AmericanCoal Holding, Inc. had two primary operating units: Riverton CoalProduction, Inc. and subsidiaries (“RCP”) and RAG American Coal Company,LLC and subsidiaries (“RACC”). On February 29, 2004, RACCsigned a definitive Stock Purchase Agreement to sell RAG Coal AG’s Coloradooperations which included Twentymile Coal Company, RAG Empire Corporation, RAGShoshone Coal Corporation and Colorado Yampa Coal Company (collectivelyreferred to as the RAG Colorado Business Unit) to a subsidiary of PeabodyEnergy Corporation. This transaction closed on April 15, 2004.Accordingly, all references to Foundation Coal Corporation, exclude the RAGColorado Business Unit which is accounted for and presented in the accompanyingfinancial statements as discontinued operations. Prior period financialstatements have also been restated to reflect the RAG Colorado Business Unit asa discontinued operation.

 

The followingprovides a description of the basis of presentation during allperiods presented:

 

“Successor”—representsthe consolidated financial position of Foundation Coal Corporationand consolidated subsidiaries as of March 31, 2005 and December 31, 2004,and the consolidated results of operations and cash flows for the three

 

6

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month period ended March 31, 2005.Foundation Coal Corporation had no significant activities until the acquisitionon July 30, 2004.

 

“Predecessor”—represents theconsolidated results of operations and cash flows of RAG American CoalHolding, Inc. and subsidiaries for all periods prior to the acquisition.This presentation reflects the historical basis of accounting.

 

The consolidated financialstatements as of and for the period ended March 31, 2005 and December 31,2004 reflect the acquisition under the purchase method of accounting, inaccordance with the Financial Accounting Standards Board (“FASB”) Statement ofFinancial Accounting Standards (“SFAS”) No. 141, *Business Combinations*.

 

Unless otherwise indicated, “theCompany” as used throughout the remainder of these notes to the consolidatedfinancial statements refers to both the Successor and the Predecessor.

 

*Reclassifications*

 

Certainamounts in the prior period have been reclassified to conform to the 2005presentation.

 

**(2) Recent Accounting Pronouncements**

 

In December 2004, theFinancial Accounting Standards Board (“FASB”) issued SFAS No. 123 (revised2004), *Share-Based Payment*(“SFAS No. 123R”), which replaces SFAS No. 123, and supersedes APBNo. 25. SFAS No. 123R requires all share-based payments toemployees, including grants of employee stock options, to be recognized in thefinancial statements based on their fair value at the grant date. SFASNo. 123R generally requires companies to measure the cost of employeeservices received in exchange for an award of equity instruments (such as stockoptions and restricted stock) based on the grant-date fair value of the award,and to recognize that cost over the period during which the employee isrequired to provide service (usually the vesting period of the award).  FAS 123R also requires the benefits oftax deductions in excess of recognized compensation cost to be reported as afinancing cash flow, rather than as an operating cash flow as required undercurrent literature. This requirement will reduce net operating cash flows andincrease net financing cash flows in periods after adoption. The proforma disclosures previously permitted under SFAS No. 123 no longer willbe an alternative to financial statement recognition. On April 14, 2005, the Securities andExchange Commission (“SEC”) delayed the implementation of SFAS No. 123R fromits original implementation date by six months for most registrants, requiringall public companies to adopt FAS 123R no later than the beginning of the firstfiscal year beginning after June 15, 2005. The impact of adoptingSFAS No. 123R cannot be predicted at this time because it will depend onlevels of share-based payments granted in the future. However, had theCompany adopted SFAS No. 123R during the prior period, the results areexpected to be consistent with the pro forma disclosure under SFASNo. 123, except that forfeitures will be considered in the calculation ofcompensation expense under SFAS No. 123R. When adopted, the Company mayelect to change the valuation method or assumptions and such changes could havea material impact on the amount of stock-based compensation the Companyrecords.

 

In March 2005, theEmerging Issues Task Force reached consensus on Issue No. 04-6, *Accounting for Stripping Costs in the Mining Industry*(“EITF No. 04-6”) concluding that post-production stripping costs are acomponent of mineral inventory costs subject to the provisions of the AmericanInstitute of Certified Public Accountants Accounting Research BulletinNo. 43, *Restatement and Revision ofAccounting Research Bulletins,* Chapter 4, *Inventory Pricing*, (“ARB No. 43”).  The FASB ratified the EITF consensus. Basedupon this consensus, post production stripping costs are considered costs ofthe extracted minerals under a full absorption costing system and arerecognized as a component of inventory to be recognized in costs of sales inthe same period as the revenue from the sale of the inventory. In addition,capitalization of such costs would be appropriate only to the extent inventoryexists at the end of a reporting period. The guidance in this consensus will beeffective for financial statements issued for fiscal years beginning afterDecember 15, 2005, with early adoption permitted. The Company is currentlyevaluating this consensus and has not determined its impact to the consolidatedfinancial statements.

 

7

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**(3) Inventories**

 

Inventories consisted of the following:

 
| ** **                                            | ** ** | **At March 31,  2005** | ** ** | **At December 31,  2004** | ** ** |
|-------------------------------------------------------|------------|------------------------|------------|---------------------------|------------|
| ** **                                            | ** ** | **(Unaudited)**        | ** ** | ** **                | ** ** |
| ** **                                            | ** ** | ** **             | ** ** | ** **                | ** ** |
| Saleable coal                                         |       | $                      | 20,089     |                      | $          | 11,609 |   |
| Raw coal                                              |       | 1,208                  |       | 2,893                     |       |
| Work-in-process (deferred overburden)                 |       | 25,115                 |       | 13,889                    |       |
| Materials and supplies                                |       | 19,555                 |       | 18,983                    |       |
|                                                  |       | 65,967                 |       | 47,374                    |       |
| Less materials and supplies reserve for  obsolescence |       | (7,656                 | )          | (7,656                    | )          |
|                                                  |       | $                      | 58,311     |                      | $          | 39,718 |   |

 

Saleable coal represents coalstockpiles ready for shipment to a customer. Raw coal represents coal thatrequires further processing prior to shipment. Work-in-process consists ofcosts incurred to remove overburden above an unmined coal seam as part of thesurface mining process and generally includes labor, supplies, operatingoverhead and equipment costs charged to operations as coal from the seam issold.

 

**(4) Other Current Assets**

 

Other current assets consistedof the following:

 
| ** **                      | ** ** | **At March 31,  2005** | ** ** | **At December 31,  2004** | ** ** |
|---------------------------------|------------|------------------------|------------|---------------------------|------------|
| ** **                      | ** ** | **(Unaudited)**        | ** ** | ** **                | ** ** |
| Prepaid royalties               |       | $                      | 3,681      |                      | $          | 3,142 |   |
| Prepaid longwall move expense   |       | 5,913                  |       | 7,497                     |       |
| Prepaid SO2 emission allowances |       | 641                    |       | 780                       |       |
| Prepaid expenses                |       | 10,571                 |       | 12,886                    |       |
| Other                           |       | 3,776                  |       | 3,516                     |       |
|                            |       | $                      | 24,582     |                      | $          | 27,821 |   |

 

8

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** **

**(5) Property, Plant, Equipment and Owned andLeased Mineral Rights**

 

Property, plant, equipment andowned and leased mineral rights consisted of the following:

 
| ** **                                        | ** ** | **At March 31,  2005** | ** ** | **At December 31, 2004** | ** ** |
|---------------------------------------------------|------------|------------------------|------------|--------------------------|------------|
| ** **                                        | ** ** | **(Unaudited)**        | ** ** | ** **               | ** ** |
| **Owned surface and coal lands**                  |       |                   |       |                     |       |
| Owned surface lands                               |       | $                      | 28,274     |                     | $          | 29,171 |   |
| Owned and leased mineral rights                   |       | $                      | 1,333,095  |                     | $          | 1,336,557 |   |
| Less accumulated depletion                        |       | 87,129                 |       | 53,568                   |       |
|                                              |       | $                      | 1,245,966  |                     | $          | 1,282,989 |   |
| **Plant, equipment and mine development costs**   |       |                   |       |                     |       |
| Plant, equipment and asset retirement costs       |       | $                      | 559,660    |                     | $          | 518,525 |   |
| Mine development costs                            |       | 8,462                  |       | 6,196                    |       |
| Coal bed methane equipment and development  costs |       | 3,409                  |       | 3,959                    |       |
|                                              |       | 571,531                |       | 528,680                  |       |
| Less accumulated depreciation and  amortization:  |       |                   |       |                     |       |
| Plant, equipment and asset retirement costs       |       | 61,930                 |       | 40,898                   |       |
| Mine development costs                            |       | 250                    |       | 108                      |       |
| Coal bed methane equipment and development  costs |       | 250                    |       | 179                      |       |
|                                              |       | 62,430                 |       | 41,185                   |       |
|                                              |       | $                      | 509,101    |                     | $          | 487,495 |   |

 

**(6) Other Noncurrent Assets**

 

Other noncurrent assetsconsisted of the following:

 
| ** **                                            | ** ** | **At March 31,  2005** | ** ** | **At December 31,  2004** | ** ** |
|-------------------------------------------------------|------------|------------------------|------------|---------------------------|------------|
| ** **                                            | ** ** | **(Unaudited)**        | ** ** | ** **                | ** ** |
| Receivables from asset dispositions                   |       | $                      | 4,897      |                      | $          | 5,863 |   |
| Prepaid major repairs                                 |       | 1,168                  |       | 737                       |       |
| Unamortized debt issuance costs, net                  |       | 23,199                 |       | 24,162                    |       |
| Advance mining royalties                              |       | 2,630                  |       | 2,620                     |       |
| Work-in-process coal inventory (deferred  overburden) |       | 3,576                  |       | 3,576                     |       |
| Prepaid longwall development                          |       | 1,633                  |       | 1,633                     |       |
| Fair value of interest rate swaps                     |       | 1,912                  |       | 530                       |       |
| Other                                                 |       | 1,803                  |       | 2,465                     |       |
|                                                  |       | $                      | 40,818     |                      | $          | 41,586 |   |

 

9

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** **

**(7) Accrued Expenses and Other CurrentLiabilities**

 

Accrued expenses and othercurrent liabilities consisted of the following:

 
| ** **                                 | ** ** | **At March 31,  2005** | ** ** | **At December 31,  2004** | ** ** |
|--------------------------------------------|------------|------------------------|------------|---------------------------|------------|
| ** **                                 | ** ** | **(Unaudited)**        | ** ** | ** **                | ** ** |
| Accrued federal and state income taxes     |       | $                      | 8,350      |                      | $          | 3,815 |   |
| Accrued sales contract settlements         |       | 1,943                  |       | 7,431                     |       |
| Wages and employee benefits                |       | 26,642                 |       | 27,977                    |       |
| Pension benefits                           |       | 6,149                  |       | 5,970                     |       |
| Postretirement benefits other than pension |       | 23,000                 |       | 21,350                    |       |
| Interest                                   |       | 3,655                  |       | 9,065                     |       |
| Royalties                                  |       | 9,021                  |       | 8,657                     |       |
| Taxes other than income taxes              |       | 29,557                 |       | 28,328                    |       |
| Asset retirement obligations               |       | 4,291                  |       | 4,398                     |       |
| Workers’ compensation                 |       | 9,718                  |       | 9,717                     |       |
| Other                                      |       | 36,937                 |       | 28,833                    |       |
|                                       |       | $                      | 159,263    |                      | $          | 155,541 |   |
|                                            |            |                        |            |                           |            |  |  |  |  |

 

**(8) Other Noncurrent Liabilities**

 

Other noncurrent liabilitiesconsisted of the following:

 
| ** **                   | ** ** | **At March 31,  2005** | ** ** | **At December 31, 2004** | ** ** |
|------------------------------|------------|------------------------|------------|--------------------------|------------|
| ** **                   | ** ** | **(Unaudited)**        | ** ** | ** **               | ** ** |
| Postemployment benefits      |       | $                      | 5,774      |                     | $          | 6,365 |   |
| Pension benefits             |       | 45,599                 |       | 43,987                   |       |
| Workers’ compensation   |       | 18,506                 |       | 18,938                   |       |
| Minimum royalty obligations  |       | 95                     |       | 876                      |       |
| Black lung reserves          |       | 5,181                  |       | 4,972                    |       |
| Contract settlement accrual  |       | 25,386                 |       | 26,672                   |       |
| Asset retirement obligations |       | 102,036                |       | 100,202                  |       |
| Deferred production tax      |       | 10,829                 |       | 7,144                    |       |
| Deferred credits and other   |       | 2,299                  |       | 2,299                    |       |
|                         |       | $                      | 215,705    |                     | $          | 211,455 |   |

 

**(9) Statements of Comprehensive Income (Loss)**

 

Accumulated other comprehensiveincome (loss) consisted of the following:

 
| ** **                                                      | ** ** | **At March 31,  2005** | ** ** | **At December 31,  2004** | ** ** |
|-----------------------------------------------------------------|------------|------------------------|------------|---------------------------|------------|
| ** **                                                      | ** ** | **(Unaudited)**        | ** ** | ** **                | ** ** |
| Changes in fair value of hedge instruments,  net of tax of $553 |       | $                      | 829        |                      | $          | — |   |
| Minimum pension liability adjustments, net  of tax of $192      |       | (326                   | )          | (326                      | )          |
|                                                            |       | $                      | 503        |                      | $          | (326 | ) |

 

10

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** **

**(10) Employee Retirement and PostretirementBenefit Plans**

 

***Retirement Plans***

 

The components of net periodicbenefit cost of the defined benefit retirement plans are as follows:

 
| ** **                                          | ** ** | **Three Months Ended March 31,** | ** ** |
|-----------------------------------------------------|------------|----------------------------------|------------|
| ** **                                          | ** ** | **2005  Successor**              | ** ** | **2004  Predecessor** | ** ** |
| Service cost                                        |       | $                                | 1,281      |   | $ | 1,292 |   |
| Interest cost                                       |       | 2,560                            |       | 2,708 |   |
| Expected return on plan assets                      |       | (2,249                           | )          | (2,133 | ) |
| Amortization of:                                    |       |                             |       |   |   |
| Prior service cost                                  |       | —                           |       | 10 |   |
| Actuarial losses                                    |       | 21                               |       | 1,108 |   |
|                                                |       | 1,613                            |       | 2,985 |   |
| Less: amounts allocated to discontinued  operations |       | —                           |       | 488 |   |
| Total from continuing operations                    |       | $                                | 1,613      |   | $ | 2,497 |   |

 

***PostretirementHealth Care and Life Insurance Benefits***

 

The components of net periodicbenefit cost for postretirement medical and life insurance are as follows:

 
| ** **                                          | ** ** | **Three Months Ended March 31,** | ** ** |
|-----------------------------------------------------|------------|----------------------------------|------------|
| ** **                                          | ** ** | **2005  Successor**              | ** ** | **2004  Predecessor** | ** ** |
| Service cost                                        |       | $                                | 2,035      |   | $ | 1,657 |   |
| Interest cost                                       |       | 8,465                            |       | 7,226 |   |
| Amortization of:                                    |       |                             |       |   |   |
| Prior service cost                                  |       | —                           |       | 182 |   |
| Actuarial losses                                    |       | —                           |       | 2,769 |   |
|                                                |       | 10,500                           |       | 11,834 |   |
| Less: amounts allocated to discontinued  operations |       | —                           |       | 278 |   |
| Total from continuing operations                    |       | $                                | 10,500     |   | $ | 11,556 |   |

 

TheCompany’s postretirement medical and life insurance plans are unfunded.

 

11

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**(11) Pneumoconiosis (Black Lung) Expense andTrust**

 

The components of net periodicbenefit cost for the indicated periods are as follows:

 
| ** **                                          | ** ** | **Three Months Ended March 31,** | ** ** |
|-----------------------------------------------------|------------|----------------------------------|------------|
| ** **                                          | ** ** | **2005  Successor**              | ** ** | **2004  Predecessor** | ** ** |
| Service cost                                        |       | $                                | 84         |   | $ | 133 |   |
| Interest cost                                       |       | 211                              |       | 322 |   |
| Expected return on plan assets                      |       | (145                             | )          | (244 | ) |
| Amortization of:                                    |       |                             |       |   |   |
| Transition asset                                    |       | —                           |       | (69 | ) |
| Prior service cost                                  |       | —                           |       | 34 |   |
| Net actuarial losses                                |       | 60                               |       | 148 |   |
|                                                |       | 210                              |       | 324 |   |
| Less: amounts allocated to discontinued  operations |       | —                           |       | 12 |   |
| Total from continuing operations                    |       | $                                | 210        |   | $ | 312 |   |

 

**(12) Stock-Based Compensation**

 

The Company recordscompensation expense for all employee stock-based compensation plans includingthose plans involving grants of Foundation Coal Holdings, Inc. commonstock and options to acquire common stock to employees of FCC, using theintrinsic value method prescribed by Accounting Principles Board OpinionNo. 25, *Accounting for Stock Issued toEmployees* (“APB No. 25”) and related interpretations. Under APBNo. 25, compensation expense is recorded over the vesting period to theextent that the fair value of the underlying stock on the date of grant exceedsthe exercise or acquisition price of the stock or stock-based award. Wehave adopted the disclosure-only provisions of SFAS No. 123, *Accounting for Stock-Based Compensation,*(“SFAS No. 123”), as amended by SFAS No. 148 *Accounting for Stock-BasedCompensation—Transition and Disclosure—an amendment of FASB StatementNo. 123* (“SFAS No. 148”).

 

Had compensation expense forstock options grants been determined based on the fair value at the grant datesconsistent with the method required by SFAS No. 123, the Company’s net incomeavailable to common shareholders would have been changed to the pro formaamounts as indicated in the following table. The Predecessor had no stockoption plans; therefore, no Predecessor information is presented.

 
| ** **                                                                                                                            | ** ** | **Three Months  Ended March 31,  2005** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------|------------|
| Net income available to common shareholders,  as reported                                                                             |       | $                                       | 19,042     |   |
| Add:                                                                                                                                  | ** ** | ** **                              | ** ** |
| Stock-based employee compensation included  in reported net income, net of related tax effects                                        |       | 188                                     |       |
| Deduct:                                                                                                                               | ** ** | ** **                              | ** ** |
| Total stock-based employee compensation  expense determined under fair value based method for all awards, net of  related tax effects |       | (376                                    | )          |
|                                                                                                                                  |       |                                    |       |   |
| Pro forma net income available to common  shareholders                                                                                |       | $                                       | 18,854     |   |

 

During the quarter ended March31, 2005, Foundation Coal Holdings, Inc. granted restricted stockperformance unit awards (“performance units”) to certain key employees of FCC.  All of the performance units granted aresubject to continued employment and vest on each December 31, beginningDecember 31, 2005 and ending on December 31, 2007 contingent upon theachievement of certain annual performance targets.  Shares of common stock are then awarded inMarch of the year following the final vesting period. Compensation expense ofapproximately $290 (pretax) was recorded for the three months ended March 31,2005 for one-quarter of the initial year’s performance units that managementexpects will vest on December 31, 2005.

 

12

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**(13) Derivative Instruments and HedgingActivities**

 

The Predecessor entered into aninterest rate swap agreement effective June 20, 1999 to manage itsexposure to fluctuations in interest rates relating to its outstanding variablerate debt. The interest rate swap agreement was designated as a cash flowhedge, and was designed to be entirely effective by matching the terms of theswap agreement with the debt. The base rate for both the debt and the swap isLIBOR and the instruments have the same renewal dates over the lives of theinstruments. The contract’s notional amount was $434,000 at inception, anddeclined semi-annually over the life of the contract in proportion to thePredecessor’s outstanding balance on its related debt. The Predecessor paid afixed rate of 6.55% and received six-month LIBOR which reset every180 days. The maturity date of the contract was July 30, 2009.  However, in connection with the definitiveStock Purchase Agreement for the sale of the RAG Colorado Business Unit enteredinto on February 29, 2004, the Predecessor notified the holders of thevariable rate notes of their intention to repay the notes. Accordingly, theinterest rate swaps no longer qualified for hedge accounting treatment and inthe quarter ended March 31, 2004, the full amount of unrealized lossincluded in accumulated other comprehensive income was recognized in netincome. The Predecessor settled the interest rate swaps in April 2004. BetweenFebruary 29, 2004 and March 31, 2004, mark-to-market losses on theinterest rate swaps were $3,166 and were included in other income.

 

On September 30, 2004, theSuccessor entered into pay-fixed, receive-variable interest rate swapagreements on a notional amount of $85,000. The term of these swaps is forthree years. Under these swaps, the Company receives a variable rate of threemonth US dollar LIBOR and pays a fixed rate of 3.26%. Settlement of interestpayments occurs quarterly. The Company was required to enter into these swapsin order to maintain at least 50% of its outstanding debt at a fixed rate asrequired by the Senior Credit Facility. These swap agreements essentiallyconvert $85,000 of the Company’s variable rate borrowings under the SeniorCredit Facility to fixed rate borrowings for a three year period beginningSeptember 30, 2004. Effective January 1, 2005, the Company designatedthese interest rate swaps as cash flow hedges of the variable interest paymentsdue on $85,000 of its variable rate date through September 2007 under SFASNo 133, *Accounting for Derivative FinancialInstruments and Hedging Activities* upon completion of theeffectiveness testing and related documentation. As of March 31, 2005, the fairvalue of this cash flow hedge was $1,912 which was recorded as a noncurrentasset and the offsetting unrealized gain of $829, net of tax expense wasrecorded in accumulated other comprehensive income. At December 31, 2004,the fair value of these swaps was $530 which was recorded as a noncurrentasset.

 

**(14) Asset Retirement Obligations**

 

The Company’s mining activitiesare subject to various federal and state laws and regulations governing theprotection of the environment. These laws and regulations are continuallychanging and are generally becoming more restrictive. The Company conducts itsoperations so as to protect the public health and environment and believes itsoperations are in compliance with all applicable laws and regulations. TheCompany has made, and expects to make in the future, expenditures to complywith such laws and regulations, but cannot predict the amount of such futureexpenditures. Estimated future reclamation costs are based principally on legaland regulatory requirements.

 

The following table is areconciliation of the Company’s asset retirement obligation (“ARO”) liabilityfrom January 1, 2005 through March 31, 2005:

 
| Asset retirement obligation, January 1,  2005 |   | $     | 104,600 |   |
|-----------------------------------------------|--------|-------|---------|--------|
| Accretion expense                             |   | 2,040 |    |
| Revisions in estimated cash flows             |   | 120   |    |
| Payments                                      |   | (433  | )       |
| Asset retirement obligation, March 31, 2005   |   | $     | 106,327 |   |

 

The current portions of theasset retirement obligation liabilities of $ 4,291 and $ 4,398 atMarch 31, 2005 and December 31, 2004, respectively, are included inaccrued expenses and other current liabilities as illustrated in Note 7. Therewere no assets that were legally restricted for purposes of settling assetretirement obligations at March 31, 2005 or December 31, 2004,respectively.

 

13

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**(15) Segment Information:**

 

The Company produces primarilysteam coal from surface and deep mines for sale to utility and industrialcustomers. The Company operates only in the United States with mines in all ofthe major coal basins. The Company has three reportable business segments:Northern Appalachia, consisting of two underground mines in southwesternPennsylvania, Central Appalachia, consisting of 6 underground mines and twosurface mines in southern West Virginia and the Powder River Basin, consistingof two surface mines in Wyoming. Corporate, Other and Eliminations includes anunderground mine in Illinois, centralized sales functions, corporate overhead,business development activities, expenses for closed mines and the eliminationof intercompany transactions. The Company evaluates the performance of itssegments based on operating income.

 

***Successor:***

 

Operating segment results forthe three months ended March 31, 2005 are as follows:

 
| ** **                               | ** ** | **Powder  River  Basin** | ** ** | **Northern  Appalachia** | ** ** | **Central  Appalachia** | ** ** | **Other** | ** ** | **Consolidated** | ** ** |
|------------------------------------------|------------|--------------------------|------------|--------------------------|------------|-------------------------|------------|-----------|------------|------------------|------------|
| Revenues                                 |       | $                        | 82,576     |                     | $          | 113,989                 |       | $         | 85,626     |             | $          | 23,315 |   | $ | 305,506 |   |
| Income from operations                   |       | 5,558                    |       | 42,472                   |       | 12,970                  |       | (15,616   | )          | 45,384           |       |
| Depreciation, depletion and amortization |       | 19,556                   |       | 19,585                   |       | 13,837                  |       | 1,822     |       | 54,800           |       |
| Amortization of coal supply agreements   |       | 4,643                    |       | (16,501                  | )          | (12,115                 | )          | 594       |       | (23,379          | )          |
| Capital expenditures                     |       | 10,049                   |       | 13,263                   |       | 12,761                  |       | 455       |       | 36,528           |       |
| Total assets                             |       | $                        | 591,194    |                     | $          | 943,985                 |       | $         | 486,740    |             | $          | 82,625 |   | $ | 2,104,544 |   |

 

***Predecessor:***

 

Operating segment results forthe three months ended March 31, 2004 are as follows:

 
| ** **                               | ** ** | **Powder  River  Basin** | ** ** | **Northern  Appalachia** | ** ** | **Central  Appalachia** | ** ** | **Other** | ** ** | **Consolidated** | ** ** |
|------------------------------------------|------------|--------------------------|------------|--------------------------|------------|-------------------------|------------|-----------|------------|------------------|------------|
| Revenues                                 |       | $                        | 79,791     |                     | $          | 54,537                  |       | $         | 67,002     |             | $          | 24,977 |   | $ | 226,307 |   |
| Income from operations                   |       | 12,720                   |       | (11,416                  | )          | —                  |       | (13,274   | )          | (11,970          | )          |
| Depreciation, depletion and amortization |       | 4,671                    |       | 11,009                   |       | 7,808                   |       | 1,529     |       | 25,017           |       |
| Amortization of coal supply agreements   |       | 3,389                    |       | 133                      |       | —                  |       | 444       |       | 3,966            |       |
| Capital expenditures                     |       | 8,269                    |       | 11,049                   |       | 4,147                   |       | 2,085     |       | 25,550           |       |
| Total assets                             |       | $                        | 420,978    |                     | $          | 637,641                 |       | $         | 250,508    |             | $          | 531,161 |   | $ | 1,840,288 |   |

 

Reconciliation of segmentincome from operations to consolidated income (loss) before income tax expense(benefit) is as follows:

 
| ** **                                                       | ** ** | **Three Months Ended March 31,** | ** ** |
|------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                       | ** ** | **2005  Successor**              | ** ** | **2004  Predecessor** | ** ** |
| Total segment income (loss) from operations                      |       | $                                | 45,384     |   | $ | (11,970 | ) |
| Interest expense                                                 |       | (14,253                          | )          | (9,971 | ) |
| Loss on termination of hedge accounting for  interest rate swaps |       | —                           |       | (48,772 | ) |
| Mark-to-market gain on interest rate swaps                       |       | —                           |       | (3,166 | ) |
| Interest income                                                  |       | 122                              |       | 773 |   |
|                                                             |       |                             |       |   |   |
| Income (loss) before income tax expense  (benefit)               |       | $                                | 31,253     |   | $ | (73,106 | ) |

 

14

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**(16) Other Revenue**

 

Other revenue consisted of thefollowing:

 
| ** **                             | ** ** | **Three Months Ended March 31,** | ** ** |
|----------------------------------------|------------|----------------------------------|------------|
| ** **                             | ** ** | **2005  Successor**              | ** ** | **2004  Predecessor** | ** ** |
| ** **                             |       |                             |       |   |   |
| Royalty income                         |       | $                                | 177        |   | $ | 823 |   |
| Synfuel fees                           |       | 1,377                            |       | 1,000 |   |
| Coalbed methane                        |       | 1,337                            |       | 137 |   |
| Transloading and plant processing fees |       | 1,130                            |       | 358 |   |
| Gain on disposition of assets          |       | —                           |       | 446 |   |
| Other                                  |       | 1,464                            |       | 1,564 |   |
|                                   |       | $                                | 5,485      |   | $ | 4,328 |   |

 

**(17) Commitments and Contingencies**

 

***Asset RetirementObligations (formerly Reclamation and Mine Closure)***

 

At March 31, 2005, theCompany’s accruals for reclamation and mine closure totaled $106,327. Theportion of the costs expected to be incurred within a year of $4,291 atMarch 31, 2005 is included in accrued expenses and other currentliabilities. At March 31, 2005, these regulatory obligations are secured by suretybonds in the amount of $230,249.  Thesesurety bonds are partially collateralized by letters of credit issued by theCompany.

 

***Guarantees***

 

One of our former parentcompanies, Cyprus Amax Minerals Company, remains a guarantor with regard tofuture minimum royalties payable under leases through the first quarter 2006 toBlackhawk Coal Company, an affiliate of American Electric Power. Under theterms of the Stock Purchase Agreement, dated May 12, 1999 between RAG CoalInternational AG and Cyprus Amax Mineral Company, the Predecessor guaranteedCyprus Amax’ performance under this obligation by issuing an irrevocable letterof credit to secure the minimum royalty payments still due. The Company assumedthis guarantee in the acquisition. The amount of this letter of credit isreduced as the Company makes the scheduled payments. At  March 31, 2005 and December 31, 2004,the letter of credit amount was $5,000 and $6,000, respectively.

 

Neweagle Industries, Inc.(“Neweagle”) is a wholly-owned indirect subsidiary of the Company.Starting in early 2001, Neweagle supplied and sold coal to Arch Coal SalesCompany, Inc. (“Arch Sales”) pursuant to a Conditional Coal SupplyAgreement dated October 1, 1996 (CCSA). This coal was in turn resold byArch Sales under a separate and distinct Coal Sales Agreement datedOctober 1, 1989 (“Rocky Mount Contract”) with Cogentrix of RockyMount, Inc. (“Cogentrix”) as the buyer. On March 23, 2003, thePredecessor (now known as Foundation American Coal Holding, Inc.)conditionally issued to Arch Sales a Guaranty and Indemnity (“Guaranty”) ofNeweagle’s performance under the CCSA, and also agreed to indemnify Arch Salesand its affiliates and other parties for any liability related to the RockyMount Contract. As part of a global settlement of litigation relating tonumerous issues between affiliates of the Predecessor and Arch Sales, a MutualRelease and Settlement Agreement (“MRSA”) was executed and effectiveNovember 12, 2004. Pursuant to the MRSA, the CCSA and the Guaranty wereterminated. Also pursuant to the MRSA, Neweagle agreed to continue selling andsupplying coal to Arch in the quantities required under the Rocky MountContract for re-sale by Arch to Cogentrix thereunder. The MRSA also wasexecuted by the Predecessor, (now known as Foundation American CoalHolding, Inc.) As a signatory to the MRSA, Foundation American CoalHolding, Inc. and Neweagle agreed to indemnify, defend, and save harmlessArch and its affiliates from any non-performance, default or breach of(i) Neweagle’s obligation to supply coal to Arch Sales under the MSRA and(ii) for so long as the MRSA remains in force, any default, breach, ornon-fulfillment of Arch Sales contract obligations under the Rocky MountContract as a result of acts or omissions (other than by Cogentrix) occurringon or after November 12, 2004.

 

15

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Neweagle Industries, Inc.,Neweagle Coal Sales Corp., Laurel Creek Co., Inc. and RockspringDevelopment, Inc. (“Sellers”) are wholly-owned indirect subsidiariesof the Company. The Sellers sell coal to Birchwood Power Partners, L.P. (“Birchwood”)under a Coal Supply Agreement dated July 22, 1993 (Birchwood Contract).Laurel Creek Co., Inc. and Rockspring Development, Inc. were partiesto the Birchwood Contract since its inception, at which time those entitieswere not affiliated with Neweagle Industries, Inc., Neweagle Coal SalesCorp., or the Company. Effective January 31, 1994, the Birchwood Contractwas assigned to Neweagle Industries, Inc. and Neweagle Coal Sales Corp. byAgipCoal Holding USA, Inc. and AgipCoal Sales USA, Inc., which at thetime were affiliates of Arch Coal, Inc. Despite this assignment, ArchCoal, Inc. (“Arch”) and its affiliates have separate contractualobligations to provide coal to Birchwood if Sellers fail to perform. Pursuantto an Agreement & Release dated September 30, 1997, thePredecessor (now known as Foundation American Coal Holding, Inc.) agreedto defend, indemnify, and hold harmless Arch and its subsidiaries from andagainst any claims arising out of any failure of Sellers to perform under theBirchwood Contract. By acknowledgement dated February 16, 2005, thePredecessor and Arch acknowledged the continuing validity and effect of theAgreement & Release dated September 30, 1997.

 

In the normal course ofbusiness, the Company is a party to guarantees and financial instruments withoff-balance sheet risk, such as bank letters of credit, performance or suretybonds and other guarantees and indemnities, which are not reflected in theaccompanying consolidated balance sheets. Such financial instruments are valuedbased on the amount of exposure under the instrument and likelihood ofperformance being required. In the Company’s past experience, no claims havebeen made against these financial instruments. Management does not expect anymaterial losses to result from these guarantees or off-balance-sheetinstruments and, therefore, is of the opinion that their fair value is zero.

 

***Contingencies***

 

Three of our subsidiaries werenamed as defendants in six separate complaints filed in Raleigh and WyomingCounties, West Virginia, in late 2001, alleging personal injury and propertydamage caused by flooding on or about July 8, 2001. Similar suits may befiled in the future based on this or subsequent weather events. The generalalleged basis for the lawsuits is that coal mining, oil and gas drilling andtimbering operations altered the topography in the area to such an extent thatflooding resulting from heavy rains caused more severe damage than would haveotherwise resulted. Numerous similar complaints were filed by hundreds ofplaintiffs against over 100 defendants, in a total of seven southern WestVirginia counties. All such civil actions have been referred by the WestVirginia Supreme Court to a three-judge panel, sitting in Raleigh County,pursuant to the Court’s Mass Litigation Rule.

 

On December 9, 2004, theWest Virginia Supreme Court issued an opinion addressing certain questions oflaw certified to it by the three-judge panel. Among other rulings, theSupreme Court decision held that plaintiffs may not proceed under a strictliability theory, as had been asserted in their complaints. The court also heldthat where damages can be shown to have been caused by an unusual act of naturecombined with the conduct of a defendant, the defendant should be given anopportunity to show by clear and convincing evidence that it caused only aportion of those damages, in order to avoid incurring liability for alldamages.

 

Pursuant to an existing order,no formal discovery has taken place in any of these cases, and the filing ofcross-claims, counterclaims and third-party actions was stayed. InMarch 2005 the three judge panel issued a scheduling order indicating thatsix different trials will be held, one for each watershed impacted. Each trialwill be held in two phases with the liability phase being held first, and thena damages phase. The first trial is currently scheduled to commence inMarch 2006. This will relate to flooding in the Upper Guyandotte Riverwatershed in which our affiliates do have operations.

 

The claims against our entitiesare covered by insurance. Common defense counsel and experts are representingnumerous defendants and costs are being shared. While the outcome of litigationis subject to uncertainties, based on our preliminary evaluation of the issuesand the potential impact on us, we believe this matter will be resolved withouta material adverse effect on our financial condition, results of operations orcash flow.

 

On October 23, 2003,several citizens groups sued the Army Corps of Engineers (“COE”) in the UnitedStates District Court for the Southern District of West Virginia seeking toinvalidate “nationwide” permits utilized by the COE and the coal industry forpermitting most in-stream disturbances associated with coal mining, includingexcess spoil valley fills and refuse impoundments. The plaintiffs sought toenjoin the prospective approval of these nationwide permits and to enjoin somecoal operators, including one of our subsidiaries, from additional use ofexisting nationwide permit approvals until they obtain more detailed “individual”permits. On

 

16

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July 8, 2004, the courtissued an order enjoining the further issuance of nationwide permits andrequiring individual permits to be obtained in their place. The order alsoprecludes activity on areas covered by certain existing nationwide permits. TheUnited States Department of Justice appealed the decision to the United StatesCourt of Appeals for the Fourth Circuit. The appeal is pending. A similar suitwas filed in January 2005 in the United States District Court for theEastern District of Kentucky. Although we have no current operations inKentucky, similar suits may be filed in other jurisdictions where we do, or mayin the future, have operations.

 

Because of the decision, onenationwide permit already issued to a subsidiary of ours developing the new PaxSurface Mine in Raleigh County, West Virginia was converted to an individualpermit. That conversion application was open to public comment and commentswere received. We responded to the comments in a timely manner and the permitwas issued in March 2005. Also because of this decision, a then pending nationwidepermit application for a second permit at the Pax Surface Mine was converted toan individual permit application. Public comments were received and weresponded to those comments in a timely manner as well. That permit was issuedin January 2005. Although the new Pax Surface Mine and other mines mayexperience additional permit requirements and potential delays in permitapprovals, based on the information available to us at this time, we believeour existing operations will not be adversely impacted in a material manner.

 

Extensive regulation of theimpacts of mining on the environment and related litigation has had and mayhave a significant effect on our costs of production and competitive position.Further regulations, legislation or litigation may also cause our sales orprofitability to decline by hindering our ability to continue our miningoperations, by increasing our costs, or by causing coal to become a lessattractive fuel source.

*** ***

***Legal Proceedings***

 

The Company is involved invarious claims and other legal actions arising in the ordinary course ofbusiness. In the opinion of management, the ultimate disposition of thesematters will not have a material adverse effect on the Company’s financialposition, results of operations or cash flows.

 

**(18) Supplemental Guarantor and Non-Guarantor Financial Information**

 

On July 30, 2004, the Company’s indirectwholly owned subsidiary, Foundation PA Coal Company (the “Issuer”), issued$300,000 aggregate principal amount of 71¤4%Senior Notes (the “Notes”) that mature on August 1, 2014. In accordancewith the indenture governing the Notes, each of the direct and indirect whollyowned subsidiaries of the Company, other than the Issuer, have fully andunconditionally guaranteed the Notes, jointly and severally, on a seniorunsecured basis. Separate financial statements and other disclosures concerningthe Guarantor Subsidiaries are not presented because management believes thatsuch information is not material to holders of the Notes. The followingcondensed financial statement information is provided for the Guarantor/Non-GuarantorSubsidiaries.

 

17

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** **

**Successor**

**SupplementalCondensed Consolidated Statements of Operations**

**Forthe Three Months Ended March 31, 2005**

**(Unaudited,in thousands)**

 
| ** **                                                                                        | ** ** | **FCC** | ** ** | **Non-Guarantor  Subsidiary (Issuer)** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|---------------------------------------------------------------------------------------------------|------------|---------|------------|----------------------------------------|------------|-----------------------------|------------|------------------|------------|------------------|------------|
| Total revenues                                                                                    |       | $       | —     |                                   | $          | —                      |       | $                | 305,506    |             | $          | — |   | $ | 305,506 |   |
| Costs and expenses:                                                                               |       |    |       |                                   |       |                        |       |             |       |             |       |
| Cost of sales (excludes depreciation depletion  and amortization)                                 |       | —  |       | 38                                     |       | 215,192                     |       | —           |       | 215,230          |       |
| Selling, general and administrative  expenses (excludes depreciation, depletion and amortization) |       | 7,367   |       | —                                 |       | 4,064                       |       | —           |       | 11,431           |       |
| Accretion on asset retirement obligation                                                          |       | —  |       | —                                 |       | 2,040                       |       | —           |       | 2,040            |       |
| Depreciation, depletion and amortization                                                          |       | —  |       | —                                 |       | 54,800                      |       | —           |       | 54,800           |       |
| Amortization of coal supply agreements                                                            |       | —  |       | —                                 |       | (23,379                     | )          | —           |       | (23,379          | )          |
| Income (loss) from operations                                                                     |       | (7,367  | )          | (38                                    | )          | 52,789                      |       | —           |       | 45,384           |       |
| Other income (expense):                                                                           |       |    |       |                                   |       |                        |       |             |       |             |       |
| Interest expense                                                                                  |       | (1,509  | )          | (6,222                                 | )          | (2,764                      | )          | (3,758           | )          | (14,253          | )          |
| Interest income                                                                                   |       | 52      |       | —                                 |       | 70                          |       | —           |       | 122              |       |
| Income (loss) from operations before income  taxes                                                |       | (8,824  | )          | (6,260                                 | )          | 50,095                      |       | (3,758           | )          | 31,253           |       |
| Income tax expense                                                                                |       | (11,188 | )          | (1,020                                 | )          | (3                          | )          | —           |       | (12,211          | )          |
| Income from continuing operations                                                                 |       | (20,012 | )          | (7,280                                 | )          | 50,092                      |       | (3,758           | )          | 19,042           |       |
| Equity in earnings of investments in issuer  and guarantor subsidiaries                           |       | 39,054  |       | 37,808                                 |       | —                      |       | (76,862          | )          | —           |       |
| Net income (loss)                                                                                 |       | $       | 19,042     |                                   | $          | 30,528                      |       | $                | 50,092     |             | $          | (80,620 | ) | $ | 19,042 |   |

 

18

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**Successor**

**SupplementalCondensed Consolidated Balance Sheets**

**March 31,2005**

**(Unaudited,in thousands)**

 
| ** **                                      | ** ** | **FCC** | ** ** | **Non-Guarantor  Subsidiary (Issuer)** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|-------------------------------------------------|------------|---------|------------|----------------------------------------|------------|-----------------------------|------------|------------------|------------|------------------|------------|
| **Assets**                                      |       |    |       |                                   |       |                        |       |             |       |             |       |
| Current assets:                                 |       |    |       |                                   |       |                        |       |             |       |             |       |
| Cash and cash equivalents                       |       | $       | 4,479      |                                   | $          | —                      |       | $                | (347       | )                | $          | — |   | $ | 4,132 |   |
| Trade accounts receivable                       |       | (473    | )          | —                                 |       | 101,741                     |       | —           |       | 101,268          |       |
| Inventories, net                                |       | —  |       | —                                 |       | 58,311                      |       | —           |       | 58,311           |       |
| Deferred income taxes                           |       | —  |       | 5,569                                  |       | 9,576                       |       | —           |       | 15,145           |       |
| Other current assets                            |       | 2,092   |       | 271                                    |       | 22,219                      |       | —           |       | 24,582           |       |
| Total current assets                            |       | 6,098   |       | 5,840                                  |       | 191,500                     |       | —           |       | 203,438          |       |
| Owned surface lands                             |       | —  |       | —                                 |       | 28,274                      |       | —           |       | 28,274           |       |
| Plant, equipment and mine development, net      |       | —  |       | —                                 |       | 509,101                     |       | —           |       | 509,101          |       |
| Leased mineral rights, net                      |       | —  |       | —                                 |       | 1,245,966                   |       | —           |       | 1,245,966        |       |
| Coal supply agreements, net                     |       | —  |       | —                                 |       | 76,947                      |       | —           |       | 76,947           |       |
| Other noncurrent assets                         |       | 400,807 |       | 442,200                                |       | 40,818                      |       | (843,007         | )          | 40,818           |       |
| Total assets                                    |       | $       | 406,905    |                                   | $          | 448,040                     |       | $                | 2,092,606  |             | $          | (843,007 | ) | $ | 2,104,544 |   |
| Liabilities and Stockholders’ Equity       |       |    |       |                                   |       |                        |       |             |       |             |       |
| Current liabilities:                            |       |    |       |                                   |       |                        |       |             |       |             |       |
| Trade accounts payable                          |       | 849     |       | —                                 |       | 30,466                      |       | —           |       | 31,315           |       |
| Accrued expenses and other current  liabilities |       | 10,268  |       | 4,910                                  |       | 144,085                     |       | —           |       | 159,263          |       |
| Total current liabilities                       |       | 11,117  |       | 4,910                                  |       | 174,551                     |       | —           |       | 190,578          |       |
| Long-term debt, excluding current portion       |       | —  |       | 685,000                                |       | —                      |       | —           |       | 685,000          |       |
| Deferred income taxes                           |       | 3,824   |       | 126,433                                |       | 7,947                       |       | —           |       | 138,204          |       |
| Noncurrent coal supply agreements, net          |       | —  |       | —                                 |       | 147,269                     |       | —           |       | 147,269          |       |
| Other noncurrent liabilities                    |       | 116,985 |       | (438,098                               | )          | 668,514                     |       | 321,113          |       | 668,514          |       |
| Total liabilities                               |       | 131,926 |       | 378,245                                |       | 998,281                     |       | 321,113          |       | 1,829,565        |       |
| Stockholders’ Equity                       |       | 274,979 |       | 69,795                                 |       | 1,094,325                   |       | (1,164,120       | )          | 274,979          |       |
| Total liabilities and stockholder’s equity |       | $       | 406,905    |                                   | $          | 448,040                     |       | $                | 2,092,606  |             | $          | (843,007 | ) | $ | 2,104,544 |   |

 

19

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** **

**Successor**

**SupplementalCondensed Consolidated Statements of Cash Flows**

**Forthe Three Months Ended March 31, 2005**

**(Unaudited,in thousands)**

 
| ** **                                                  | ** ** | **FCC** | ** ** | **Non-Guarantor  Subsidiary (Issuer)** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|-------------------------------------------------------------|------------|---------|------------|----------------------------------------|------------|-----------------------------|------------|------------------|------------|------------------|------------|
| Net cash provided by (used in) operating  activities        |       | $       | 6,769      |                                   | $          | —                      |       | $                | 4,495      |             | $          | — |   | $ | 11,264 |   |
| Investing activities                                        |       |    |       |                                   |       |                        |       |             |       |             |       |
| Purchases of property, plant and equipment                  |       | —  |       | —                                 |       | (36,528                     | )          | —           |       | (36,528          | )          |
| Proceeds from disposition of property,  plant and equipment |       | —  |       | —                                 |       | 4,353                       |       | —           |       | 4,353            |       |
| Net cash used in investing activities                       |       | —  |       | —                                 |       | (32,175                     | )          | —           |       | (32,175          | )          |
| Financing activities:                                       |       |    |       |                                   |       |                        |       |             |       |             |       |
| Proceeds from revolving credit line                         |       | —  |       | 39,000                                 |       | —                      |       | —           |       | 39,000           |       |
| Repayment of revolving credit line                          |       | —  |       | (39,000                                | )          | —                      |       | —           |       | (39,000          | )          |
| Net cash provided by (used in) financing  activities        |       | —  |       | —                                 |       | —                      |       | —           |       | —           |       |
| Net increase (decrease) in cash and cash  equivalents       |       | 6,769   |       | —                                 |       | (27,680                     | )          | —           |       | (20,911          | )          |
| Cash and cash equivalents at beginning of  period           |       | (2,290  | )          | —                                 |       | 27,333                      |       | —           |       | 25,043           |       |
| Cash and cash equivalents at end of period                  |       | $       | 4,479      |                                   | $          | —                      |       | $                | (347       | )                | $          | — |   | $ | 4,132 |   |

 

20

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** **

**ITEM2****.  MANAGEMENT’S DISCUSSION AND ANALYSIS OFFINANCIAL CONDITION AND RESULTS OF OPERATIONS**

 

**SPECIAL NOTE REGARDING FORWARD–LOOKINGSTATEMENTS**

 

This Form 10-Q contains forward-looking statements that are notstatements of historical fact and may involve a number of risks anduncertainties. These statements relate to analyses and other information thatare based on forecasts of future results and estimates of amounts not yetdeterminable. These statements may also relate to our future prospects, developmentsand business strategies.

 

We have used the words “anticipate,” “believe,” “could,” “estimate,”“expect,” “intend,” “may,” “plan,” “predict,” “project” and similar terms andphrases, including references to assumptions, in this Form 10-Q toidentify forward-looking statements. These forward-looking statements are madebased on expectations and beliefs concerning future events affecting us and aresubject to uncertainties and factors relating to our operations and businessenvironment, all of which are difficult to predict and many of which are beyondour control, that could cause our actual results to differ materially fromthose matters expressed in or implied by these forward-looking statements. Thefactors, described below and elsewhere in this Form 10-Q, and in otherdocuments we file with the SEC from time to time, are among those that maycause actual results to differ materially from our forward-looking statements:

 

•                  marketdemand for coal, electricity and steel;

•                  futureeconomic or capital market conditions;

•                  weatherconditions or catastrophic weather-related damage;

•                  ourproduction capabilities;

•                  theconsummation of financing, acquisition or disposition transactions and theeffect thereof on our business;

•                  ourplans and objectives for future operations and expansion or consolidation;

•                  ourrelationships with, and other conditions affecting, our customers;

•                  timingof reductions or increases in customer coal inventories;

•                  long-termcoal supply arrangements;

•                  risksin coal mining;

•                  environmentallaws, including those directly affecting our coal mining and production, andthose affecting our customers’ coal usage;

•                  competition;

•                  railroad,barge, trucking and other transportation performance and costs;

•                  ourassumptions concerning economically recoverable coal reserve estimates;

•                  employeeworkforce factors;

•                  regulatoryand court decisions;

•                  futurelegislation and changes in regulations or governmental policies or changes ininterpretations thereof;

•                  changesin postretirement benefit and pension obligations;

•                  ourliquidity, results of operations and financial condition.

 

You should keep in mind that any forward-looking statement made by usin this Form 10-Q or elsewhere speaks only as of the date on which we makeit. New risks and uncertainties come up from time to time, and it is impossiblefor us to predict these events or how they may affect us. We have no duty to,and do not intend to, update or revise the forward-looking statements in thisForm 10-Q after the date of this Form 10-Q, except as may be requiredby law. In light of these risks and uncertainties, you should keep in mind thatany forward-looking statement made in this Form 10-Q or elsewhere mightnot occur.

 

**Overview**

 

We are the fifth largest coal company in the United States operatingnine mining complexes that consist of thirteen individual coal mines. Ourmining operations are located in southwest Pennsylvania, southern WestVirginia, southern Illinois and the southern Powder River Basin region ofWyoming. Three of our mining complexes are surface mines, two of our complexesare underground

 

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mines using highly efficientlongwall mining technology and the remaining four complexes are undergroundmines that utilize continuous miners. In addition to mining coal, we alsopurchase coal from other producers and utilize it with our own production incoal brokering and trading activities.

 

Our primary product is steam coal, sold primarily to electric powergenerators located in the United States. Approximately 10% of our coal salesrevenue for the three months ended March 31, 2005 and 8% of our pro-forma 2004sales revenue was made from the sale of metallurgical coal to the domestic andexport metallurgical coal markets where it is used to make coke for steelproduction.

 

While the majority of our revenues are derived from the sale of coal,we also realize revenues from coal production royalties, override royaltypayments from a coal supply agreement now fulfilled by another producer, feesfrom the processing of our production by a synfuel facility, fees to transloadcoal through our Rivereagle facility on the Big Sandy River and revenues fromthe sale of coalbed methane.

 

From July 1, 1999 through July 29, 2004, we were a stand-alonewholly owned subsidiary of RAG Coal International AG (“RAG”) headquartered inEssen, Germany. In October 2003, RAG announced its intention to divest itsinternational mining subsidiaries. In addition to RAG American CoalHolding, Inc., these international mining subsidiaries consisted ofoperations in Australia and Venezuela. On February 29, 2004, RAG announcedthe sale of four of our subsidiaries, collectively known as the RAG ColoradoBusiness Unit, to a third party. The subsidiaries comprising the RAG ColoradoBusiness Unit owned an underground longwall mine located in Routt County,Colorado, an idled underground longwall mine located in Moffat County, Coloradoand surface lands located in northwest Colorado and southern Wyoming. Thetransaction closed on April 15, 2004. In the financial statements of thepredecessor for the first quarter of 2004, the RAG Colorado Business Unit wasclassified as a discontinued operation.

 

On May 24, 2004, RAG, entered into a definitive agreement withFoundation Coal Corporation, which was owned by affiliates of First Reserve,Blackstone and AMCI, to sell all of its operations except the RAG ColoradoBusiness Unit which was sold on April 15, 2004. The transaction closed onJuly 30, 2004.

 

**Results of Continuing Operations**

 

**Basis of Presentation:**

 

RAG American Coal Holding, Inc. and its subsidiaries, excludingthe subsidiaries comprising the RAG Colorado Business Unit which were sold onApril 15, 2004, were acquired by the Company on July 30, 2004. Due tothe change in ownership, and the resultant application of purchase accounting,the historical financial statements of the Predecessor and the Successorincluded in this Form 10-Q have been prepared on different bases for theperiods presented and are not comparable.

 

The following provides a description of the basis of presentationduring all periods presented:

 

**Successor**—representsthe consolidated financial position of Foundation Coal Corporation as ofDecember 31, 2004 and March 31, 2005 and our consolidated results of operationsand cash flows for the three months ended March 31, 2005. Our consolidatedfinancial position at December 31, 2004 and March 31, 2005 and ourconsolidated results of operations for the three months ended March 31, 2005reflect our preliminary estimates of purchase price allocation based onpreliminary appraisals prepared by independent valuation specialists andpreliminary employee benefit valuations prepared by independent actuaries.Deferred income taxes have been provided in the consolidated balance sheetbased on our best estimates of the tax versus book basis of the assets acquiredand liabilities assumed, as adjusted to estimated fair values. The amounts thatwe may record based on the final assessment and determination of fair valuesmay differ significantly from the information presented in the consolidatedbalance sheets as of December 31, 2004 and March 31, 2005 and theconsolidated statement of operations for the three months ended March 31, 2005.The application of purchase accounting to the acquired assets of RAG AmericanCoal Holding, Inc. resulted in increases to owned and leased mineralrights, surface lands, coal inventories, and the asset arising from recognitionof asset retirement obligations. It resulted in decreases to plant and equipmentand current deferred taxes. In addition, the historical cost assigned todeferred overburden in the acquired asset balance sheet was eliminated. Thevalues assigned to uncovered and partially covered coal lands considered thestage of the mining process in which these two groups of coal lands were at theacquisition date. The application of purchase accounting to the acquiredliabilities of RAG American Coal Holding, Inc. resulted in increases topostretirement health care obligations, pension obligations, black lungobligations, asset retirement obligations and noncurrent deferred taxes.Separate assets or liabilities were established to reflect the valuation ofabove or below market coal supply agreements in relation to market pricecurves. With regard to consolidated results of operations for the three monthsended March 31, 2005, the principal effects of the application of purchase

 

22

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accounting, in comparison toreporting for historical periods, were to decrease the cost of coal sold due tolower expenses for postretirement health care and pensions, to decrease thecost of coal sold for net deferrals of deferred overburden costs, to decreasenet amortization expense for coal supply agreements which is now a creditbecause our contracts at acquisition represented a net liability, and toincrease the cost of depletion expense for owned and leased mineral rights.

 

**Predecessor**—representsthe results of operations and cash flows for RAG American Coal Holding, Inc.for the three months ended March 31, 2004. These consolidated financialstatements are based on the historical assets, liabilities, sales and expensesof the Predecessor for these periods. During the three months ended March 31,2004, RAG American Coal Holding, Inc. reported a loss from continuingoperations before income tax expense of $73.1 million. This result included:(a) $48.8 million in pre-tax charges related to termination of hedgeaccounting for interest rate swaps since it became probable during the threemonth period that the underlying variable rate bank debt would be repaid earlyrather than held to maturity; and (b) $3.1 million in pre-tax mark-to-marketlosses for the one month portion of the three months that the interest swaps didnot qualify for hedge accounting.

 

**Pro forma**—Tofacilitate first quarter to first quarter comparisons throughout management’sdiscussion and analysis, we discuss “pro forma” results for the three monthsended March 31, 2004.  The pro formaresults present the first quarter of 2004 as if Foundation Coal Corporation:(a) acquired RAG American Coal Holding, Inc. on January 1, 2004; (b) receivedfunds from the Initial Public Offering (“IPO”) of Foundation Coal Holdings,Inc. with which to prepay debt on January 1, 2004; and (c) transacted the saleof the RAG Colorado Business Unit and associated repayment of Predecessor bankdebt and settlement of Predecessor interest rate swaps on December 31,2003.  Pro-forma amounts are notrecognized measures under GAAP and do not purport to be alternatives to GAAPoperating measures. Management believes that the discussion of pro formaoperating results is important to the readers of the financial statements tounderstand key operating trends in comparing the first quarter of 2005 to thefirst quarter of 2004.  The followingtable presents unaudited results of operations for the Successor for the threemonths ended March 31, 2005 and unaudited results of operations for the Predecessoron a pro forma basis as described above for the three months ended March 31,2004.

 

***Three months endedMarch 31, 2005—Successor compared to three months ended March 31,2004—Predecessor***

 

As previously described there are significant differences in the basisof financial reporting between the Successor and Predecessor periods as aresult of the purchase of RAG American Coal Holding, Inc. by Foundation CoalCorporation on July 30, 2004, and the resultant application of purchaseaccounting to the assets and liabilities acquired.  The Successor reported income from continuingoperations of $19.0 million for the three months ended March 31, 2005 whereasthe Predecessor reported a loss from continuing operations of $46.1 million forthe three months ended March 31, 2004.

 

During the prior year first quarter the Predecessor incurredapproximately $32.8 million, net of income taxes, of non-cash charges relatedto termination of hedge accounting for interest rate swaps and mark-to-marketlosses on the interest rate swaps.  Thesecharges in combination with below normal coal production from our NorthernAppalachia mines, were primarily responsible for the Predecessor’s loss in thefirst quarter of 2004.

 

During the first quarter of 2005, the Successor achieved strongerproduction and tons sold, enjoyed significantly higher per ton salesrealizations and received the benefit of a net credit from amortization of coalsupply agreements, reflecting amortization of a liability established for belowmarket contracts in purchase accounting. Year-to-year increases in cost of coal sales and administrative expenseswere more than absorbed by higher coal sales revenues.  The operating trends discussed in thefollowing section, ***Historical three months ended March 31, 2005compared to pro forma three months ended March 31, 2004***, alsoapply to comparisons of the Successor and Predecessor periods for the threemonths ended March 31, 2005 and 2004, respectively.

 

23

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**Historical and Pro Forma**

**Consolidated Condensed Statements of Operations**

**(Dollars in millions)**

**(Unaudited)**

 
| ** **                                                       | ** ** | **Successor  Three Months  Ended March  31, 2005** | ** ** | **Predecessor  Three Months  Ended March  31, 2004** | ** ** | **Pro Forma  Adjustments** | ** ** | **Pro Forma  Three Months Ended March 31, 2004** | ** ** |
|------------------------------------------------------------------|------------|----------------------------------------------------|------------|------------------------------------------------------|------------|----------------------------|------------|--------------------------------------------------|------------|
| Revenues                                                         |       | $                                                  | 305.5      |                                                 | $          | 226.3                      |       | $                                                | (0.5       | )(a) | $ | 225.8 |   |
| Cost of coal sales                                               |       | 215.2                                              |       | 197.2                                                |       | (9.2                       | )(b)       | 188.0                                            |       |
| Selling, general & administrative  expense                   |       | 11.4                                               |       | 10.4                                                 |       | (1.3                       | )(c)       | 9.1                                              |       |
| Asset retirement obligation accretion                            |       | 2.0                                                |       | 1.7                                                  |       | 0.3                        |  (d)  | 2.0                                              |       |
| Depreciation, depletion & amortization                       |       | 54.8                                               |       | 25.0                                                 |       | 26.2                       |  (e)  | 51.2                                             |       |
| Amortization of coal supply agreements                           |       | (23.3                                              | )          | 4.0                                                  |       | (35.6                      | )(f)       | (31.6                                            | )          |
| Income (loss) from operations                                    |       | 45.4                                               |       | (12.0                                                | )          | 19.1                       |       | 7.1                                              |       |
| Interest expense                                                 |       | (14.3                                              | )          | (9.9                                                 | )          | (5.6                       | )(g)       | (15.5                                            | )          |
| Interest income                                                  |       | 0.1                                                |       | 0.8                                                  |       | —                     |       | 0.8                                              |       |
| Loss on termination of hedge accounting for  interest rate swaps |       | —                                             |       | (48.8                                                | )          | 48.8                       |  (h)  | —                                           |       |
| Mark-to-market loss on interest rate swaps                       |       | —                                             |       | (3.2                                                 | )          | 3.2                        |  (h)  | —                                           |       |
| Income (loss) before income taxes                                |       | 31.2                                               |       | (73.1                                                | )          | 65.5                       |       | (7.6                                             | )          |
| Income tax (expense) benefit                                     |       | (12.2                                              | )          | 27.0                                                 |       | (23.3                      | )(i)       | 3.7                                              |       |
| Income (loss) from continuing operations                         |       | 19.0                                               |       | (46.1                                                | )          | 42.2                       |       | (3.9                                             | )          |
| Income from discontinued operations, net of  income tax expense  |       | —                                             |       | 2.8                                                  |       | (2.8                       | )(h)       | —                                           |       |
| Net income (loss)                                                |       | $                                                  | 19.0       |                                                 | $          | (43.3                      | )          | $                                                | (39.4      | ) | $ | (3.9 | ) |

 

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(a) Reflects the elimination of royalty income as a result of purchaseaccounting

(b) Reflects an adjustment of $9.2 million of overburden removal costsreflected on depreciation, depletion and amortization as a result of purchaseaccounting, $3.7 million of elimination of actuarial losses on pension andother postretirement benefits as a result of purchase accounting and $3.8million of additional costs due to coal inventories written up to fair value inpurchase accounting.

(c) Reflects an adjustment of $1.1 million for expense arising from amanagement incentive plan eliminated when RAG American Coal holding, Inc. wasacquired by Foundation Coal Corporation and $0.2 million of elimination ofactuarial losses on pensions, other postretirement benefits and black lung benefitsas a result of purchase accounting.

(d) Reflects accretion expense on the additional asset retirementobligation recognized in purchase accounting.

(e) Reflects increased depreciation, depletion and amortization,primarily cost depletion on mineral rights, as a result of purchase accounting.

(f) Reflects net credit to amortization of coal supply agreements as aresult of purchase accounting.

(g) Reflects adjustment to interest expense based on capital structureput in place by the acquisition.

(h) Reflects adjustments to eliminate debt extinguishment charges andincome from discontinued operations arising from sale of the Colorado BusinessUnit.

(i) Represents the tax effect of the pro forma adjustments computedsuch that the pro forma income tax benefit is recognized at the effectiveincome tax rate recorded in the Successor period of 2004.

 

24

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***Historical threemonths ended March 31, 2005 compared to pro forma three months ended March 31,2004***

 

Coal sales realization per ton sold represents the average revenuerealized on each ton of coal sold. It is calculated by dividing coal salesrevenues by tons sold.

 

***Revenues***

 
| ** **                          | ** ** | **Historical**                                    | ** ** | **Pro Forma**                           | ** ** | **Increase (Decrease)** | ** ** |
|-------------------------------------|------------|---------------------------------------------------|------------|-----------------------------------------|------------|-------------------------|------------|
| ** **                          | ** ** | **Three Months  Ended  March 31, 2005**           | ** ** | **Three Months  Ended  March 31, 2004** | ** ** | ** **              | ** ** |
| ** **                          |
| **$**                               | ** ** | **%**                                             |
| ** **                          | ** ** | **(Unaudited, in millions, except per ton data)** | ** ** |
| Coal sales                          |       | $                                                 | 300.0      |                                    | $          | 222.0                   |       | $ | 78.0 |   | 35.1 | % |
| Other revenues                      |       | 5.5                                               |       | 3.8                                     |       | 1.7                     |       | 44.7 | % |
| Total revenues                      |       | $                                                 | 305.5      |                                    | $          | 225.8                   |       | $ | 79.7 |   | 35.3 | % |
| Tons sold                           |       | 17.3                                              |       | 15.4                                    |       | 1.9                     |       | 12.3 | % |
| Coal sales realization per ton sold |       | $                                                 | 17.38      |                                    | $          | 14.45                   |       | $ | 2.93 |   | 20.3 | % |

 

Coal sales revenues for the three months ended March 31, 2005 increasedby 35.1% compared to the pro forma coal sales revenues for the three monthsended March 31, 2004 as a result of a 12.3% increase in tons sold and a 20.3%increase in average coal sales realization per ton.

 

Coal sales volumes in Northern Appalachia increased by 1.4 million tons(70%) primarily as a result of uninterrupted operations during the firstquarter of 2005.  Coal sale volumes inNorthern Appalachia in the first quarter of 2004 were decreased byinterruptions to operations caused by the idling of the Cumberland Minelongwall for approximately one-half of the quarter and an extended durationlongwall move at the Emerald Mine.  FromFebruary 17 through May 7, 2004, the longwall mining equipment at theCumberland Mine was idled due to alleged violations resulting from a revisedinterpretation of regulations issued by MSHA regarding the ventilation systemat the mine.  In response, we revised theventilation system to minimize any future business disruption and on May 7,2004 we resumed longwall operations at the Cumberland Mine.  There was no interruption of production dueto ventilation issues during the first quarter of 2005.  Coal sales volumes in the Powder River Basinincreased by 0.6 million tons (5.7%) primarily as a result of higher levels ofcommitted sales.

 

Coal sales realization per ton sold in Northern and Central Appalachiaeach increased by 25% in 2005 due to substitution of higher priced contractswhich took effect in late 2004 and early 2005 for lower priced contracts thatrolled off.  An additional factor inNorthern Appalachia were higher coal quality premiums for sulfur content as aresult of record prices for sulfur dioxide allowances and lower sulfur contentof shipped coal.  In the Powder RiverBasin, coal sales realizations per ton declined by 2% due to expiration at theend of 2004 of higher priced contracts signed during the 2001 market uptick,partly offset by higher sulfur premiums. The weighted average coal sales realization per ton sold of $17.38 forthe first quarter of 2005 also benefited from a larger proportion of higherpriced Northern Appalachia tons sold relative to the lower priced tons from thePowder River Basin.

 

Approximately 98% of our 2005 projected production is committed andpriced. At March 31, 2005, uncommitted and unpriced tonnage was 11% and 30% ofplanned production in 2006 and 2007, respectively. Higher value eastern coalsaccount for the majority of uncommitted tonnage as 23% and 43% of the Company’splanned eastern production remains uncommitted and unpriced in 2006 and 2007,respectively, including 56% and 74%, respectively, of the Company’s plannedmetallurgical coal production in those years.

 

Other revenues for the three months ended March 31, 2005 increased by$1.7 million compared to the pro forma other revenues for the three monthsended March 31, 2004.  The increase wasprimarily due to higher coalbed methane revenues of $1.2 million and highersynfuel fees of $0.4 million.

 

25

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***Costs and Expenses***

 
| ** **                                                                                        | ** ** | **Historical**                          | ** ** | **Pro Forma**                           | ** ** | **Increase (Decrease)** | ** ** |
|---------------------------------------------------------------------------------------------------|------------|-----------------------------------------|------------|-----------------------------------------|------------|-------------------------|------------|
| ** **                                                                                        | ** ** | **Three Months  Ended March  31, 2005** | ** ** | **Three Months  Ended March  31, 2004** | ** ** | ** **              | ** ** | ** ** | ** ** |
| ** **                                                                                        |
| **$**                                                                                             | ** ** | **%**                                   |
| ** **                                                                                        | ** ** | **(Unaudited, in millions)**            | ** ** |
| Cost of coal sales (excludes depreciation,  depletion and amortization)                           |       | $                                       | 215.2      |                                    | $          | 188.0                   |       | $ | 27.2 |   | 14.5 | % |
| Selling, general and administrative  expenses (excludes depreciation, depletion and amortization) |       | 11.4                                    |       | 9.1                                     |       | 2.3                     |       | 25.3 | % |
| Accretion on asset retirement obligations                                                         |       | 2.0                                     |       | 2.0                                     |       | —                  |       | — |   |
| Depreciation, depletion and amortization                                                          |       | 54.8                                    |       | 51.2                                    |       | 3.6                     |       | 7.0 | % |
| Amortization of coal supply agreements                                                            |       | (23.3                                   | )          | (31.6                                   | )          | 8.3                     |       | 26.3 | % |
| Total costs and expenses                                                                          |       | $                                       | 260.1      |                                    | $          | 218.7                   |       | $ | 41.6 |   | 19.0 | % |

 

***Cost of coal sales.***  The cost of coal sales for the three monthsended March 31, 2005 increased from the pro forma cost of coal sales for thethree months ended March 31, 2004 due to: (a) increases in labor costs as aresult of both compensation increases and hiring of additional personnel; (b)increases in most categories of materials and services as a result ofsignificantly higher commodity prices particularly for steel products anddiesel fuel; (c) increases in royalties and coal production taxes as a resultof higher revenues; and (d) increased operating levels particularly at theCumberland Mine.   Cost of coal sales perton were $12.47 for the three months ended March 31, 2005 compared to a proforma figure of $12.24 for the three months ended March 31, 2004, an increaseof 1.9%.

 

***Selling, general andadministrative expenses.***  Selling, general and administrative expensesfor the three months ended March 31, 2005 totaled $11.4 million compared to proforma expense of $9.1 million for the three months ended March 31, 2004.  The increase is primarily due to additionalexpenses incurred for audit fees and compensation expenses, including bonusaccruals based on the strong level of performance in the first quarter.

 

***Accretion on assetretirement obligation.***  Accretion on asset retirement obligation is acomponent of accounting for asset retirement obligations under SFASNo. 143. Accretion represents the increase in the asset retirementliability to reflect the change in the liability for the passage of time.  Accretion expense was comparable between thetwo periods.

*** ***

***Depreciation,depletion and amortization. ***Depreciation,depletion and amortization includes depreciation of plant and equipment, costdepletion of amounts assigned to coal lands and mining rights and amortizationof mine development costs and leasehold improvements.  Expense increased in the three months endedMarch 31, 2005 compared to the pro forma expense for the three months endedMarch 31, 2004 as a result of higher cost depletion due to increased volumes ofcoal mined and higher depreciation due to equipment additions over the pastyear.

*** ***

***Coal supplyagreement amortization.***  Application of purchase accounting resultedin recognition of a significant liability for below market priced coal supplyagreements as well as a significant asset for above market priced coal supplyagreements, both in relation to market prices at the acquisition date.Amortization of the liability for below market priced coal supply agreementsduring the three months ended March 31, 2005 totals $30.9 million ofcredit to expense. Amortization of the asset for above market priced coalsupply agreements during the same period totals $7.6 million of charges toexpense. The decrease in the net credit for amortization of coal supplyagreements compared to the pro forma amount for the three months ended March31, 2004 is primarily due to reduced amortization of below market priced coalsupply agreements due to roll-off of lower priced contracts in Northern andCentral Appalachia.

 

**Segment Analysis**

 

***Powder River Basin***—Incomefrom operations for the three months ended March 31, 2005 was $5.6 million. Thepro forma loss from operations for the three months ended March 31, 2004 was$0.7 million.  The increase in operatingincome is due to higher tons sold of 0.6 million, lower pro forma net expensefor amortization of coal supply agreements as a result of the expiration ofseveral above market contracts at year end 2004, and higher coal qualitypremiums, partly offset by lower sales realizations per ton also reflecting theexpiration of above market contracts. Cost of coal sales per ton sold increased 0.4% year over year.

 

26

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***Northern Appalachia***—Incomefrom operations for the three months ended March 31, 2005 was $42.5 millioncompared with pro forma income from operations of $4.8 million for the threemonths ended March 31, 2004.  Thesignificant improvement is primarily due to increased coal sales revenues of$58.9 million resulting from a 70% increase in tons sold and a 25% increase inaverage sales realization per ton.  BothCumberland and Emerald mines had uninterrupted operations in the first quarterof 2005.  During the first quarter of2004, Cumberland’s longwall was idle for approximately one-half of the quarter,for reasons previously described, and Emerald had an extended duration longwallmove during the prior year period.  Theseinterruptions had the effect of lowering coal sales volumes in 2004.  Higher sales revenues were partly offset byincreases in labor costs, active and retiree medical benefits, materials andsupplies, coal production taxes, cost depletion, depreciation and a reduced creditfor amortization of coal supply agreements.  Cost of coal sales per ton decreased 25% year over year.

 

***Central Appalachia***—Incomefrom operations for the three months ended March 31, 2005 was$13.0 million compared with pro forma operating income of $11.7 millionfor the three months ended March 31, 2004. Coal sales revenues increased $17.5 million primarily due to a 25%increase in average sales realizations per ton; tons sold were approximatelyequal to the prior year.   Higher salesrevenues were partly offset by increased expenses for: (a) labor and fringebenefits; (b) materials and supplies, led by increases for roof controlmaterials and diesel fuel; (c) royalties and severance taxes driven by highersales revenues; (d) cost depletion; and (e) amortization of coal supplyagreements, representing a smaller net credit due to roll-off of lower pricedsales contracts valued in the purchase accounting.  Also, the pro forma operating income for thethree months ended March 31, 2004 included a $1.5 million charge for settlementof litigation.  Cost of coal sales perton increased 12.6% year over year.

 

***Interest Expense,Net***

 
| ** **                                                     | ** ** | **Historical**                          | ** ** | **Pro Forma**                           | ** ** | **Increase (Decrease)** | ** ** |
|----------------------------------------------------------------|------------|-----------------------------------------|------------|-----------------------------------------|------------|-------------------------|------------|
| ** **                                                     | ** ** | **Three Months  Ended  March 31, 2005** | ** ** | **Three Months  Ended  March 31, 2004** | ** ** |                    | ** ** |
| ** **                                                     |
| **$**                                                          | ** ** | **%**                                   |
| ** **                                                     | ** ** | **(Unaudited, in millions)**            | ** ** |
| Interest expense—debt related                             |       | $                                       | (11.1      | )                                       | $          | (10.3                   | )          | $ | 0.8 |   | 7.8 | % |
| Interest expense—amortization of deferred  financing fees |       | (0.8                                    | )          | (2.6                                    | )          | (1.8                    | )          | (69.2 | )% |
| Interest expense—surety bond and letter of  credit fees   |       | (2.4                                    | )          | (2.6                                    | )          | (0.2                    | )          | (7.6 | )% |
| Interest income                                                |       | 0.1                                     |       | 0.8                                     |       | 0.7                     |       | 88.0 | % |
| Interest expense, net                                          |       | $                                       | (14.2      | )                                       | $          | (14.7                   | )          | $ | (0.5 | ) | (3.4 | )% |

 

Debt related interest expense for the three months ended March 31, 2005was higher than the pro forma debt related interest expense for three monthsended March 31, 2004 due to: (a) about a 100 basis point increase in theinterest rate on variable rate debt; (b) a full quarter of fixed interest rateson $85 million of the variable rate debt via interest rate swaps and (c) greaterutilization of the revolving credit agreement. These factors were partly offset by the impact of repaying approximately$39 million of variable rate debt from cash on hand at December 31, 2004.  The remaining portion of the $85 millionprepayment made on December 31, 2004 was funded by proceeds from the IPO andhas been considered in calculating the pro forma interest expense for the threemonths ended March 31, 2004.  Pro formaamortization of deferred financing fees for the three months ended March 31,2004 includes $1.7 million of accelerated amortization from the repayment ofvariable rate debt with IPO proceeds; there is no accelerated amortization inthe three months ended March 31, 2005. The decrease in surety bond and letter of credit fees in the firstquarter of 2005 is due to reductions in the amounts of these financialassurance instruments compared to the period immediately following the purchaseof RAG American Coal Holding, Inc.  Thereduction in interest income between quarters is primarily due to lower cashbalances available for investment in the three months ended March 31, 2005.

 

27

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***Income Tax Expense(Benefit)***

 
| ** **                   | ** ** | **Historical**                          | ** ** | **Pro Forma**                           | ** ** | **Increase (Decrease)** | ** ** |
|------------------------------|------------|-----------------------------------------|------------|-----------------------------------------|------------|-------------------------|------------|
| ** **                   | ** ** | **Three Months  Ended March 31,  2005** | ** ** | **Three Months  Ended March 31,  2004** | ** ** | ** **              | ** ** | ** ** | ** ** |
| ** **                   |
| **$**                        | ** ** | **%**                                   |
| ** **                   | ** ** | **(Unaudited, in millions)**            | ** ** |
| Income tax (expense) benefit |       | $                                       | (12.2      | )                                       | $          | 3.7                     |       | $ | 15.9 |   | 429.7 | % |
|                              |            |                                         |            |                                         |            |                         |            |  |  |  |  |  |

 

For the three months ended March 31, 2005, income taxes are provided atan effective rate of 39.4% based on projected full year taxable income andprojected full year temporary differences.  Current tax expense, which represents taxes currently payable onoperations, was approximately 26.7% of pre-tax income.  We are providing a full valuation allowanceagainst deferred tax assets attributable to AMT tax credits.  For the three months ended March 31, 2004, apro forma income tax benefit was recognized at an effective rate of 48.3%, thesame effective rate used to provide taxes on the Successor’s pre-tax income forthe five months ended December 31, 2004.

 

**Liquidity and Capital Resources**

 

Our primary sources of cash have been sales of our coal production andpurchased coal to customers, plus cash from sales of non-core assets andmiscellaneous revenues.

 

Our primary uses of cash have been our cash costs of coal production,the cash cost of purchased coal, capital expenditures, interest costs, cashpayments for employee benefit obligations such as defined benefit pensions andretiree health care benefits, cash outlays related to post mining assetretirement obligations and support of working capital requirements such as coalinventories and trade accounts receivable. Our ability to service our debt(principal and interest) and acquire new productive assets for use in ouroperations has been and will be dependent upon our ability to generate cashfrom our operations. We normally fund all of our capital expenditurerequirements with cash generated from operations. Historically, we have engagedin minimal financing of assets such as through operating leases.

 

In the Predecessor periods, cash balances in excess of our day-to-dayoperating requirements were placed on deposit with RAG where cash balancescould be aggregated to earn better investment returns. This cash on deposit wasavailable to us on a one day turn-around. Increases in the cash on deposit withRAG have been classified under financing activities as uses of cash in theconsolidated cash flow statements. Decreases in cash on deposit with RAG havebeen classified under financing activities as cash provided.

 

The following is a summary of cash provided by or used in each of theindicated categories of activities during three months ended March 31, 2005 and2004, respectively.

 
| ** **                                         | ** ** | **Successor**                          | ** ** | **Predecessor**                        | ** ** | ** **               | ** ** |
|----------------------------------------------------|------------|----------------------------------------|------------|----------------------------------------|------------|--------------------------|------------|
| ** **                                         | ** ** | **Three Months Ended  March 31, 2005** | ** ** | **Three Months Ended  March 31, 2004** | ** ** | **Increase  (Decrease)** | ** ** |
| ** **                                         | ** ** | **(Unaudited, in millions)**           | ** ** |
| Cash provided by (used in):                        |       |                                   |       |                                   |       |                     |       |
| Operating activities—continuing operations    |       | $                                      | 11.3       |                                   | $          | 2.4                      |       | $ | 8.9 |   |
| Operating activities—discontinued  operations |       | —                                 |       | 9.6                                    |       | (9.6                     | )          |
| Investing activities—continuing operations    |       | (32.2                                  | )          | (23.8                                  | )          | (8.4                     | )          |
| Investing activities—discontinued  operations |       | —                                 |       | (0.1                                   | )          | 0.1                      |       |
| Financing activities—borrowings(2)            |       | 39.0                                   |       | —                                 |       | 39.0                     |       |
| Financing activities—repayments (2)           |       | (39.0                                  | )          | (0.8                                   | )          | (38.2                    | )          |
| Financing activities—on deposit with RAG(1)   |       | —                                 |       | 5.3                                    |       | (5.3                     | )          |
| Change in cash and cash equivalents                |       | $                                      | (20.9      | )                                      | $          | (7.4                     | )          | $ | (13.5 | ) |

 

----

(1)          Represents the decrease in the balance ofcash on deposit with RAG.

 

(2)          The borrowings and repayments during thethree months ended March 31, 2005 represent use of the Revolving Creditfacility to maintain day-to-day liquidity.

 

28

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Cash provided by operating activities from continuing operationsincreased in the three months ended March 31, 2005 as compared to the Predecessorresults for the three months ended March 31, 2004 primarily due to higher netincome from continuing operations partly offset by increases in workingcapital, mainly trade accounts receivable and inventories.

 

Cash used in investing activities for continuing operations increasedin the three months ended March 31, 2005 as compared to the Predecessor resultsfor the three months ended March 31, 2004 mainly due to higher capitalexpenditures.  Capital expenditures forthe three months ended March 31, 2005 totaled $36.5 million, including $17.7million of expenditures related to the expansion of the Belle Ayr Mine in thePowder River Basin, development of the Pax surface Mine in Central Appalachia,addition of a continuous mining unit to the Kingston Mine in CentralAppalachia, and the widening of the Emerald Mine longwall face to 1,450 feetfrom 1,250 feet.  Capital expenditures forthe three months ended March 31, 2004 of $25.5 million were mainly forreplacement of equipment and other expenditures necessary to sustain mineoperations.

 

Our primary source of liquidity will continue to be cash from sales ofour coal production and purchased coal to customers. We have availability underour revolving credit facility, subject to certain conditions.

 

As of March 31, 2005, we have outstanding $685.0 million inaggregate indebtedness, with an additional $149.1 million of availableborrowings under our revolving credit facility (after giving effect to$200.9 million of letters of credit outstanding as of March 31,2005). Our liquidity requirements will be significant, primarily due to debtservice requirements. Of the $14.3 million of interest expense for the threemonths ended March 31, 2005, approximately $13.1 million has or will bepaid in cash.

 

Based on our current levels of operations, we believe that remainingcash on hand, cash flow from operations and available borrowings under therevolving credit portion of our Senior Credit Facilities will enable us to meetour working capital, capital expenditure, debt service and other fundingrequirements for at least the next twelve months.

 

As a regular part of our business, we review opportunities for, andengage in discussions and negotiations concerning, the acquisition of coalmining assets, including LBA bids, and acquisitions of, or combinations with,coal mining companies. When we believe that these opportunities are consistentwith our growth plans and our acquisition criteria, we will make bids orproposals and/or enter into letters of intent and other similar agreements,which may be binding or nonbinding, that are customarily subject to a varietyof conditions and usually permit us to terminate the discussions and any relatedagreements if, among other things, we are not satisfied with the results of ourdue diligence investigation. Any acquisition opportunities we pursue couldmaterially affect our liquidity and capital resources and may require us toincur indebtedness, seek equity capital or both.

 

**Covenant Compliance**

 

We believe that our Senior Credit Facilities and the indenturegoverning our outstanding 7 1¤4%Senior Notes are material agreements, that the covenants are material terms ofthese agreements and that information about the covenants is material to aninvestor’s understanding of our financial condition and liquidity. The breachof covenants in the Senior Credit Facilities that are tied to ratios based onAdjusted EBITDA, as defined below, could result in a default under the SeniorCredit Facilities and the lenders could elect to declare all amounts borroweddue and payable. Any such acceleration would also result in a default under ourindenture. Additionally, under the Senior Credit Facilities and indenture, ourability to engage in activities such as incurring additional indebtedness,making investments and paying dividends is also tied to ratios based onAdjusted EBITDA.

 

29

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Covenant levels and adjusted EBITDA ratios for the four quarters endedMarch 31, 2005 are as follows:

 
| ** **                                                                                                    | ** ** | **Covenant  Level** | ** ** | **Adjusted EBITDA  March 31,  2005 Ratios** | ** ** |
|---------------------------------------------------------------------------------------------------------------|------------|---------------------|------------|--------------------------------------------------|------------|
| **Senior Credit Facilities(1)**                                                                               |       |                |       |                                             |       |
| Minimum Adjusted EBITDA to cash interest  ratio                                                               |       | 1.75                | x          | 3.6                                              | x          |
| Maximum total debt to Adjusted EBITDA ratio                                                                   |       | 6.0                 | x          | 3.8                                              | x          |
| **Indenture(2)**                                                                                              |       |                |       |                                             |       |
| Minimum Adjusted EBITDA to fixed charge  ratio required to incur additional debt pursuant to ratio provisions |       | 2.0                 | x          | 3.6                                              | x          |

 

----

(1)                                  The Senior CreditFacilities require us to maintain an Adjusted EBITDA to cash interest ratiostarting at a minimum of 1.75x and a total debt to Adjusted EBITDA ratiostarting at a maximum of 6.0x in each case for the most recent four quarterperiod. Failure to satisfy these ratio requirements would constitute a defaultunder the Senior Credit Facilities. If lenders under the Senior CreditFacilities failed to waive any such default, repayment obligations under theSenior Credit Facilities could be accelerated, which would also constitute adefault under the indenture.

 

(2)                                  Our ability to incuradditional debt and make certain restricted payments under our indenture,subject to specified exceptions, is tied to an Adjusted EBITDA to fixed chargeratio of at least 2.0 to 1.

 

Adjusted EBITDA is defined as EBITDA further adjusted to excludenon-recurring items, non-cash items and other adjustments permitted incalculating covenant compliance under the indenture, and the Senior CreditFacilities, as shown in the table below. We believe that the inclusion ofsupplementary adjustments to EBITDA applied in presenting Adjusted EBITDA isappropriate to provide additional information to investors to demonstratecompliance with financing covenants.

 
| ** **                                    | ** ** | ** **                               | ** ** | **Deduct:**                              | ** ** | **Add:**                                   | ** ** | ** ** | ** ** |
|-----------------------------------------------|------------|------------------------------------------|------------|------------------------------------------|------------|--------------------------------------------|------------|------------|------------|
| **Four  Quarters  Ended  December 31,  2004** | ** ** | **Three  Months  Ended March  31, 2004** | ** ** | **Three  Months  Ended March  31, 2005** | ** ** | **Four  Quarters  Ended  March 31,  2005** |
| ** **                                    | ** ** | **(Unaudited, in millions)**             | ** ** |
| EBITDA(1)                                     |       | $                                        | 15.6       |                                     | $          | (34.9                                      | )          | $          | 76.8       |   | $ | 127.3 |   |
| Non-cash charges (income)(2)                  |       | 70.4                                     |       | 57.6                                     |       | (5.3                                       | )          | 7.5        |       |
| Unusual or non-recurring items(3)             |       | 35.9                                     |       | 2.2                                      |       | —                                     |       | 33.7       |       |
| Cumberland Mine force majeure(4)              |       | 31.1                                     |       | 20.2                                     |       | —                                     |       | 10.9       |       |
| Other adjustments(5)                          |       | (0.5                                     | )          | (0.6                                     | )          | 0.2                                        |       | 0.3        |       |
| Adjusted EBITDA                               |       | $                                        | 152.5      |                                     | $          | 44.5                                       |       | $          | 71.7       |   | $ | 179.7 |   |

 

----

(1)           EBITDA is calculatedin the table below:

 

30

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| ** **                                           | ** ** | ** **                                     | ** ** | **Deduct:**                               | ** ** | **Add:**                                  | ** ** | ** **                                 | ** ** |
|------------------------------------------------------|------------|------------------------------------------------|------------|-------------------------------------------|------------|-------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                           | ** ** | **Four  Quarters  Ended  December  31,  2004** | ** ** | **Three  Months  Ended  March 31,  2004** | ** ** | **Three  Months  Ended  March 31,  2005** | ** ** | **Four  Quarters  Ended  March 31,  2005** | ** ** |
| ** **                                           | ** ** | **(Unaudited, in millions)**                   | ** ** |
| Income (loss) from continuing operations             |       | $                                              | (76.1      | )                                         | $          | (46.1                                     | )          | $                                          | 19.0       |   | $ | (11.0 | ) |
| Interest expense                                     |       | 44.7                                           |       | 10.0                                      |       | 14.3                                      |       | 49.0                                       |       |
| Interest income                                      |       | (2.3                                           | )          | (0.8                                      | )          | (0.1                                      | )          | (1.6                                       | )          |
| Income tax expense (benefit)                         |       | (38.2                                          | )          | (27.0                                     | )          | 12.2                                      |       | 1.0                                        |       |
| Depreciation, depletion and amortization             |       | 146.0                                          |       | 25.0                                      |       | 54.8                                      |       | 175.8                                      |       |
| Amortization of above market coal supply  agreements |       | (58.5                                          | )          | 4.0                                       |       | (23.4                                     | )          | (85.9                                      | )          |
| EBITDA                                               |       | $                                              | 15.6       |                                      | $          | (34.9                                     | )          | $                                          | 76.8       |   | $ | 127.3 |   |

 

----

(2)           We are required toadjust EBITDA, as defined above, for the following non-cash charges (income):

 
| ** **                                                                  | ** ** | ** **                                     | ** ** | **Deduct:**                               | ** ** | **Add:**                                  | ** ** | ** **                                 | ** ** |
|-----------------------------------------------------------------------------|------------|------------------------------------------------|------------|-------------------------------------------|------------|-------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                  | ** ** | **Four  Quarters  Ended  December  31,  2004** | ** ** | **Three  Months  Ended  March 31,  2004** | ** ** | **Three  Months  Ended  March 31,  2005** | ** ** | **Four  Quarters  Ended  March 31,  2005** | ** ** |
| ** **                                                                  | ** ** | **(Unaudited, in millions)**                   | ** ** |
| Interest rate swaps(a)                                                      |       | $                                              | 42.6       |                                      | $          | 52.0                                      |       | $                                          | —     |   | $ | (9.4 | ) |
| Early extinguishment of debt                                                |       | 21.7                                           |       | —                                    |       | —                                    |       | 21.7                                       |       |
| Profit in inventory(b)                                                      |       | 3.8                                            |       | —                                    |       | —                                    |       | 3.8                                        |       |
| Overburden removal included in  depreciation, depletion and amortization(c) |       | (15.3                                          | )          | —                                    |       | (7.6                                      | )          | (22.9                                      | )          |
| Accretion on asset retirement  obligations/reclamation expense              |       | 7.3                                            |       | 1.7                                       |       | 2.0                                       |       | 7.6                                        |       |
| Stock based compensation expense (d)                                        |       | —                                         |       | —                                    |       | 0.3                                       |       | 0.3                                        |       |
| Asset impairment charges                                                    |       | —                                         |       | —                                    |       | —                                    |       | —                                     |       |
| Amortization included in benefits  expense(e)                               |       | 10.3                                           |       | 3.9                                       |       | —                                    |       | 6.4                                        |       |
| Total                                                                       |       | $                                              | 70.4       |                                      | $          | 57.6                                      |       | $                                          | (5.3       | ) | $ | 7.5 |   |

 

----

(a)          Includes $48.9 million of expenseresulting in the four quarters ended December 31, 2004 from loss on terminationof hedge accounting for interest rate swaps less $6.3 millionmark-to-market adjustment.

 

(b)         Represents incremental cost of sales recordedin the period arising from the preliminary estimate of manufacturing profitadded to inventory in purchase accounting.

 

(c)          In purchase accounting, the fair value ofpartially and fully uncovered coal included consideration of the effort spentprior to the purchase date to remove overburden and get the coal to itspartially or fully uncovered state. Therefore, the fair value assigned topartially or fully uncovered coal reserves was higher than that assigned toother coal reserves. Depletion of coal reserves, including the incremental fairvalue related to pre-acquisition overburden removal efforts, is included indepreciation, depletion and amortization. Subsequent to the acquisition date,the costs associated with removal of overburden to uncover coal reserves isinventoried as work-in-process until the related coal is mined and theinventoried cost charged to cost of coal sales when the coal is sold. Untilcoal valued as partially or fully uncovered at the acquisition date is fullydepleted, depreciation, depletion and amortization will include the value ofoverburden removal performed prior to the acquisition date which if incurredsubsequent to the acquisition date would have been included in cost of coalsales.

 

31

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(d)         Represents an accrual for compensation expenseattributable to restricted stock performance units and restricted stock awardedto certain directors.

 

(e)          Represents the portion of pension, otherpostretirement and black lung expense resulting from the amortization ofunrecognized actuarial losses, prior service costs and transition obligations.Unrecognized actuarial losses, prior service costs and transition obligationswere eliminated when the pension, other postretirement and black lung obligationswere fair valued in purchase accounting.

 

(3)                                                          Weare also required by the credit agreement to adjust EBITDA, as defined above,for the following unusual (income) expense:

 
| ** **                                           | ** ** | ** **                                    | ** ** | **Deduct:**                               | ** ** | **Add:**                                  | ** ** | ** **                                  | ** ** |
|------------------------------------------------------|------------|-----------------------------------------------|------------|-------------------------------------------|------------|-------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                           | ** ** | **Four  Quarters  Ended  December 31,  2004** | ** ** | **Three  Months  Ended  March  31, 2004** | ** ** | **Three  Months  Ended  March  31, 2005** | ** ** | **Four  Quarters  Ended  March  31,  2005** | ** ** |
| ** **                                           | ** ** | **(Unaudited, in millions)**                  | ** ** |
| Litigation/arbitration/contract  settlements, net(a) |       | $                                             | 28.9       |                                      | $          | 1.5                                       |       | $                                           | —     |   | $ | 27.4 |   |
| Transaction bonus(b)                                 |       | 1.8                                           |       | —                                    |       | —                                    |       | 1.8                                         |       |
| Long-term incentive plan expense(c)                  |       | 2.4                                           |       | 1.1                                       |       | —                                    |       | 1.3                                         |       |
| Gain on asset sales                                  |       | (1.0                                          | )          | (0.4                                      | )          | —                                    |       | (0.6                                        | )          |
| Other(d)                                             |       | 3.8                                           |       | —                                    |       | —                                    |       | 3.8                                         |       |
| Total                                                |       | $                                             | 35.9       |                                      | $          | 2.2                                       |       | $                                           | —     |   | $ | 33.7 |   |

 

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(a)          Represents arbitration awards, litigation andcontract settlements, net of related legal and tax fees.

 

(b)         Represents the cost of a one-time bonusawarded to certain employees in connection with the sale of RAG American CoalHolding, Inc.

 

(c)          Represents the cost of a long-term incentiveplan instituted by RAG American Coal Holding, Inc. in 2001 that wasterminated prior to closing as required by the change in control provisions inthe plan agreement. We have implemented a management equity program that willnot result in a cash cost to us.

 

(d)         Represents $2.0 million from a sponsormonitoring fee and $1.8 million from a tax allowance related to the IPO inthe four quarters ended December 31, 2004.

 

(4)                                  Represents theadjustment required for the estimated impact of the temporary idling of ourCumberland Mine in the first half of 2004 as a result of a revisedinterpretation of mine ventilation laws by MSHA. See “Management’s Discussionand Analysis of Financial Condition and Results of Operations” for additionalinformation.

 

(5)                                  We are also requiredto make adjustments to EBITDA for items such as incremental insurance costs andfranchise taxes not included in income tax expense.

 

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Pro-forma cash interest for the four quarters ended March 31, 2005is calculated as follows (unaudited, in millions):

 
| Cash interest amounts stipulated in Credit  Agreement for period April 1 through July 29, 2004                            |   | $    | 16.0   |   |
|-------------------------------------------------------------------------------------------------------------------------------------|--------|------|--------|--------|
| Interest expense for five month operating  period ended December 31, 2004                                                      |   | 26.7 |   |
| Less: Amortization of deferred financing  costs for the five month operating period                                                 |   | (4.4 | )      |
| Less: Cash interest income for the five  month operating period                                                                     |   | (0.5 | )      |
| Less: Pro-forma cash interest for five  month operating period associated with $85 million senior secured term  loan repayment |   | (1.4 | )      |
| Interest expense for the three month period  ended March 31, 2005                                                                   |   | 14.3 |   |
| Less: Amortization of deferred financing  costs for three month period ended March 31, 2005                                         |   | (0.8 | )      |
| Less: Cash interest income for the three  month period ended March 31, 2005                                                         |   | (0.2 | )      |
| Less: Other non cash interest expense for  three months ended March 31, 2005                                                        |   | (0.4 | )      |
|                                                                                                                                |   | $    | 49.3   |   |

 

In future periods, adjustments to EBITDA that could be used tocalculate compliance with the debt covenants are: (a) accretion on assetretirement obligations, (b) credits from deferral of overburden removalcosts, (c) any non-cash expenses or charges arising as a result of theapplication of purchase accounting in acquisitions, (d) businessoptimization expenses or other restructuring charges, (e) non-cashimpairment charges resulting from the application of SFAS No. 142 or SFASNo. 144, (f) amortization of intangibles pursuant to SFASNo. 141, and (g) any long term incentive plan accruals or anynon-cash compensation expense realized from grants of stock appreciation or similarrights, stock options or other rights to officers, directors and employees.

 

In future periods, cash interest is expected to be calculated by addingback amortization of deferred debt issuance costs and deducting cash interestincome from the interest expense reported in the Statement of Operations.

 

**Contractual Obligations**

 

The following is a summary of our significant future contractualobligations by year as of December 31, 2004.  There have been no significant changes to ourcontractual obligations during the three months ended March 31, 2005.

 
| ** **                                      | ** ** | **2005**                     | ** ** | **2006-2007** | ** ** | **2008-2009** | ** ** | **After 2009** | ** ** | **Total** | ** ** |
|-------------------------------------------------|------------|------------------------------|------------|---------------|------------|---------------|------------|----------------|------------|-----------|------------|
| ** **                                      | ** ** | **(Unaudited, in millions)** | ** ** |
| Long-term debt and capital leases               |       | $                            | —     |          | $          | —        |       | $              | —     |      | $          | 685.0 |   | $ | 685.0 |   |
| Cash interest on long term debt                 |       | 41.3                         |       | 81.4          |       | 73.6          |       | 123.7          |       | 320.0     |       |
| Cash payments for asset retirement  obligations |       | 3.7                          |       | 5.6           |       | 3.5           |       | 197.0          |       | 209.8     |       |
| Unconditional purchase commitments              |       | 56.0                         |       | 7.4           |       | 17.2          |       | —         |       | 80.6      |       |
| Operating leases                                |       | 5.8                          |       | 9.8           |       | 3.5           |       | 1.1            |       | 20.2      |       |
| Minimum royalties                               |       | 4.0                          |       | 1.0           |       | —        |       | —         |       | 5.0       |       |
| Total                                           |       | $                            | 110.8      |          | $          | 105.2         |       | $              | 97.8       |      | $          | 1,006.8 |   | $ | 1,320.6 |   |

 

We expect to invest in the range of $150.0 to $160.0 million incapital expenditures during calendar year 2005 of which approximately$100.0 million is to maintain production and replace mining equipment. Theadditional $50.0 to $60.0 million is expected to be directed towardselective expansions of production and improvements in productivity.Approximately $34 million of expected 2005 capital expenditures areincluded in unconditional purchase commitments shown above. The remaining 2005unconditional purchase commitments and $3 million of the 2006-2007unconditional purchase commitments relate to forward contracts to purchasediesel fuel and explosives in normal quantities for use at our surface mines.The remaining unconditional purchase commitments, totaling $4.4 million in2006-2007 and $17.2 million in 2008-2009, relate to a contractualcommitment to purchase underground mining equipment. We expect to contributeapproximately $6.0 million to our defined benefit retirement plans and topay approximately $23.0 million of retiree health care benefits incalendar year 2005. We also expect to incur approximately $9.0 million peryear for surety bond premiums and letters of credit fees. We believe that cashbalances plus cash generated by operations will be sufficient to meet theseobligations plus fund requirements for working capital and capital expenditureswithout incurring additional borrowings.

 

**Off-Balance Sheet Arrangements**

 

In the normal course of business, we are a party to certain off-balancesheet arrangements. These arrangements include guarantees, indemnifications andfinancial instruments with off-balance sheet risk, such as bank letters ofcredit and performance

 

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or surety bonds. Liabilitiesrelated to these arrangements are not reflected in our consolidated balancesheets. However, the underlying obligations that they secure, such as assetretirement obligations, self-insured workers’ compensation liabilities, royaltyobligations and certain retiree medical obligations, are reflected in ourconsolidated balance sheets.

 

We are required to provide financial assurance in order to perform thepost-mining reclamation required by our mining permits, pay our federalproduction royalties, pay workers’ compensation claims under self-insuredworkers’ compensation laws in the various states, pay federal black lungbenefits, pay retiree health care benefits to certain retired UMWA employeesand perform certain other obligations.

 

In order to provide the required financial assurance, we generally usesurety bonds for post-mining reclamation and royalty payment obligations andbank letters of credit for self-insured workers’ compensation obligations andUMWA retiree health care obligations. Federal black lung benefits are paid froma dedicated trust fund that has sufficient assets to fund these obligations forthe next several years. Bank letters of credit are also used to collateralize aportion of the surety bonds.

 

We had outstanding surety bonds with a total face amount of$252.8 million as of March 31, 2005, of which $230.2 millionsecured reclamation obligations, $10.7 million secured coal leaseobligations and $9.6 million secured self-insured workers’ compensationobligations. In addition, we had $200.9 million of letters of credit inplace for the following purposes: $36.5 million for workers’ compensation,including collateral for workers’ compensation bonds; $24.1 million forUMWA retiree health care obligations; $130.5 million for collateral forreclamation surety bonds, $5.0 million for minimum royalty paymentobligations for a closed mine in Utah; and $4.8 million for othermiscellaneous obligations. Recently, surety bond costs have increased, whilethe market terms under which surety bonds can be obtained have generally becomeless favorable to all mining companies. In the event that additional suretybonds become unavailable, we would seek to secure our obligations with letters ofcredit, cash deposits or other suitable forms of collateral.

 

**Certain Trends and Uncertainties**

 

Our revenues depend on the price at which we are able to sell our coal.The current pricing environment for United States coal is strong. Any decreasein coal prices due to, among other reasons, the supply of domestic and foreigncoal, the demand for electricity and the price and availability of alternativefuels for electricity generation could adversely affect our revenues and ourability to generate cash flows. In addition, our results of operations dependon the cost of coal production. We are experiencing increased operating costsfor fuel and explosives, steel products, health care, wages, salaries, contractlabor, and increased interest expenses for surety bonds and letters of credit.In addition, historically low interest rates have had a negative impact onexpenses related to our actuarially determined employee-related liabilities.

 

**Recent Accounting Pronouncements**

 

In December 2004, the Financial Accounting Standards Board(“FASB”) issued SFAS No. 123 (revised 2004), *Share-Based Payment* (“SFAS No. 123R”), which replacesSFAS No. 123, and supersedes APB No. 25. SFAS No. 123R requiresall share-based payments to employees, including grants of employee stockoptions, to be recognized in the financial statements based on their fair valueat the grant date. SFAS No. 123R generally requires companies to measurethe cost of employee services received in exchange for an award of equityinstruments (such as stock options and restricted stock) based on thegrant-date fair value of the award, and to recognize that cost over the periodduring which the employee is required to provide service (usually the vestingperiod of the award).  FAS 123Ralso requires the benefits of tax deductions in excess of recognizedcompensation cost to be reported as a financing cash flow, rather than as anoperating cash flow as required under current literature. This requirement willreduce net operating cash flows and increase net financing cash flows inperiods after adoption. The pro forma disclosures previously permittedunder SFAS No. 123 no longer will be an alternative to financial statementrecognition. On April 14,2005, the Securities and Exchange Commission (“SEC”) delayed the implementationof SFAS No. 123R from its original implementation date by six months for mostregistrants, requiring all public companies to adopt FAS 123R no later than thebeginning of the first fiscal year beginning after June 15, 2005. Theimpact of adopting SFAS No. 123R cannot be predicted at this time becauseit will depend on levels of share-based payments granted in the future.However, had the Company adopted SFAS No. 123R during the prior period,the results are expected to be consistent with the pro forma disclosure underSFAS No. 123, except that forfeitures will be considered in thecalculation of compensation expense under SFAS No. 123R. When adopted, theCompany may elect to change the valuation method or assumptions and such changescould have a material impact on the amount of stock-based compensation theCompany records.

 

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In March 2005, the Emerging Issues Task Force reached consensus onIssue No. 04-6, *Accounting forStripping Costs in the Mining Industry* (“EITF No. 04-6”)concluding that post-production stripping costs are a component of mineralinventory costs subject to the provisions of the American Institute ofCertified Public Accountants Accounting Research Bulletin No. 43, *Restatement and Revision of Accounting ResearchBulletins,* Chapter 4, *InventoryPricing*, (“ARB No. 43”). The FASB ratified the EITF consensus. Based upon this consensus, postproduction stripping costs are considered costs of the extracted minerals undera full absorption costing system and are recognized as a component of inventoryto be recognized in costs of sales in the same period as the revenue from thesale of the inventory. In addition, capitalization of such costs would beappropriate only to the extent inventory exists at the end of a reportingperiod. The guidance in this consensus will be effective for financialstatements issued for fiscal years beginning after December 15, 2005, withearly adoption permitted. The Company is currently evaluating this consensusand has not determined its impact to the consolidated financial statements.

 

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**ITEM 3****. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.**

 

**Commodity Price Risk**

 

We manage our commodity price risk for coal sales through the use oflong-term coal supply agreements rather than through the use of derivativeinstruments. As of March 31, 2005, we had sales commitments forapproximately 98% of our planned 2005 production. Some of the products used inour mining activities, such as diesel fuel, explosives, steel products andelectricity, are subject to price volatility. Through our suppliers, we utilizeforward purchase contracts to manage the exposure related to this volatility.

 

**Credit Risk**

 

Our credit risk is primarily with electric power generators and, to alesser extent, steel producers. Most electric power generators to whom we sellhave investment grade credit ratings. Our policy is to independently evaluateeach customer’s creditworthiness prior to entering into transactions and toconstantly monitor outstanding accounts receivable against established creditlimits. When appropriate (as determined by our credit management function), wehave taken steps to reduce our credit exposure to customers that do not meetour credit standards or whose credit has deteriorated. These steps includeobtaining letters of credit or cash collateral, requiring prepayments forshipments or establishing customer trust accounts held for our benefit in theevent of a failure to pay.

 

Counterparty risk with respect to interest rate swaps is not consideredto be significant based upon the creditworthiness of the participatingfinancial institutions.

 

**Interest Rate Risk**

 

Historically, we have had exposure to changes in interest rates on aportion of our existing level of indebtedness under the Predecessor. Thisexposure had been completely hedged for the life of the debt using pay-fixed,receive-variable interest rate swaps. From July 30, 2004 forward, we haveexposure to changes in interest rates on our bank term loan and our revolvingcredit facility. As described below, we have used interest rate swaps to managethis risk.

 

We entered into swap contracts for the purpose of complying withcertain financial covenants in our senior secured credit facility that requirefixing the interest rate for at least three years on a minimum of 50% of ourtotal outstanding debt. The swap contracts cover $85 million toSeptember 2007. The following table summarizes our outstanding swap contractsat March 31, 2005.

 
| **Notional Amount** | ** ** | **Term**                             | ** ** | **Floating Rate** | ** ** | **Fixed Rate** | ** ** |
|---------------------|------------|--------------------------------------|------------|-------------------|------------|----------------|------------|
| $20 million         |       | September 2004 – September 2007 |       | 3-month LIBOR     |       | 3.26           | %          |
| $25 million         |       | September 2004 – September 2007 |       | 3-month LIBOR     |       | 3.26           | %          |
| $20 million         |       | September 2004 – September 2007 |       | 3-month LIBOR     |       | 3.26           | %          |
| $20 million         |       | September 2004 – September 2007 |       | 3-month LIBOR     |       | 3.26           | %          |

 

As of March 31, 2005, after giving effect to the $85 millionof interest rate swaps that were entered into, we had $300 million ofvariable rate indebtedness, representing approximately 44% of our outstandingindebtedness. A 1% change in interest rates would affect the interest expenseon such indebtedness by $3.0 million. At March 31, 2005, the fairvalue of these swap agreements was an unrealized gain of $1.9 million.Effective January 1, 2005, these swaps were designated as hedges.  The increase in the unrealized gain of $1.4million pre-tax ($0.8 million, net of tax) for the three months ended March 31,2005 was reported as a component of comprehensive income (loss).

 

**ITEM4****. CONTROLS ANDPROCEDURES.**

 

*Evaluation of Disclosure Controls and Procedures*

* *

We maintaindisclosure controls and procedures and internal controls designed to ensurethat information required to be disclosed in our filings under the SecuritiesExchange Act of 1934, as amended, is recorded, processed, evaluated, summarizedand reported accurately within the time periods specified in the Securities andExchange Commission’s (SEC) rules and forms. In designing and evaluating the disclosurecontrols and procedures, our management recognized that any controls andprocedures, no matter how well designed and operated, can provide onlyreasonable assurance of achieving the desired control objectives and

 

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management necessarily wasrequired to apply its judgment in evaluating the cost-benefit relationship ofpossible controls and procedures. An evaluation was performed under thesupervision and with the participation of management, including the ChiefExecutive Officer (CEO) and Chief Financial Officer (CFO), of the effectivenessof the design and operations of our disclosure controls and procedures pursuantto Exchange Act Rule 13a-14. Based upon that evaluation as of the end ofthe period covered by this report, the CEO and CFO concluded that ourdisclosure controls and procedures are effective in timely alerting them tomaterial information required to be included in our periodic SEC filings. Theconclusions of the CEO and CFO from this evaluation were communicated to theAudit Committee. In connection with this evaluation, there were no breaches ofsuch controls that would require disclosure to the Audit Committee or ourauditors.

 

*Changes in Disclosure Controls*

* *

There were nosignificant changes in our disclosure controls or in other factors that couldsignificantly affect these disclosure controls in the fiscal quarter endedMarch 31, 2005. Management is not aware of any material weaknesses; therefore,there were no corrective actions to be taken.

 

*Sarbanes-Oxley Act of 2002 Section 404*

* *

During theyear ended December 31, 2004, we did not meet the definition of anAccelerated Filer because we have been a public company subject to thereporting requirements of Sections 13(a) and 15(d) of the Securities ExchangeAct of 1934, as amended, for less than twelve months and we have not previouslyfiled an Annual Report on Form 10-K. We are required to comply with thefinal Section 404 Rule of the Sarbanes-Oxley Act of 2002 in our AnnualReport on Form 10-K for the fiscal year ended December 31, 2005.

 

37

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** **

**PARTII-OTHER INFORMATION**

 

**Item1.  Legal Proceedings.**

 

Information required by thisItem is contained in Note 17 to the consolidated financial statements entitled“Commitments and Contingencies” contained in this Report and is incorporatedherein by reference.

 

**Item 2.  Unregistered Sales ofEquity Securities and Use of Proceeds.**

 

None.

 

**Item 3.  Defaults Upon SeniorSecurities.**

 

None.

 

**Item 4.  Submission of Matters toa Vote of Security Holders.**

 

None.

 

**Item5.  Other Information.**

 

(a)          TheForm of Restricted Stock Agreement approved on February 15, 2005, by FoundationCoal Holdings, Inc’s Compensation Committee regarding restricted stock grantedto its independent directors pursuant to the 2004 Incentive Stock Plan isattached as Exhibit 10.1

 

(b)         None.

 

**Item 6. Exhibits.**

 

(a) The exhibits to this reportare listed in the Exhibit Index.

 

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**SIGNATURES**

 

Pursuant to therequirements of the Securities Exchange Act of 1934, the registrant has dulycaused this report to be signed on its behalf by the undersigned thereunto dulyauthorized.

 
| Date: May 16, 2005 |   | Foundation Coal  Corporation |
|--------------------|--------|------------------------------|
|               |   | (Registrant)                 |

 

 
| ** ** | **Name**              | ** ** | **Title**                                                       | ** ** |
|------------|-----------------------|------------|-----------------------------------------------------------------|------------|
| ** ** | ** **            | ** ** | ** **                                                      | ** ** |
| ** ** | ** **            | ** ** | ** **                                                      | ** ** |
|       | /s/ JAMES  F. ROBERTS |       | President, Chief Executive Officer                              |       |
|       | James F. Roberts      |       | and Director (Principal Executive  Officer)                     |       |
|       |                  |       |                                                            |       |
|       |                  |       |                                                            |       |
|       | /s/ FRANK  J. WOOD    |       | Senior Vice President and Chief                                 |       |
|       | Frank J. Wood         |       | Financial Officer (Principal Financial  and Accounting Officer) |       |

 

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**EXHIBIT INDEX**

 
| **Exhibit No.** | ** ** | **Description of Exhibit**                                                                                                                                                                                                                                                                                                  |
|-----------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 2.1*            |       | Stock Purchase Agreement, dated as of May 24, 2004, between RAG Coal  International AG and Foundation Coal Corporation (formerly known as American  Coal Acquisition Corp.)                                                                                                                                                 |
|            |       |                                                                                                                                                                                                                                                                                                                        |
| 2.2*            |       | Agreement and Plan of Merger, dated as of August 9, 2004, between  Foundation Coal Holdings, LLC and Foundation Coal Holdings, Inc.                                                                                                                                                                                         |
|            |       |                                                                                                                                                                                                                                                                                                                        |
| 3.1**           |       | Form of Amended and Restated Certificate of Incorporation of  Foundation Coal Holdings, Inc.                                                                                                                                                                                                                                |
|            |       |                                                                                                                                                                                                                                                                                                                        |
| 3.2**           |       | Form of Amended and Restated By-laws of Foundation Coal Holdings,  Inc.                                                                                                                                                                                                                                                     |
|            |       |                                                                                                                                                                                                                                                                                                                        |
| 4.1*            |       | Form of certificate of Foundation Coal Holdings, Inc. common stock                                                                                                                                                                                                                                                          |
|            |       |                                                                                                                                                                                                                                                                                                                        |
| 4.2*            |       | Amended and Restated Stockholders Agreement, dated as of October 4,  2004, by and among Foundation Coal Holdings, Inc., Blackstone FCH Capital  Partners IV, L.P., Blackstone Family Investment Partnership IV-A L.P., First  Reserve Fund IX, L.P., AMCI Acquisition, LLC and the management stockholders  parties thereto |
|            |       |                                                                                                                                                                                                                                                                                                                        |
| 10.1***         |       | Form of  Independent Directors Restricted Stock Agreement.                                                                                                                                                                                                                                                                  |
|            |       |                                                                                                                                                                                                                                                                                                                        |
| 31.1***         |       | Certification of periodic report by Foundation Coal Corporation’s  Chief Executive Officer pursuant to Rule 13a-14(a) under the Securities Exchange  Act of 1934, as amended pursuant to Section 302 of the Sarbanes-Oxley Act of  2002.                                                                               |
|            |       |                                                                                                                                                                                                                                                                                                                        |
| 31.2***         |       | Certification of periodic report by Foundation Coal Corporation’s  Chief Financial Officer pursuant to Rule 13a-14(a) under the Securities  Exchange Act of 1934, as amended pursuant to Section 302 of the  Sarbanes-Oxley Act of 2002.                                                                               |
|            |       |                                                                                                                                                                                                                                                                                                                        |
| 32.1***         |       | Certification of periodic report by Foundation Coal Corporation’s  Chief Executive Officer pursuant to 18 U.S.C. Section 1350, adopted pursuant  to Section 906 of the Sarbanes-Oxley Act of 2002.                                                                                                                     |
|            |       |                                                                                                                                                                                                                                                                                                                        |
| 32.2***         |       | Certification of periodic report by Foundation Coal Corporation’s  Chief Financial Officer pursuant to 18 U.S.C. Section 1350, adopted pursuant  to Section 906 of the Sarbanes-Oxley Act of 2002.                                                                                                                     |

 

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* Incorporated by reference to the samenumbered exhibit previously filed with Foundation Coal Holdings, Inc. registration statement on Form S-1 (SEC FileNo. 333-118427).

 

** Previously filed as an exhibit to Foundation Coal Corporation’sRegistration Statement on Form S-4 (File No. 333-20979) and incorporated hereinby reference.

 

***         Filed herewith.

 

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