**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

**FORM 10-Q**

**(Mark One)**

**x**                              QUARTERLYREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF1934

**Forthe Quarterly Period Ended June 30, 2005**

**or**

**o**                                 TRANSITIONREPORT PURSUANT TO SECTION 13 OR 15(d) OF THESECURITIES EXCHANGE ACT OF 1934

**Forthe Transition Period From              to              **

**CommissionFile Number 333-120979-49**

**Foundation Coal Corporation**

(Exact Name of Registrantas 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 markwhether the Registrant (1) has filed all reports required to be filed by Section 13or 15(d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the registrant was required tofile such reports), and (2) has been subject to such filing requirementsfor the past 90 days. Yes x  No o

Indicate by check markwhether the Registrant is an accelerated filer (as defined in Rule 12b-2of the Exchange Act). Yes o  No x

TheRegistrant’s common equity is not publicly traded. The common stock of theRegistrant’s ultimate parent, Foundation Coal Holdings, Inc., begantrading on the New York Stock Exchange on December 9, 2004. There were44,630,047 shares of Foundation Coal Holdings, Inc. common stockoutstanding on August 5, 2005. There were 100 shares of Foundation CoalCorporation common stock outstanding on August 5, 2005, all held by it’sparent FC2 Corp. which are not publicly traded.

 

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**TABLE OF CONTENTS**
|            | ** ** | ** **                                                                                                          | **Page** |
|------------|------------|---------------------------------------------------------------------------------------------------------------------|----------|
| ** ** | ** ** | **PART I—FINANCIAL INFORMATION**                                                                          |     |   |   |
| ITEM 1.    |       | FINANCIAL  STATEMENTS                                                                                               |     |   |   |
|       |       | Statements  of Consolidated Operations and Comprehensive Income for the Three Months  Ended June 2005 and 2004 |     | 3 |   |
|       |       | Statements  of Consolidated Operations and Comprehensive Income for the Six Months Ended  June 2005 and 2004   |     | 4 |   |
|       |       | Consolidated  Balance Sheets                                                                                        |     | 5 |   |
|       |       | Statements  of Consolidated Cash Flows                                                                              |     | 6 |   |
|       |       | Notes  to Consolidated Financial Statements                                                                         |     | 7 |   |
| ITEM 2.    |       | MANAGEMENT’S  DISCUSSION AND ANALYSIS OF CONSOLIDATED FINANCIAL CONDITION AND RESULTS OF  OPERATIONS           |     | 25 |   |
| ITEM 3.    |       | QUANTITATIVE  AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK                                                         |     | 48 |   |
| ITEM 4.    |       | CONTROLS  AND PROCEDURES                                                                                            |     | 49 |   |
| ** ** | ** ** | **PART II—OTHER  INFORMATION**                                                                            |     |   |   |
| ITEM 1.    |       | LEGAL  PROCEEDINGS                                                                                                  |     | 51 |   |
| ITEM 2.    |       | UNREGISTERED  SALES OF EQUITY SECURITIES AND USE OF PROCEEDS                                                        |     | 51 |   |
| ITEM 3.    |       | DEFAULTS  UPON SENIOR SECURITIES                                                                                    |     | 51 |   |
| ITEM 4.    |       | SUBMISSION  OF MATTERS OF VOTE OF SECURITY HOLDERS                                                                  |     | 51 |   |
| ITEM 5.    |       | OTHER  INFORMATION                                                                                                  |     | 51 |   |
| ITEM 6.    |       | EXHIBITS                                                                                                            |     | 51 |   |

 

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**Part I—FINANCIAL INFORMATION**

Unless the context otherwise indicates, as used inthis Form 10-Q the terms “we”, “our”, “us” and similar terms refer toFoundation Coal Corporation and its consolidated subsidiaries.

**ITEM 1.  **FINANCIAL STATEMENTS

**Foundation Coal Corporation and Subsidiaries (An Indirect Wholly Owned Subsidiary of Foundation Coal Holdings, Inc.)Statements ofConsolidated Operations and Comprehensive Income(Dollars in thousands)(Unaudited)**
| ** **                                                                                       | ** ** | **Three Months Ended June 30,** | ** ** |
|--------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                                                       | ** ** | **2005**                                            | ** ** | **2004** | ** ** |
| ** **                                                                                       | ** ** | **   Successor   **   | ** ** | **  Predecessor  ** | ** ** |
| Revenues:                                                                                        |       |                                                |       |   |   |   |   |   |   |
| Coal sales                                                                                       |       |                                                | $          | 324,537 |   |   |   | $ | 252,054 |   |   |
| Other revenue                                                                                    |       |                                                | 4,941      |   |   |   | 101 |   |   |
| Total revenues                                                                                   |       |                                                | 329,478    |   |   |   | 252,155 |   |   |
| Costs and  expenses:                                                                             |       |                                                |       |   |   |   |   |   |   |
| Cost of coal sales (excludes depreciation, depletion  and amortization)                          |       |                                                | 241,268    |   |   |   | 216,308 |   |   |
| Selling, general and administrative expense  (excludes depreciation, depletion and amortization) |       |                                                | 8,958      |   |   |   | 10,477 |   |   |
| Accretion on asset retirement obligations                                                        |       |                                                | 2,044      |   |   |   | 1,723 |   |   |
| Depreciation, depletion and amortization                                                         |       |                                                | 52,694     |   |   |   | 27,469 |   |   |
| Amortization of coal supply agreements                                                           |       |                                                | (23,137    | ) |   |   | 3,829 |   |   |
| Income (loss)  from operations                                                                   |       |                                                | 47,651     |   |   |   | (7,651 | ) |   |
| Other income (expense):                                                                          |       |                                                |       |   |   |   |   |   |   |
| Interest expense                                                                                 |       |                                                | (14,424    | ) |   |   | (6,293 | ) |   |
| Loss on termination of hedge accounting for interest  rate swaps                                 |       |                                                | —     |   |   |   | (82 | ) |   |
| Mark-to-market gain on interest rate  swaps                                                      |       |                                                | —     |   |   |   | 8,970 |   |   |
| Interest income                                                                                  |       |                                                | 180        |   |   |   | 429 |   |   |
| Income (loss)  before income tax (expense) benefit                                               |       |                                                | 33,407     |   |   |   | (4,627 | ) |   |
| Income tax  (expense) benefit                                                                    |       |                                                | (13,024    | ) |   |   | 2,432 |   |   |
| Income (loss)  from continuing operations                                                        |       |                                                | 20,383     |   |   |   | (2,195 | ) |   |
| Loss from  discontinued operations, net of income tax benefit of $1,090 in 2004   |       |                                                | —     |   |   |   | (477 | ) |   |
| Gain on disposal  of discontinued operations, net of income tax expense of $4,913           |       |                                                | —     |   |   |   | 20,783 |   |   |
| Net income                                                                                       |       |                                                | 20,383     |   |   |   | 18,111 |   |   |
| Components of  comprehensive income:                                                             |       |                                                |       |   |   |   |   |   |   |
| Unrealized loss on interest rate swaps, net of tax  benefit of $293 in 2005                      |       |                                                | (413       | ) |   |   | — |   |   |
| Comprehensive income                                                                             |       |                                                | $          | 19,970 |   |   |   | $ | 18,111 |   |   |

 

The accompanying notes are an integral part of these financial statements.

3

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**Foundation Coal Corporation and Subsidiaries (An Indirect Wholly Owned Subsidiary of Foundation Coal Holdings, Inc.)Statements ofConsolidated Operations and Comprehensive Income(Dollars in thousands)(Unaudited)**
| ** **                                                                                                | ** ** | **Six Months Ended June 30,** | ** ** |
|-----------------------------------------------------------------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                                                                                | ** ** | **2005**                                          | ** ** | **2004** | ** ** |
| ** **                                                                                                | ** ** | **   Successor   ** | ** ** | ** Predecessor ** | ** ** |
| Revenues:                                                                                                 |       |                                              |       |   |   |   |   |   |   |
| Coal sales                                                                                                |       |                                              | $          | 624,558 |   |   |   | $ | 474,033 |   |   |
| Other revenue                                                                                             |       |                                              | 10,426     |   |   |   | 4,429 |   |   |
| Total revenues                                                                                            |       |                                              | 634,984    |   |   |   | 478,462 |   |   |
| Costs and  expenses:                                                                                      |       |                                              |       |   |   |   |   |   |   |
| Cost of coal sales (excludes depreciation, depletion  and amortization)                                   |       |                                              | 456,498    |   |   |   | 413,468 |   |   |
| Selling, general and administrative expense  (excludes depreciation, depletion and amortization)     |       |                                              | 20,389     |   |   |   | 20,888 |   |   |
| Accretion on asset retirement obligations                                                                 |       |                                              | 4,084      |   |   |   | 3,446 |   |   |
| Depreciation, depletion and amortization                                                                  |       |                                              | 107,494    |   |   |   | 52,486 |   |   |
| Amortization of coal supply agreements                                                                    |       |                                              | (46,516    | ) |   |   | 7,795 |   |   |
| Income (loss)  from operations                                                                            |       |                                              | 93,035     |   |   |   | (19,621 | ) |   |
| Other income (expense):                                                                                   |       |                                              |       |   |   |   |   |   |   |
| Interest expense                                                                                          |       |                                              | (28,677    | ) |   |   | (16,264 | ) |   |
| Loss on termination of hedge accounting for interest  rate swaps                                          |       |                                              | —     |   |   |   | (48,854 | ) |   |
| Mark-to-market gain on interest rate  swaps                                                               |       |                                              | —     |   |   |   | 5,804 |   |   |
| Interest income                                                                                           |       |                                              | 302        |   |   |   | 1,202 |   |   |
| Income (loss)  before income tax (expense) benefit                                                        |       |                                              | 64,660     |   |   |   | (77,733 | ) |   |
| Income tax  (expense) benefit                                                                             |       |                                              | (25,235    | ) |   |   | 29,444 |   |   |
| Income (loss)  from continuing operations                                                                 |       |                                              | 39,425     |   |   |   | (48,289 | ) |   |
| Income from  discontinued operations, net of income tax expense of $546 in 2004                 |       |                                              | —     |   |   |   | 2,315 |   |   |
| Gain on disposal  of discontinued operations, net of income tax expense of $4,913               |       |                                              | —     |   |   |   | 20,783 |   |   |
| Net income (loss)                                                                                         |       |                                              | 39,425     |   |   |   | (25,191 | ) |   |
| Components of  comprehensive income:                                                                      |       |                                              |       |   |   |   |   |   |   |
| Unrealized gain on interest rate swaps, net of tax  expense of $260 in 2005 and $16,890 in 2004 |       |                                              | 416        |   |   |   | 28,820 |   |   |
| Comprehensive income                                                                                      |       |                                              | $          | 39,841 |   |   |   | $ | 3,629 |   |   |

 

The accompanying notes are an integral part of these financial statements.

4

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**FoundationCoal Corporation and Subsidiaries (An Indirect Wholly Owned Subsidiary of Foundation Coal Holdings, Inc.)Consolidated Balance Sheets(Dollars in thousands, except share data)**
| ** **                                                                                                                         | ** ** | **June 30,  2005** | ** ** | ** December 31,   2004** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|-----------------------------------------|------------|
| ** **                                                                                                                         | ** ** | **(Unaudited)**         | ** ** | ** **                              | ** ** |
| **ASSETS**                                                                                                                         |       |                    |       |                                    |       |   |   |
| Current assets:                                                                                                                    |       |                    |       |                                    |       |   |   |
| Cash and cash  equivalents                                                                                                         |       | $                       | 27,206     |                                    |       | $ | 25,043 |   |   |
| Trade accounts  receivable, net of allowance ($217 in 2005 and 2004, respectively)                                                 |       | 102,238                 |       |                                    | 66,484     |   |   |
| Inventories, net                                                                                                                   |       | 67,784                  |       |                                    | 39,718     |   |   |
| Deferred income taxes                                                                                                              |       | 15,145                  |       |                                    | 15,145     |   |   |
| Other current assets                                                                                                               |       | 22,365                  |       |                                    | 27,821     |   |   |
| Total current assets                                                                                                               |       | 234,738                 |       |                                    | 174,211    |   |   |
| Owned surface lands                                                                                                                |       | 28,501                  |       |                                    | 29,171     |   |   |
| Plant, equipment and  mine development costs, net                                                                                  |       | 514,981                 |       |                                    | 487,495    |   |   |
| Owned and leased mineral  rights, net                                                                                              |       | 1,219,410               |       |                                    | 1,282,989  |   |   |
| Coal supply agreements,  net                                                                                                       |       | 69,323                  |       |                                    | 84,508     |   |   |
| Other noncurrent assets                                                                                                            |       | 36,770                  |       |                                    | 41,586     |   |   |
| Total assets                                                                                                                       |       | $                       | 2,103,723  |                                    |       | $ | 2,099,960 |   |   |
| **LIABILITIES**                                                                                                                    |       |                    |       |                                    |       |   |   |
| Current liabilities:                                                                                                               |       |                    |       |                                    |       |   |   |
| Trade accounts payable                                                                                                             |       | $                       | 29,897     |                                    |       | $ | 30,512 |   |   |
| Accrued expenses and  other current liabilities                                                                                    |       | 163,345                 |       |                                    | 155,541    |   |   |
| Total current  liabilities                                                                                                         |       | 193,242                 |       |                                    | 186,053    |   |   |
| Long-term debt                                                                                                                     |       | 685,000                 |       |                                    | 685,000    |   |   |
| Deferred income taxes                                                                                                              |       | 140,664                 |       |                                    | 133,828    |   |   |
| Coal supply agreements,  net                                                                                                       |       | 119,824                 |       |                                    | 178,210    |   |   |
| Postretirement benefits                                                                                                            |       | 457,442                 |       |                                    | 449,683    |   |   |
| Other noncurrent  liabilities                                                                                                      |       | 212,517                 |       |                                    | 211,455    |   |   |
| Total liabilities                                                                                                                  |       | 1,808,689               |       |                                    | 1,844,229  |   |   |
| Commitments and contingencies *(Note 17)*                                                                                          |       |                    |       |                                    |       |   |   |
| **STOCKHOLDER EQUITY**                                                                                                             |       |                    |       |                                    |       |   |   |
| Common stock, $0.01 par  value; 100 shares authorized, issued and outstanding at June 30, 2005  and at December 31, 2004 |       | —                  |       |                                    | —     |   |   |
| Additional paid-in  capital                                                                                                        |       | 241,572                 |       |                                    | 241,993    |   |   |
| Retained earnings                                                                                                                  |       | 53,489                  |       |                                    | 14,064     |   |   |
| Unearned restricted  stock compensation                                                                                            |       | (117                    | )          |                                    | —     |   |   |
| Accumulated other  comprehensive income (loss)                                                                                     |       | 90                      |       |                                    | (326       | ) |   |
| Total stockholder equity                                                                                                           |       | 295,034                 |       |                                    | 255,731    |   |   |
| Total liabilities and stockholder equity                                                                                           |       | $                       | 2,103,723  |                                    |       | $ | 2,099,960 |   |   |

 

The accompanying notes are an integral part of these financial statements.

5

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**Foundation Coal Corporation and Subsidiaries (An Indirect Wholly Owned Subsidiary of Foundation Coal Holdings, Inc.)Statements ofConsolidated Cash Flows(Dollars in thousands)(Unaudited)**
| ** **                                                                                | ** ** | **Six Months Ended June 30,** | ** ** |
|-------------------------------------------------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                                                                | ** ** | **2005**                                          | ** ** | **2004** | ** ** |
| ** **                                                                                | ** ** | **  Successor  **             | ** ** | **  Predecessor  ** | ** ** |
| **Operating activities:**                                                                 |       |                                              |       |   |   |   |   |   |   |
| Net income (loss)                                                                         |       |                                              | $          | 39,425 |   |   |   | $ | (25,191 | ) |   |
| Loss from  discontinued operations                                                        |       |                                              | —     |   |   |   | (23,098 | ) |   |
| Income (loss) from  continuing operations                                                 |       |                                              | 39,425     |   |   |   | (48,289 | ) |   |
| Adjustments to reconcile net income (loss) to net  cash provided by operating activities: |       |                                              |       |   |   |   |   |   |   |
| Accretion on asset  retirement obligations                                                |       |                                              | 4,084      |   |   |   | 3,446 |   |   |
| Depreciation,  depletion and amortization                                                 |       |                                              | 60,978     |   |   |   | 60,281 |   |   |
| Amortization of  deferred financing costs                                                 |       |                                              | 1,547      |   |   |   | — |   |   |
| Gain on sale of  assets                                                                   |       |                                              | —     |   |   |   | (683 | ) |   |
| Non-cash  restricted stock compensation                                                   |       |                                              | 394        |   |   |   | — |   |   |
| Non-cash mark-to-market  adjustment for interest rate swap                                |       |                                              | —     |   |   |   | (5,804 | ) |   |
| Non-cash expense  from termination of hedge accounting for interest rate swap             |       |                                              | —     |   |   |   | 48,854 |   |   |
| Deferred income  taxes                                                                    |       |                                              | 6,577      |   |   |   | (27,402 | ) |   |
| Other                                                                                     |       |                                              | 265        |   |   |   | — |   |   |
| Changes in operating  assets and liabilities:                                             |       |                                              |       |   |   |   |   |   |   |
| Trade accounts  receivable                                                                |       |                                              | (35,754    | ) |   |   | (20,634 | ) |   |
| Inventories, net                                                                          |       |                                              | (28,066    | ) |   |   | (4,471 | ) |   |
| Other current  assets                                                                     |       |                                              | 4,524      |   |   |   | 5,472 |   |   |
| Other noncurrent  assets                                                                  |       |                                              | 3,944      |   |   |   | 1,982 |   |   |
| Trade accounts  payable                                                                   |       |                                              | (615       | ) |   |   | 1,601 |   |   |
| Accrued expenses  and other current liabilities                                           |       |                                              | 2,113      |   |   |   | 19,025 |   |   |
| Noncurrent  liabilities                                                                   |       |                                              | 3,066      |   |   |   | (8,306 | ) |   |
| Net cash provided  by continuing operations                                               |       |                                              | 62,482     |   |   |   | 25,072 |   |   |
| Net cash provided  by discontinued operations                                             |       |                                              | —     |   |   |   | 6,973 |   |   |
| Net cash provided  by operating activities                                                |       |                                              | 62,482     |   |   |   | 32,045 |   |   |
| **Investing activities:**                                                                 |       |                                              |       |   |   |   |   |   |   |
| Purchases of  property, plant and equipment                                               |       |                                              | (65,093    | ) |   |   | (50,452 | ) |   |
| Proceeds from  disposition of property, plant and equipment                               |       |                                              | 4,774      |   |   |   | 2,029 |   |   |
| Net cash used in  continuing operations                                                   |       |                                              | (60,319    | ) |   |   | (48,423 | ) |   |
| Net cash provided  by discontinued operations                                             |       |                                              | —     |   |   |   | 184,988 |   |   |
| Net cash (used in)  provided by investing activities                                      |       |                                              | (60,319    | ) |   |   | 136,565 |   |   |
| **Financing activities:**                                                                 |       |                                              |       |   |   |   |   |   |   |
| Proceeds from  revolving credit facility                                                  |       |                                              | 60,000     |   |   |   | — |   |   |
| Repayment of  revolving credit facility                                                   |       |                                              | (60,000    | ) |   |   | — |   |   |
| Repayment of long-term  debt                                                              |       |                                              | —     |   |   |   | (358,024 | ) |   |
| Repayment of  capital lease obligations                                                   |       |                                              | —     |   |   |   | (821 | ) |   |
| Net decrease in  cash pledged on debt                                                     |       |                                              | —     |   |   |   | 20,000 |   |   |
| Early  extinguishment of debt and interest rate swap termination                          |       |                                              | —     |   |   |   | (48,854 | ) |   |
| Net decrease in  cash on deposit with the Predecessor                                     |       |                                              | —     |   |   |   | 233,023 |   |   |
| Net cash used in  financing activities                                                    |       |                                              | —     |   |   |   | (154,676 | ) |   |
| Net (decrease)  increase in cash and cash equivalents                                     |       |                                              | 2,163      |   |   |   | 13,934 |   |   |
| Cash and cash  equivalents at beginning of period                                         |       |                                              | 25,043     |   |   |   | 7,649 |   |   |
| Cash and cash  equivalents at end of period                                               |       |                                              | $          | 27,206 |   |   |   | $ | 21,583 |   |   |
| **Supplemental cash flow information:**                                                   |       |                                              |       |   |   |   |   |   |   |
| Cash paid for  interest                                                                   |       |                                              | $          | 23,812 |   |   |   | $ | 22,372 |   |   |
| Cash paid for income  taxes                                                               |       |                                              | $          | — |   |   |   | $ | — |   |   |

 

The accompanying notes are an integral part of these financial statements.

6

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**Foundation Coal Corporation, Inc. and Subsidiaries (An Indirect Wholly Owned Subsidiary of Foundation Coal Holdings, Inc.) Notes to Consolidated Financial Statements (Unaudited, dollars in thousands)**

**(1)**   Basis of Presentation of FinancialStatements

The following interim consolidated financialstatements of Foundation Coal Corporation and Subsidiaries (“FCC” or the “Company”)are unaudited and prepared in accordance with the rules and regulations ofthe Securities and Exchange Commission for Form 10-Q. Such rules andregulations allow the omission of certain information and footnote disclosuresnormally included in financial statements prepared in accordance with UnitedStates generally accepted accounting principles as long as the statements arenot misleading. In the opinion of management, these financial statementsreflect all normal and recurring adjustments necessary for a fair presentationof the results of the periods presented. These interim consolidated financialstatements should be read in conjunction with the consolidated financialstatements of the Company included in its Annual Report on Form 10-K forthe year ended December 31, 2004, filed March 31, 2005.

The Company’s consolidated financial statements havebeen prepared in accordance with accounting principles generally accepted inthe United States of America. The preparation of the Company’s consolidatedfinancial statements requires management to make estimates and assumptions thataffect the reported amounts of assets and liabilities at the date of theconsolidated financial statements and the reported amounts of revenues andexpenses during the reporting period. The more significant areas requiring theuse of management estimates and assumptions relate to coal reserves that arethe basis for future cash flow estimates and units-of-production depreciation,depletion and amortization calculations; environmental and reclamationobligations; asset impairments; post-employment, post-retirement and otheremployee benefit liabilities; valuation allowances for deferred taxes; reservesfor contingencies and litigation; and the fair value and accounting treatmentof certain financial instruments. Management bases its estimates on historicalexperience and on various other assumptions that are believed to be reasonableunder the circumstances. Accordingly, actual results may differ significantlyfrom these estimates. In addition, different assumptions or conditions couldreasonably be expected to yield different results. The operating results forthe three and six months ended June 30, 2005 may not necessarily beindicative of the results to be expected in future quarters for the year ended December 31,2005.

Foundation Coal Holdings, Inc. and its indirectwholly owned subsidiary FCC were formed to acquire the North American coalmining assets of RAG American Coal Holding, Inc., a wholly ownedsubsidiary of RAG Coal International AG (“RAG”), which acquisition closed on July 30,2004 (the “acquisition”). The acquisition was accounted for using the purchasemethod of accounting whereby identifiable assets acquired and liabilitiesassumed 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 of 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 American Coal Holding, Inc. had two primaryoperating units: Riverton Coal Production, Inc. and subsidiaries (“RCP”)and RAG American Coal Company, LLC and subsidiaries (“RACC”). On February 29,2004, RACC signed a definitive Stock Purchase Agreement to sell RAG Coal AG’sColorado 

7

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**Foundation Coal Corporation, Inc. and Subsidiaries (An Indirect Wholly Owned Subsidiary of Foundation Coal Holdings, Inc.) Notes to Consolidated Financial Statements (Continued) (Unaudited, dollars in thousands)**

operations which includedTwentymile Coal Company, RAG Empire Corporation, RAG Shoshone Coal Corporationand Colorado Yampa Coal Company (collectively referred to as the RAG ColoradoBusiness Unit) to a subsidiary of Peabody Energy Corporation. This transactionclosed on April 15, 2004. Accordingly, all references to Foundation CoalCorporation, exclude the RAG Colorado Business Unit which is accounted for andpresented in the accompanying financial statements as discontinued operations.Prior period financial statements have also been restated to reflect the RAGColorado Business Unit as a discontinued operation.

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

“Successor”—represents the consolidated financialposition of Foundation Coal Corporation and consolidated subsidiaries as of June 30,2005 and December 31, 2004, and the consolidated results of operations andcash flows for the three and six month period ended June 30, 2005.Foundation Coal Corporation had no significant activities until the acquisitionon July 30, 2004.

“Predecessor”—represents the consolidated results ofoperations and cash flows of RAG American Coal Holding, Inc. andsubsidiaries for all periods prior to the acquisition. This presentationreflects the historical basis of accounting.

The consolidated financial statements as of and forthe period ended June 30, 2005 and December 31, 2004 reflect theacquisition under the purchase method of accounting, in accordance with theFinancial Accounting Standards Board (“FASB”) Statement of Financial AccountingStandards (“SFAS”) No. 141, *BusinessCombinations*.

Unless otherwiseindicated, “the Company” as used throughout the remainder of these notes to theconsolidated financial statements refers to both the Successor and thePredecessor.

*Reclassifications*

Certain amounts in theprior period have been reclassified to conform to the 2005 presentation.

**(2)**   Recent Accounting Pronouncements

In December 2004, the Financial AccountingStandards Board (“FASB”) issued SFAS No. 123 (revised 2004), *Share-Based Payment* (“SFAS No. 123R”),which replaces SFAS No. 123, and supersedes APB No. 25. SFAS No. 123Rrequires all share-based payments to employees, including grants ofemployee stock options, to be recognized in the financial statements based ontheir fair value at the grant date. SFAS No. 123R generally requires companiesto measure the cost of employee services received in exchange for an award ofequity instruments (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 123R also requires the benefits of tax deductions inexcess of recognized compensation cost to be reported as a financing cash flow,rather than as an operating cash flow as required under current literature.This requirement will reduce net operating cash flows and increase netfinancing cash flows in periods after adoption. The pro forma disclosurespreviously permitted under SFAS No. 123 no longer will be an alternativeto financial statement recognition. On April 14, 2005, the Securities andExchange Commission (“SEC”) delayed the 

8

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**Foundation Coal Corporation, Inc. and Subsidiaries (An Indirect Wholly Owned Subsidiary of Foundation Coal Holdings, Inc.) Notes to Consolidated Financial Statements (Continued) (Unaudited, dollars in thousands)**

implementation of SFAS No. 123Rfrom its original implementation date by six months for most registrants,requiring all public companies to adopt FAS 123R no later than the beginning ofthe first fiscal year beginning after June 15, 2005. The impact ofadopting SFAS No. 123R cannot be predicted at this time because it willdepend on levels of share-based payments granted in the future. However,had the Company adopted SFAS No. 123R during the prior period, the resultsare expected to be consistent with the pro forma disclosure under SFAS No. 123,except that forfeitures will be considered in the calculation of compensationexpense under SFAS No. 123R. When adopted, the Company may elect to changethe valuation method or assumptions and such changes could have a materialimpact on the amount of stock-based compensation the Company records.

In March 2005, the Emerging Issues Task Forcereached consensus on Issue No. 04-6, *Accountingfor Stripping 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 of CertifiedPublic 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, post production stripping costs are considered costsof the 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, capitalizationof such costs would be appropriate only to the extent inventory exists at theend of a reporting period. The guidance in this consensus will be effective forfinancial statements issued for fiscal years beginning after December 15,2005, with early adoption permitted. The Company is currently evaluating thisconsensus and has not determined its impact to the consolidated financialstatements.

The FASB issued FASBInterpretation (“FIN”) No. 47, “Accounting for Conditional AssetRetirement Obligations” in March of 2005. FIN 47 clarifies that an entitymust record a liability for a conditional asset retirement obligation if thefair value of the obligation can be reasonably estimated. This interpretationalso clarifies the circumstances under which an entity would have sufficientinformation to reasonably estimate the fair value of an asset retirementobligation. This Interpretation is effective no later than the end of fiscalyears ending after December 15, 2005. The Company does not expect thisguidance to have a material impact on its financial statements.

**(3)**   Inventories

Inventoriesconsisted of the following:
| ** **                                            | ** ** | **At June 30,  2005** | ** ** | **At December 31,  2004** | ** ** |
|-------------------------------------------------------|------------|---------------------------------|------------|-------------------------------------|------------|
| ** **                                            | ** ** | **(Unaudited)**                 | ** ** | ** **                          | ** ** |
| Saleable coal                                         |       |                            | $          | 15,035                              |       |   |   | $ | 11,609 |   |   |
| Raw coal                                              |       |                            | 838        |                                |       |   | 2,893 |   |   |
| Work-in-process  (deferred overburden)                |       |                            | 38,893     |                                |       |   | 13,889 |   |   |
| Materials and  supplies                               |       |                            | 20,756     |                                |       |   | 18,983 |   |   |
|                                                  |       |                            | 75,522     |                                |       |   | 47,374 |   |   |
| Less materials  and supplies reserve for obsolescence |       |                            | (7,738     | )                                   |       |   | (7,656 | ) |   |
|                                                  |       |                            | $          | 67,784                              |       |   |   | $ | 39,718 |   |   |

 

9

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**Foundation Coal Corporation, Inc. and Subsidiaries (An Indirect Wholly Owned Subsidiary of Foundation Coal Holdings, Inc.) Notes to Consolidated Financial Statements (Continued) (Unaudited, dollars in thousands)**

 

Saleable coal representscoal stockpiles 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)**   OtherCurrent Assets

Othercurrent assets consisted of the following:
| ** **                       | ** ** | **At June 30,  2005** | ** ** | **At December 31,  2004** | ** ** |
|----------------------------------|------------|---------------------------------|------------|-------------------------------------|------------|
| ** **                       | ** ** | **(Unaudited)**                 | ** ** | ** **                          | ** ** |
| Prepaid royalties                |       |                            | $          | 3,391                               |       |   |   | $ | 3,142 |   |   |
| Prepaid longwall  move expense   |       |                            | 5,863      |                                |       |   | 7,497 |   |   |
| Prepaid SO2  emission allowances |       |                            | 1,030      |                                |       |   | 780 |   |   |
| Prepaid expenses                 |       |                            | 7,117      |                                |       |   | 12,886 |   |   |
| Other                            |       |                            | 4,964      |                                |       |   | 3,516 |   |   |
|                             |       |                            | $          | 22,365                              |       |   |   | $ | 27,821 |   |   |

 

**(5)**   Property, Plant, Equipment and Ownedand Leased Mineral Rights

Property,plant, equipment and owned and leased mineral rights consisted of thefollowing:
| ** **                                        | ** ** | **At June 30,  2005** | ** ** | **At December 31,  2004** | ** ** |
|---------------------------------------------------|------------|---------------------------------|------------|-------------------------------------|------------|
| ** **                                        | ** ** | **(Unaudited)**                 | ** ** | ** **                          | ** ** |
| **Owned  surface and coal lands**                 |       |                            |       |                                |       |   |   |
| Owned surface  lands                              |       | $                               | 28,501     |                                |       | $ | 29,171 |   |   |
| Owned and leased  mineral rights                  |       | $                               | 1,337,272  |                                |       | $ | 1,336,557 |   |   |
| Less accumulated  depletion                       |       | (117,862                        | )          |                                | (53,568    | ) |   |
|                                              |       | $                               | 1,219,410  |                                |       | $ | 1,282,989 |   |   |
| **Plant,  equipment and mine development costs**  |       |                            |       |                                |       |   |   |
| Plant, equipment  and asset retirement costs      |       | $                               | 583,378    |                                |       | $ | 518,525 |   |   |
| Mine development  costs                           |       | 12,453                          |       |                                | 6,196      |   |   |
| Coal bed methane  equipment and development costs |       | 3,409                           |       |                                | 3,959      |   |   |
|                                              |       | 599,240                         |       |                                | 528,680    |   |   |
| Less accumulated  depreciation and amortization:  |       |                            |       |                                |       |   |   |
| Plant, equipment and asset retirement costs       |       | (83,517                         | )          |                                | (40,898    | ) |   |
| Mine development costs                            |       | (397                            | )          |                                | (108       | ) |   |
| Coal bed methane equipment and development costs  |       | (345                            | )          |                                | (179       | ) |   |
|                                              |       | (84,259                         | )          |                                | (41,185    | ) |   |
|                                              |       | $                               | 514,981    |                                |       | $ | 487,495 |   |   |

 

10

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**Foundation Coal Corporation, Inc. and Subsidiaries (An Indirect Wholly Owned Subsidiary of Foundation Coal Holdings, Inc.) Notes to Consolidated Financial Statements (Continued) (Unaudited, dollars in thousands)**

**(6)**   OtherNoncurrent Assets

Othernoncurrent assets consisted of the following:
| ** **                                            | ** ** | **At June 30,  2005** | ** ** | **At December 31,  2004** | ** ** |
|-------------------------------------------------------|------------|---------------------------------|------------|-------------------------------------|------------|
| ** **                                            | ** ** | **(Unaudited)**                 | ** ** | ** **                          | ** ** |
| Receivables from  asset dispositions                  |       |                            | $          | 4,746                               |       |   |   | $ | 5,863 |   |   |
| Prepaid major  repairs                                |       |                            | 2,417      |                                |       |   | 737 |   |   |
| Unamortized debt  issuance costs, net                 |       |                            | 22,426     |                                |       |   | 24,162 |   |   |
| Advance mining  royalties                             |       |                            | 2,764      |                                |       |   | 2,620 |   |   |
| Work-in-process  coal inventory (deferred overburden) |       |                            | —     |                                |       |   | 3,576 |   |   |
| Prepaid longwall  development                         |       |                            | 1,633      |                                |       |   | 1,633 |   |   |
| Fair value of  interest rate swaps                    |       |                            | 1,206      |                                |       |   | 530 |   |   |
| Other                                                 |       |                            | 1,578      |                                |       |   | 2,465 |   |   |
|                                                  |       |                            | $          | 36,770                              |       |   |   | $ | 41,586 |   |   |

 

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

Accruedexpenses and other current liabilities consisted of the following:
| ** **                                  | ** ** | **At June 30,          2005        ** | ** ** | **At December 31,  2004** | ** ** |
|---------------------------------------------|------------|---------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------|------------|
| ** **                                  | ** ** | **(Unaudited)**                                                                                                                 | ** ** | ** **                          | ** ** |
| Accrued federal  and state income taxes     |       |                                                                                                                            | $          | 6,044                               |       |   |   | $ | 3,815 |   |   |
| Accrued sales  contract settlements         |       |                                                                                                                            | —     |                                |       |   | 7,431 |   |   |
| Wages and  employee benefits                |       |                                                                                                                            | 30,818     |                                |       |   | 27,977 |   |   |
| Pension benefits                            |       |                                                                                                                            | 6,903      |                                |       |   | 5,970 |   |   |
| Postretirement  benefits other than pension |       |                                                                                                                            | 23,000     |                                |       |   | 21,350 |   |   |
| Interest                                    |       |                                                                                                                            | 9,092      |                                |       |   | 9,065 |   |   |
| Royalties                                   |       |                                                                                                                            | 7,414      |                                |       |   | 8,657 |   |   |
| Taxes other than  income taxes              |       |                                                                                                                            | 28,523     |                                |       |   | 28,328 |   |   |
| Asset retirement  obligations               |       |                                                                                                                            | 4,555      |                                |       |   | 4,398 |   |   |
| Workers’  compensation                 |       |                                                                                                                            | 9,728      |                                |       |   | 9,717 |   |   |
| Other                                       |       |                                                                                                                            | 37,268     |                                |       |   | 28,833 |   |   |
|                                        |       |                                                                                                                            | $          | 163,345                             |       |   |   | $ | 155,541 |   |   |

 

11

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**Foundation Coal Corporation, Inc. and Subsidiaries (An Indirect Wholly Owned Subsidiary of Foundation Coal Holdings, Inc.) Notes to Consolidated Financial Statements (Continued) (Unaudited, dollars in thousands)**

**(8)**   OtherNoncurrent Liabilities

Othernoncurrent liabilities consisted of the following:
| ** **                    | ** ** | **At June 30,  2005** | ** ** | **At December 31,  2004** | ** ** |
|-------------------------------|------------|---------------------------------|------------|-------------------------------------|------------|
| ** **                    | ** ** | **(Unaudited)**                 | ** ** | ** **                          | ** ** |
| Postemployment benefits       |       |                            | $          | 5,785                               |       |   |   | $ | 6,365 |   |   |
| Pension benefits              |       |                            | 44,377     |                                |       |   | 43,987 |   |   |
| Workers’ compensation    |       |                            | 19,614     |                                |       |   | 18,938 |   |   |
| Minimum royalty  obligations  |       |                            | 95         |                                |       |   | 876 |   |   |
| Black lung reserves           |       |                            | 5,392      |                                |       |   | 4,972 |   |   |
| Contract settlement  accrual  |       |                            | 24,022     |                                |       |   | 26,672 |   |   |
| Asset retirement  obligations |       |                            | 104,051    |                                |       |   | 100,202 |   |   |
| Deferred production tax       |       |                            | 6,884      |                                |       |   | 7,144 |   |   |
| Deferred credits and  other   |       |                            | 2,297      |                                |       |   | 2,299 |   |   |
|                          |       |                            | $          | 212,517                             |       |   |   | $ | 211,455 |   |   |

 

**(9**   ComprehensiveIncome (Loss)

Accumulatedother comprehensive income (loss) consisted of the following:
| ** **                                                      | ** ** | **At June 30,  2005** | ** ** | **At December 31,  2004** | ** ** |
|-----------------------------------------------------------------|------------|---------------------------------|------------|-------------------------------------|------------|
| ** **                                                      | ** ** | **(Unaudited)**                 | ** ** | ** **                          | ** ** |
| Changes in fair  value of hedge instruments, net of tax of $260 |       |                            | $          | 416                                 |       |   |   | $ | — |   |   |
| Minimum pension  liability adjustments, net of tax of $192      |       |                            | (326       | )                                   |       |   | (326 | ) |   |
|                                                            |       |                            | $          | 90                                  |       |   |   | $ | (326 | ) |   |

 

**(10)**   Pension and Postretirement BenefitPlans

*Components of NetPeriodic Pension Costs*

Netperiodic pension costs included the following:
| ** **                                          | ** ** | **Three Months Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|-----------------------------------------------------|------------|-----------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                          | ** ** | **2005**                                            | ** ** | **2004**                                          | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                          | ** ** | **  Successor  **               | ** ** | **  Predecessor  **           | ** ** | ** Successor ** | ** ** | ** Predecessor ** | ** ** |
| Service cost                                        |       |                                                | $          | 1,607                                             |       |   |   | $ | 1,417 |   |   |   | $ | 2,888 |   |   |   | $ | 2,709 |   |   |
| Interest cost                                       |       |                                                | 3,343      |                                              |       |   | 2,805 |   |   |   | 5,903 |   |   |   | 5,513 |   |   |
| Expected return  on plan assets                     |       |                                                | (3,418     | )                                                 |       |   | (2,631 | ) |   |   | (5,667 | ) |   |   | (4,764 | ) |   |
| Amortization of:                                    |       |                                                |       |                                              |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Prior service cost                                  |       |                                                | —     |                                              |       |   | 10 |   |   |   | — |   |   |   | 20 |   |   |
| Actuarial losses                                    |       |                                                | 186        |                                              |       |   | 842 |   |   |   | 207 |   |   |   | 1,950 |   |   |
|                                                |       |                                                | 1,718      |                                              |       |   | 2,443 |   |   |   | 3,331 |   |   |   | 5,428 |   |   |
| Less: amounts  allocated to discontinued operations |       |                                                | —     |                                              |       |   | (81 | ) |   |   | — |   |   |   | (569 | ) |   |
| Total from continuing  operations                   |       |                                                | $          | 1,718                                             |       |   |   | $ | 2,362 |   |   |   | $ | 3,331 |   |   |   | $ | 4,859 |   |   |

 

12

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**Foundation Coal Corporation, Inc. and Subsidiaries (An Indirect Wholly Owned Subsidiary of Foundation Coal Holdings, Inc.) Notes to Consolidated Financial Statements (Continued) (Unaudited, dollars in thousands)**

*Components of Net Periodic Postretirement BenefitCosts*

Netperiodic postretirement medical and life insurance are as follows:
| ** **                                          | ** ** | **Three Months Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|-----------------------------------------------------|------------|-----------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                          | ** ** | **2005**                                            | ** ** | **2004**                                          | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                          | ** ** | **  Successor  **               | ** ** | **  Predecessor  **           | ** ** | ** Successor ** | ** ** | ** Predecessor ** | ** ** |
| Service cost                                        |       |                                                | $          | 1,921                                             |       |   |   | $ | 1,793 |   |   |   | $ | 3,956 |   |   |   | $ | 3,450 |   |   |
| Interest cost                                       |       |                                                | 7,866      |                                              |       |   | 7,774 |   |   |   | 16,331 |   |   |   | 15,000 |   |   |
| Amortization of:                                    |       |                                                |       |                                              |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Prior service cost                                  |       |                                                | —     |                                              |       |   | 118 |   |   |   | — |   |   |   | 300 |   |   |
| Actuarial losses                                    |       |                                                | —     |                                              |       |   | 3,845 |   |   |   | — |   |   |   | 6,614 |   |   |
|                                                |       |                                                | 9,787      |                                              |       |   | 13,530 |   |   |   | 20,287 |   |   |   | 25,364 |   |   |
| Less: amounts allocated  to discontinued operations |       |                                                | —     |                                              |       |   | (46 | ) |   |   | — |   |   |   | (324 | ) |   |
| Total from continuing operations                    |       |                                                | $          | 9,787                                             |       |   |   | $ | 13,484 |   |   |   | $ | 20,287 |   |   |   | $ | 25,040 |   |   |

 

The Company’s postretirement medical and lifeinsurance plans are unfunded.

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

Thecomponents of net periodic benefit cost are as follows:
| ** **                                          | ** ** | **Three Months Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|-----------------------------------------------------|------------|-----------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                          | ** ** | **2005**                                            | ** ** | **2004**                                          | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                          | ** ** | **  Successor  **               | ** ** | **  Predecessor  **           | ** ** | ** Successor ** | ** ** | ** Predecessor ** | ** ** |
| Service cost                                        |       |                                                | $          | 84                                                |       |   |   | $ | 132 |   |   |   | $ | 168 |   |   |   | $ | 265 |   |   |
| Interest cost                                       |       |                                                | 211        |                                              |       |   | 322 |   |   |   | 422 |   |   |   | 644 |   |   |
| Expected return on plan  assets                     |       |                                                | (145       | )                                                 |       |   | (243 | ) |   |   | (290 | ) |   |   | (487 | ) |   |
| Amortization of:                                    |       |                                                |       |                                              |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Transition asset                                    |       |                                                | —     |                                              |       |   | (69 | ) |   |   | — |   |   |   | (138 | ) |   |
| Prior service cost                                  |       |                                                | —     |                                              |       |   | 34 |   |   |   | — |   |   |   | 68 |   |   |
| Actuarial losses                                    |       |                                                | 60         |                                              |       |   | 148 |   |   |   | 120 |   |   |   | 296 |   |   |
|                                                |       |                                                | 210        |                                              |       |   | 324 |   |   |   | 420 |   |   |   | 648 |   |   |
| Less: amounts allocated  to discontinued operations |       |                                                | —     |                                              |       |   | (2 | ) |   |   | — |   |   |   | (14 | ) |   |
| Total from continuing operations                    |       |                                                | $          | 210                                               |       |   |   | $ | 322 |   |   |   | $ | 420 |   |   |   | $ | 634 |   |   |

 

**(12)**   Stock-BasedCompensation

The Company records compensation expense for allemployee stock-based compensation plans using the intrinsic value methodprescribed by Accounting Principles Board Opinion No. 25, *Accounting for Stock Issued to Employees* (“APBNo. 25”) and related interpretations. Under APB No. 25, compensationexpense is recorded over the vesting period to the extent that the fair valueof the underlying stock on the date of grant exceeds the exercise oracquisition price of the stock or stock-based award. We have adopted thedisclosure-only provisions of SFAS No. 123, *Accounting for Stock-Based Compensation,* (“SFAS No. 123”),as amended by SFAS No. 148 *Accountingfor Stock-Based Compensation—Transition and Disclosure—an amendment of FASBStatement No. 123* (“SFAS No. 148”).

13

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**Foundation Coal Corporation, Inc. and Subsidiaries (An Indirect Wholly Owned Subsidiary of Foundation Coal Holdings, Inc.) Notes to Consolidated Financial Statements (Continued) (Unaudited, dollars in thousands)**

Hadcompensation expense for stock option grants been determined based on the fairvalue at the grant dates consistent with the method required by SFAS No. 123,the Company’s net income would have been changed to the pro forma amounts asindicated in the following table. The Predecessor had no stock option plans;therefore, no Predecessor information is presented.
| ** **                                                                                                                            | ** ** | **Three Months  Ended June 30,  2005** | ** ** | **Six Months  Ended June 30,  2005** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------|------------|-----------------------------------------------------|------------|
| Net income as reported                                                                                                                |       |                                                  | $          | 20,167                                              |       |   |   | $ | 39,102 |   |   |
| Add:                                                                                                                                  |       |                                                  |       |                                                |       |   |   |   |   |
| Stock-based employee  compensation included in reported net income, net of related tax effects                                        |       |                                                  | 47         |                                                |       |   | 235 |   |   |
| Deduct:                                                                                                                               |       |                                                  |       |                                                |       |   |   |   |   |
| Total stock-based  employee compensation expense determined under fair value based method for  all awards, net of related tax effects |       |                                                  | (227       | )                                                   |       |   | (603 | ) |   |
| Pro forma net income                                                                                                                  |       |                                                  | $          | 19,987                                              |       |   |   | $ | 38,734 |   |   |

 

The Company grantedrestricted stock performance unit awards (“performance units”) to certain keyemployees in March 2005. All of the performance units granted are subject tocontinued employment and vest on each December 31, beginning December 31,2005 and ending on December 31, 2007 contingent upon the achievement ofcertain annual performance targets. Shares of common stock are then awarded in March ofthe year following the final vesting period. Compensation expense ofapproximately $80 and $370 (pretax) were recorded for the three and six monthsended June 30, 2005 for the initial year’s performance units that managementexpects will vest on December 31, 2005.

**(13)**   Derivative Instruments and HedgingActivities

The Predecessor enteredinto an interest 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 is LIBORand 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 definitive Stock Purchase Agreement for thesale of the RAG Colorado Business Unit entered into on February 29, 2004,the Predecessor notified the holders of the variable rate notes of theirintention to repay the notes. Accordingly, the interest rate swaps no longerqualified for hedge accounting treatment and in the quarter ended March 31, 2004,the full amount of unrealized loss included in accumulated other comprehensiveincome was recognized in net income. The Predecessor settled the interest rateswaps in April 2004. Between February 29, 2004 and April 27,2004, mark-to-market gains on the interest rate swaps were $5,804and were included in other income.

14

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**Foundation Coal Corporation, Inc. and Subsidiaries (An Indirect Wholly Owned Subsidiary of Foundation Coal Holdings, Inc.) Notes to Consolidated Financial Statements (Continued) (Unaudited, dollars in thousands)**

On September 30,2004, the Successor entered into pay-fixed, receive-variable interestrate swap agreements on a notional amount of $85,000. The term of these swapsis for three years. Under these swaps, the Company receives a variable rate ofthree month US dollar LIBOR and pays a fixed rate of 3.26%. Settlement ofinterest payments occurs quarterly. The Company was required to enter intothese swaps in order to maintain at least 50% of its outstanding debt at afixed rate as required by the Senior Credit Facility. These swap agreementsessentially convert $85,000 of the Company’s variable rate borrowings under theSenior Credit Facility to fixed rate borrowings for a three year periodbeginning September 30, 2004. Effective January 1, 2005, the Companydesignated these interest rate swaps as cash flow hedges of the variableinterest payments due on $85,000 of its variable rate date through September 2007under SFAS No 133, *Accounting for DerivativeFinancial Instruments and Hedging Activities* upon completion of theeffectiveness testing and related documentation. As of June 30, 2005, thefair value of this cash flow hedge was $1,206 which was recorded as anoncurrent asset and the offsetting unrealized gain of $416, net of tax expensewas recorded in accumulated other comprehensive income. At December 31,2004, the fair value of these swaps was $530 which was recorded as a noncurrentasset.

**(14)**   AssetRetirement Obligations

The Company’s mining activities are subject to variousfederal and state laws and regulations governing the protection of theenvironment. These laws and regulations are continually changing and aregenerally becoming more restrictive. The Company conducts its operations so asto protect the public health and environment and believes its operations are incompliance with all applicable laws and regulations. The Company has made, andexpects to make in the future, expenditures to comply with such laws andregulations, but cannot predict the amount of such future expenditures.Estimated future reclamation costs are based principally on legal andregulatory requirements.

Thefollowing table is a reconciliation of the Company’s asset retirementobligation (“ARO”) liability from January 1, 2005 through June 30,2005:
| Asset retirement  obligation, January 1, 2005 |   | $     | 104,600 |   |
|----------------------------------------------------|--------|-------|---------|--------|
| Accretion expense                                  |   | 4,084 |    |
| Revisions in  estimated cash flows                 |   | 903   |    |
| Payments                                           |   | (981  | )       |
| Asset retirement obligation,  June 30, 2005   |   | $     | 108,606 |   |

 

The current portions ofthe asset retirement obligation liabilities of $4,555 and $4,398 at June 30,2005 and December 31, 2004, respectively, are included in accrued expensesand other current liabilities as illustrated in Note 7. There were no assetsthat were legally restricted for purposes of settling asset retirementobligations at June 30, 2005 or December 31, 2004, respectively.

**(15)**   SegmentInformation

The Company producesprimarily steam coal from surface and deep mines for sale to utility andindustrial customers. The Company operates only in the United States with minesin all of the major coal basins. The Company has three reportable businesssegments: Northern Appalachia, consisting of two 

15

----

**Foundation Coal Corporation, Inc. and Subsidiaries (An Indirect Wholly Owned Subsidiary of Foundation Coal Holdings, Inc.) Notes to Consolidated Financial Statements (Continued) (Unaudited, dollars in thousands)**

undergroundmines in southwestern Pennsylvania, Central Appalachia, consisting of sixunderground mines and two surface mines in southern West Virginia and thePowder River Basin, consisting of two surface mines in Wyoming. Other includesan underground mine in Illinois, centralized sales functions, corporateoverhead, business development activities, expenses for closed mines and theelimination of intercompany transactions. The Company evaluates the performanceof its segments based on operating income.

***Successor:***

Operatingsegment results for the three months ended June 30, 2005 are as follows:
| ** **                                | ** ** | **Powder  River  Basin** | ** ** | **Northern   Appalachia ** | ** ** | **Central   Appalachia ** | ** ** | **Other** | ** ** | **Consolidated** | ** ** |
|-------------------------------------------|------------|--------------------------|------------|--------------------------------------|------------|-------------------------------------|------------|-----------|------------|------------------|------------|
| Revenues                                  |       | $                        | 72,131     |                                 |       | $                                   | 124,167    |      |       |             | $          | 113,800 |   |   | $ | 19,380 |   | $ | 329,478 |   |
| Income from  operations                   |       | (2,219                   | )          |                                 | 39,370     |                                |       |      | 30,264     |             |       | (19,764 | ) | 47,651 |   |
| Depreciation,  depletion and amortization |       | 17,466                   |       |                                 | 17,778     |                                |       |      | 15,568     |             |       | 1,882 |   | 52,694 |   |
| Amortization of  coal supply agreements   |       | 4,365                    |       |                                 | (14,399    | )                                   |       |      | (10,920    | )                |       | (2,183 | ) | (23,137 | ) |
| Capital  expenditures                     |       | 7,348                    |       |                                 | 8,208      |                                |       |      | 11,887     |             |       | 1,122 |   | 28,565 |   |
| Total assets                              |       | $                        | 588,156    |                                 |       | $                                   | 971,775    |      |       |             | $          | 497,604 |   |   | $ | 46,188 |   | $ | 2,103,723 |   |

 

***Predecessor:***

Operatingsegment results for the three months ended June 30, 2004 are as follows:
| ** **                                | ** ** | **Powder  River  Basin** | ** ** | **Northern   Appalachia ** | ** ** | **Central   Appalachia ** | ** ** | **Other** | ** ** | **Consolidated** | ** ** |
|-------------------------------------------|------------|--------------------------|------------|--------------------------------------|------------|-------------------------------------|------------|-----------|------------|------------------|------------|
| Revenues                                  |       | $                        | 76,128     |                                 |       | $                                   | 82,076     |      |       |             | $          | 73,116 |   |   | $ | 20,835 |   | $ | 252,155 |   |
| Income from  operations                   |       | 13,400                   |       |                                 | 3,306      |                                |       |      | (3,250     | )                |       | (21,107 | ) | (7,651 | ) |
| Depreciation,  depletion and amortization |       | 4,759                    |       |                                 | 12,877     |                                |       |      | 8,241      |             |       | 1,592 |   | 27,469 |   |
| Amortization of  coal supply agreements   |       | 3,258                    |       |                                 | 198        |                                |       |      | —     |             |       | 373 |   | 3,829 |   |
| Capital  expenditures                     |       | 2,270                    |       |                                 | 14,644     |                                |       |      | 7,336      |             |       | 653 |   | 24,903 |   |
| Total assets                              |       | $                        | 423,969    |                                 |       | $                                   | 649,374    |      |       |             | $          | 246,931 |   |   | $ | 115,945 |   | $ | 1,436,219 |   |

 

16

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**Foundation Coal Corporation, Inc. and Subsidiaries (An Indirect Wholly Owned Subsidiary of Foundation Coal Holdings, Inc.) Notes to Consolidated Financial Statements (Continued) (Unaudited, dollars in thousands)**

***Successor:***

Operatingsegment results for the six months ended June 30, 2005 are as follows:
| ** **                                | ** ** | **Powder  River  Basin** | ** ** | **Northern   Appalachia ** | ** ** | **Central   Appalachia ** | ** ** | **Other** | ** ** | ** Consolidated ** | ** ** |
|-------------------------------------------|------------|--------------------------|------------|--------------------------------------|------------|-------------------------------------|------------|-----------|------------|------------------------------|------------|
| Revenues                                  |       | $                        | 154,707    |                                 |       | $                                   | 238,156    |      |       |                         | $          | 199,426 |   |   | $ | 42,695 |   |   | $ | 634,984 |   |   |
| Income from  operations                   |       | 3,339                    |       |                                 | 81,842     |                                |       |      | 43,234     |                         |       | (35,380 | ) |   | 93,035 |   |   |
| Depreciation,  depletion and amortization |       | 37,022                   |       |                                 | 37,363     |                                |       |      | 29,405     |                         |       | 3,704 |   |   | 107,494 |   |   |
| Amortization of  coal supply agreements   |       | 9,008                    |       |                                 | (30,900    | )                                   |       |      | (23,035    | )                            |       | (1,589 | ) |   | (46,516 | ) |   |
| Capital  expenditures                     |       | 17,397                   |       |                                 | 21,471     |                                |       |      | 24,648     |                         |       | 1,577 |   |   | 65,093 |   |   |
| Total assets                              |       | $                        | 588,156    |                                 |       | $                                   | 971,775    |      |       |                         | $          | 497,604 |   |   | $ | 46,188 |   |   | $ | 2,103,723 |   |   |

 

***Predecessor:***

Operatingsegment results for the six months ended June 30, 2004 are as follows:
| ** **                                | ** ** | **Powder  River  Basin** | ** ** | **Northern   Appalachia ** | ** ** | **Central   Appalachia ** | ** ** | **Other** | ** ** | ** Consolidated ** | ** ** |
|-------------------------------------------|------------|--------------------------|------------|--------------------------------------|------------|-------------------------------------|------------|-----------|------------|------------------------------|------------|
| Revenues                                  |       | $                        | 155,919    |                                 |       | $                                   | 136,613    |      |       |                         | $          | 140,118 |   |   | $ | 45,812 |   |   | $ | 478,462 |   |   |
| Income from  operations                   |       | 26,120                   |       |                                 | (8,110     | )                                   |       |      | (3,250     | )                            |       | (34,381 | ) |   | (19,621 | ) |   |
| Depreciation,  depletion and amortization |       | 9,430                    |       |                                 | 23,886     |                                |       |      | 16,049     |                         |       | 3,121 |   |   | 52,486 |   |   |
| Amortization of  coal supply agreements   |       | 6,647                    |       |                                 | 331        |                                |       |      | —     |                         |       | 817 |   |   | 7,795 |   |   |
| Capital  expenditures                     |       | 10,539                   |       |                                 | 25,693     |                                |       |      | 11,483     |                         |       | 2,738 |   |   | 50,453 |   |   |
| Total assets                              |       | $                        | 423,969    |                                 |       | $                                   | 649,374    |      |       |                         | $          | 246,931 |   |   | $ | 115,945 |   |   | $ | 1,436,219 |   |   |

 

**(16)**   OtherRevenue 

Otherrevenue consisted of the following:
| ** **                              | ** ** | **Three Months Ended June 30,**                                                      | ** ** | **Six Month Ended June 30,**                                                         | ** ** |
|-----------------------------------------|------------|----------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------|------------|
| ** **                              | ** ** | **        2005        ** | ** ** | **        2004        ** | ** ** | **        2005        ** | ** ** | **        2004        ** | ** ** |
| ** **                              | ** ** | **Successor**                                                                                            | ** ** | **Predecessor**                                                                                          | ** ** | **Successor** | ** ** | **Predecessor** | ** ** |
| Royalty income                          |       |                                                                                                     | $          | 390                                                                                                      |       |   |   | $ | 683 |   |   |   | $ | 567 |   |   |   | $ | 1,506 |   |   |
| Synfuel fees                            |       |                                                                                                     | 1,845      |                                                                                                     |       |   | 1,012 |   |   |   | 3,222 |   |   |   | 2,012 |   |   |
| Coalbed methane                         |       |                                                                                                     | 1,372      |                                                                                                     |       |   | 963 |   |   |   | 2,709 |   |   |   | 1,100 |   |   |
| Transloading and  plant processing fees |       |                                                                                                     | 446        |                                                                                                     |       |   | 401 |   |   |   | 1,576 |   |   |   | 759 |   |   |
| Gain (loss) on  disposition of assets   |       |                                                                                                     | (39        | )                                                                                                        |       |   | 237 |   |   |   | (39 | ) |   |   | 683 |   |   |
| Other                                   |       |                                                                                                     | 927        |                                                                                                     |       |   | (3,195 | ) |   |   | 2,391 |   |   |   | (1,631 | ) |   |
|                                    |       |                                                                                                     | $          | 4,941                                                                                                    |       |   |   | $ | 101 |   |   |   | $ | 10,426 |   |   |   | $ | 4,429 |   |   |

** **

17

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**Foundation Coal Corporation, Inc. and Subsidiaries (An Indirect Wholly Owned Subsidiary of Foundation Coal Holdings, Inc.) Notes to Consolidated Financial Statements (Continued) (Unaudited, dollars in thousands)**

**(17)**   Commitments and Contingencies

***AssetRetirement Obligations (formerly Reclamation and Mine Closure)***

At June 30, 2005, theCompany’s accruals for reclamation and mine closure totaled $108,606. Theportion of the costs expected to be incurred within a year of $4,555 at June 30,2005 is included in accrued expenses and other current liabilities. At June 30,2005, these regulatory obligations are secured by surety bonds in the amount of$229,567. These surety bonds are partially collateralized by letters of creditissued by the Company.

***Guarantees***

One of our former parent companies, Cyprus AmaxMinerals Company, remains a guarantor with regard to future minimum royaltiespayable under leases through the first quarter 2006 to Blackhawk Coal Company,an affiliate of American Electric Power. Under the terms of the Stock PurchaseAgreement, dated May 12, 1999 between RAG Coal International AG and CyprusAmax Minerals Company, the Predecessor guaranteed Cyprus Amax’ performanceunder this obligation by issuing an irrevocable letter of credit to secure theminimum royalty payments still due. The Company assumed this guarantee in theacquisition. The amount of this letter of credit is reduced as the Companymakes the scheduled payments. At June 30, 2005 and December 31, 2004,the letter of credit amount was $3,000 and $6,000, respectively.

Neweagle Industries, Inc. (“Neweagle”) is awholly-owned indirect subsidiary of the Company. Starting in early 2001,Neweagle supplied and sold coal to Arch Coal Sales Company, Inc. (“ArchSales”) pursuant to a Conditional Coal Supply Agreement dated October 1,1996 (CCSA). This coal was in turn resold by Arch Sales under a separate anddistinct Coal Sales Agreement dated October 1, 1989 (“Rocky Mount Contract”)with Cogentrix of Rocky Mount, Inc. (“Cogentrix”) as the buyer. On March 23,2003, the Predecessor (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  effective November 12, 2004. Pursuant tothe MRSA, the CCSA and the Guaranty were terminated. Also pursuant to the MRSA,Neweagle agreed to continue selling and supplying coal to Arch in thequantities required under the Rocky Mount Contract for re-sale by Arch toCogentrix thereunder. The MRSA also was executed by the Predecessor (now knownas Foundation American Coal Holding, Inc.) As a signatory to the MRSA,Foundation American Coal Holding, Inc. and Neweagle agreed to indemnify,defend, and save harmless Arch and its affiliates from any non-performance,default or breach of (i) Neweagle’s obligation to supply coal to ArchSales under the MSRA and (ii) for so long as the MRSA remains in force,any default, breach, or non-fulfillment of Arch Sales contract obligationsunder the Rocky Mount Contract as a result of acts or omissions (other than byCogentrix) occurring on or after November 12, 2004.

Neweagle Industries, Inc., Neweagle Coal SalesCorp., Laurel Creek Co., Inc. and Rockspring Development, Inc. (“Sellers”)are wholly-owned indirect subsidiaries of the Company. The Sellers sellcoal to Birchwood Power Partners, L.P. (“Birchwood”) under a Coal SupplyAgreement dated July 22, 1993 

18

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**Foundation Coal Corporation, Inc. and Subsidiaries (An Indirect Wholly Owned Subsidiary of Foundation Coal Holdings, Inc.) Notes to Consolidated Financial Statements (Continued) (Unaudited, dollars in thousands)**

(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, Arch Coal, Inc.(“Arch”) and its affiliates have separate contractual obligations to providecoal to Birchwood if Sellers fail to perform. Pursuant to an Agreement &Release dated September 30, 1997, the Predecessor (now known as FoundationAmerican Coal Holding, Inc.) agreed to defend, indemnify, and holdharmless Arch and its subsidiaries from and against any claims arising out ofany failure of Sellers to perform under the Birchwood Contract. Byacknowledgement dated February 16, 2005, the Predecessor and Archacknowledged the continuing validity and effect of the Agreement &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 of performancebeing required. In the Company’s past experience, no claims have been madeagainst these financial instruments. Management does not expect any materiallosses to result from these guarantees or off-balance-sheet instrumentsand, therefore, is of the opinion that their fair value is zero.

***Contingencies***

Three of our subsidiaries were named as defendants insix separate complaints filed in Raleigh and Wyoming Counties, West Virginia,in late 2001, alleging personal injury and property damage caused by floodingon or about July 8, 2001. Similar suits may be filed in the future basedon this or subsequent weather events. The general alleged basis for thelawsuits is that coal mining, oil and gas drilling and timbering operationsaltered the topography in the area to such an extent that flooding resultingfrom heavy rains caused more severe damage than would have otherwise resulted.Numerous similar complaints were filed by hundreds of plaintiffs against over100 defendants, in a total of seven southern West Virginia counties. All suchcivil actions have been referred by the West Virginia Supreme Court to a three-judgepanel, sitting in Raleigh County, pursuant to the Court’s Mass Litigation Rule.

On December 9, 2004, the West Virginia SupremeCourt issued an opinion addressing certain questions of law certified to it bythe three-judge panel. Among other rulings, the Supreme Court decisionheld that plaintiffs may not proceed under a strict liability theory, as hadbeen asserted in their complaints. The court also held that where damages canbe shown to have been caused by an unusual act of nature combined with theconduct of a defendant, the defendant should be given an opportunity to show byclear and convincing evidence that it caused only a portion of those damages,in order to avoid incurring liability for all damages.

Pursuant to an existing order, no formal discovery hastaken place in any of these cases, and the filing of cross-claims,counterclaims and third-party actions was stayed. In March 2005 thethree judge panel issued a scheduling order indicating that six differenttrials will be held, one for each watershed impacted. Each trial will be heldin two phases with the liability phase being held first, and then a damagesphase. 

19

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**Foundation Coal Corporation, Inc. and Subsidiaries (An Indirect Wholly Owned Subsidiary of Foundation Coal Holdings, Inc.) Notes to Consolidated Financial Statements (Continued) (Unaudited, dollars in thousands)**

The first trial is currentlyscheduled to commence in March 2006. This will relate to flooding in theUpper Guyandotte River watershed in which our affiliates do have operations.

The claims against our entities are covered byinsurance. Common defense counsel and experts are representing numerousdefendants and costs are being shared. While the outcome of litigation issubject to uncertainties, based on our preliminary evaluation of the issues andthe potential impact on us, we believe this matter will be resolved without a materialadverse effect on our financial condition, results of operations or cash flow.

Extensive regulation ofthe impacts 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.

***LegalProceedings***

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)   SupplementalGuarantor and Non-Guarantor Financial Information**

On July 30, 2004, the Company’s indirect whollyowned subsidiary, Foundation PA Coal Company (the “Issuer”), issued $300,000aggregate principal amount of 71¤4% Senior Notes(the “Notes”) that mature on August 1, 2014. In accordance with theindenture governing the Notes, each of the direct and indirect wholly ownedsubsidiaries 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.

20

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**Foundation Coal Corporation, Inc. and Subsidiaries (An Indirect Wholly Owned Subsidiary of Foundation Coal Holdings, Inc.) Notes to Consolidated Financial Statements (Continued) (Unaudited, dollars in thousands)**

**SuccessorUnaudited Supplemental Condensed Consolidated Statements of OperationsFor the Three Months Ended June 30, 2005**
| ** **                                                                                        | ** ** | **FCC** | ** ** | **Non-Guarantor  Subsidiary  (Issuer)** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|---------------------------------------------------------------------------------------------------|------------|---------|------------|-----------------------------------------|------------|-----------------------------|------------|------------------|------------|------------------|------------|
| Total revenues                                                                                    |       | $       | 3          |                                    |       | $                           | —     |             |       |             | $          | 329,475 |   |   |   | $ | — |   |   |   | $ | 329,478 |   |   |
| Costs and expenses:                                                                               |       |    |       |                                    |       |                        |       |             |       |             |       |   |   |   |   |   |   |   |   |
| Cost of sales (excludes depreciation depletion and  amortization)                                 |       | 150     |       |                                    | 38         |                        |       |             | 241,080    |             |       |   | — |   |   |   | 241,268 |   |   |
| Selling, general and administrative expenses  (excludes depreciation, depletion and amortization) |       | 4,602   |       |                                    | —     |                        |       |             | 4,356      |             |       |   | — |   |   |   | 8,958 |   |   |
| Accretion on asset retirement obligations                                                         |       | —  |       |                                    | —     |                        |       |             | 2,044      |             |       |   | — |   |   |   | 2,044 |   |   |
| Depreciation, depletion and amortization                                                          |       | —  |       |                                    | —     |                        |       |             | 52,694     |             |       |   | — |   |   |   | 52,694 |   |   |
| Amortization of coal supply agreements                                                            |       | —  |       |                                    | —     |                        |       |             | (23,137    | )                |       |   | — |   |   |   | (23,137 | ) |   |
| Income (loss)  from operations                                                                    |       | (4,749  | )          |                                    | (38        | )                           |       |             | 52,438     |             |       |   | — |   |   |   | 47,651 |   |   |
| Other income (expense):                                                                           |       |    |       |                                    |       |                        |       |             |       |             |       |   |   |   |   |   |   |   |   |
| Interest expense:                                                                                 |       |    |       |                                    |       |                        |       |             |       |             |       |   |   |   |   |   |   |   |   |
| Debt and other                                                                                    |       | (140    | )          |                                    | (11,499    | )                           |       |             | (2,785     | )                |       |   | — |   |   |   | (14,424 | ) |   |
| Intercompany                                                                                      |       | (1,249  | )          |                                    | 5,108      |                        |       |             | (3,859     | )                |       |   | — |   |   |   | — |   |   |
| Interest income                                                                                   |       | 112     |       |                                    | —     |                        |       |             | 68         |             |       |   | — |   |   |   | 180 |   |   |
| Income (loss)  from operations before income taxes                                                |       | (6,026  | )          |                                    | (6,429     | )                           |       |             | 45,862     |             |       |   | — |   |   |   | 33,407 |   |   |
| Income tax  expense                                                                               |       | (10,586 | )          |                                    | (2,348     | )                           |       |             | (90        | )                |       |   | — |   |   |   | (13,024 | ) |   |
| Income (loss)  from continuing operations                                                         |       | (16,612 | )          |                                    | (8,777     | )                           |       |             | 45,772     |             |       |   | — |   |   |   | 20,383 |   |   |
| Equity in  earnings of investments in issuer and guarantor subsidiaries                           |       | 36,995  |       |                                    | 34,907     |                        |       |             | —     |             |       |   | (71,902 | ) |   |   | — |   |   |
| Net income (loss)                                                                                 |       | $       | 20,383     |                                    |       | $                           | 26,130     |             |       |             | $          | 45,772 |   |   |   | $ | (71,902 | ) |   |   | $ | 20,383 |   |   |

 

21

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**Foundation Coal Corporation, Inc. and Subsidiaries (An Indirect Wholly Owned Subsidiary of Foundation Coal Holdings, Inc.) Notes to Consolidated Financial Statements (Continued) (Unaudited, dollars in thousands)**

**SuccessorUnaudited Supplemental Condensed Consolidated Statements of OperationsFor the Six Months Ended June 30, 2005**
| ** **                                                                                        | ** ** | **FCC** | ** ** | **Non-Guarantor  Subsidiary  (Issuer)** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|---------------------------------------------------------------------------------------------------|------------|---------|------------|-----------------------------------------|------------|-----------------------------|------------|------------------|------------|------------------|------------|
| Total revenues                                                                                    |       | $       | 3          |                                    |       | $                           | —     |             |       |             | $          | 634,981 |   |   |   | $ | — |   |   |   | $ | 634,984 |   |   |
| Costs and  expenses:                                                                              |       |    |       |                                    |       |                        |       |             |       |             |       |   |   |   |   |   |   |   |   |
| Cost of sales (excludes depreciation depletion and  amortization)                                 |       | 150     |       |                                    | 76         |                        |       |             | 456,272    |             |       |   | — |   |   |   | 456,498 |   |   |
| Selling, general and administrative expenses  (excludes depreciation, depletion and amortization) |       | 11,969  |       |                                    | —     |                        |       |             | 8,420      |             |       |   | — |   |   |   | 20,389 |   |   |
| Accretion on asset retirement obligations                                                         |       | —  |       |                                    | —     |                        |       |             | 4,084      |             |       |   | — |   |   |   | 4,084 |   |   |
| Depreciation, depletion and amortization                                                          |       | —  |       |                                    | —     |                        |       |             | 107,494    |             |       |   | — |   |   |   | 107,494 |   |   |
| Amortization of coal supply agreements                                                            |       | —  |       |                                    | —     |                        |       |             | (46,516    | )                |       |   | — |   |   |   | (46,516 | ) |   |
| Income (loss)  from operations                                                                    |       | (12,116 | )          |                                    | (76        | )                           |       |             | 105,227    |             |       |   | — |   |   |   | 93,035 |   |   |
| Other income  (expense):                                                                          |       |    |       |                                    |       |                        |       |             |       |             |       |   |   |   |   |   |   |   |   |
| Interest expense:                                                                                 |       |    |       |                                    |       |                        |       |             |       |             |       |   |   |   |   |   |   |   |   |
| Debt and other                                                                                    |       | (281    | )          |                                    | (22,847    | )                           |       |             | (5,549     | )                |       |   | — |   |   |   | (28,677 | ) |   |
| Intercompany                                                                                      |       | (2,617  | )          |                                    | 10,234     |                        |       |             | (7,617     | )                |       |   | — |   |   |   | — |   |   |
| Interest income                                                                                   |       | 164     |       |                                    | —     |                        |       |             | 138        |             |       |   | — |   |   |   | 302 |   |   |
| Income (loss)  from operations before income taxes                                                |       | (14,850 | )          |                                    | (12,689    | )                           |       |             | 92,199     |             |       |   | — |   |   |   | 64,660 |   |   |
| Income tax expense                                                                                |       | (21,774 | )          |                                    | (3,368     | )                           |       |             | (93        | )                |       |   | — |   |   |   | (25,235 | ) |   |
| Income (loss)  from continuing operations                                                         |       | (36,624 | )          |                                    | (16,057    | )                           |       |             | 92,106     |             |       |   | — |   |   |   | 39,425 |   |   |
| Equity in  earnings of investments in issuer and guarantor subsidiaries                           |       | 76,049  |       |                                    | 72,715     |                        |       |             | —     |             |       |   | (148,764 | ) |   |   | — |   |   |
| Net income (loss)                                                                                 |       | $       | 39,425     |                                    |       | $                           | 56,658     |             |       |             | $          | 92,106 |   |   |   | $ | (148,764 | ) |   |   | $ | 39,425 |   |   |

 

22

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**Foundation Coal Corporation, Inc. andSubsidiaries(An Indirect Wholly Owned Subsidiary of Foundation Coal Holdings, Inc.)Notes to Consolidated Financial Statements (Continued)(Unaudited, dollars in thousands)**

**SuccessorUnaudited Supplemental Condensed Consolidated Balance Sheets**

**June 30,2005**
| ** **                                             | ** ** | **FCC** | ** ** | **Non-Guarantor  Subsidiary  (Issuer)** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|--------------------------------------------------------|------------|---------|------------|-----------------------------------------|------------|-----------------------------|------------|------------------|------------|------------------|------------|
| **Assets**                                             |       |    |       |                                    |       |                        |       |             |       |             |       |   |   |
| Current assets:                                        |       |    |       |                                    |       |                        |       |             |       |             |       |   |   |
| Cash and cash equivalents                              |       | $       | 27,184     |                                    |       | $                           | —     |             |       | $                | 22         |   | $ | — |   | $ | 27,206 |   |
| Trade accounts receivable, net                         |       | (146    | )          |                                    | —     |                        |       | 102,384          |       | —           |       | 102,238 |   |
| Inventories, net                                       |       | —  |       |                                    | —     |                        |       | 67,784           |       | —           |       | 67,784 |   |
| Deferred income taxes                                  |       | —  |       |                                    | 5,569      |                        |       | 9,576            |       | —           |       | 15,145 |   |
| Other current assets                                   |       | (41,334 | )          |                                    | (686       | )                           |       | 64,385           |       | —           |       | 22,365 |   |
| Total current assets                                   |       | (14,296 | )          |                                    | 4,883      |                        |       | 244,151          |       | —           |       | 234,738 |   |
| Owned surface  lands                                   |       | —  |       |                                    | —     |                        |       | 28,501           |       | —           |       | 28,501 |   |
| Plant, equipment  and mine development costs, net |       | —  |       |                                    | —     |                        |       | 514,981          |       | —           |       | 514,981 |   |
| Owned and leased  mineral rights, net                  |       | 1,035   |       |                                    | —     |                        |       | 1,218,375        |       | —           |       | 1,219,410 |   |
| Coal supply  agreements, net                           |       | —  |       |                                    | —     |                        |       | 69,323           |       | —           |       | 69,323 |   |
| Other noncurrent  assets                               |       | 435,887 |       |                                    | 475,628    |                        |       | 542,224          |       | (1,416,969       | )          | 36,770 |   |
| Total assets                                           |       | $       | 422,626    |                                    |       | $                           | 480,511    |             |       | $                | 2,617,555  |   | $ | (1,416,969 | ) | $ | 2,103,723 |   |
| Current liabilities:                                   |       |    |       |                                    |       |                        |       |             |       |             |       |   |   |
| Trade accounts payable                                 |       | $       | 1,706      |                                    |       | $                           | 9          |             |       | $                | 28,182     |   | $ | — |   | $ | 29,897 |   |
| Accrued expenses and other current liabilities         |       | 15,413  |       |                                    | 11,947     |                        |       | 135,985          |       | —           |       | 163,345 |   |
| Total current liabilities                              |       | 17,119  |       |                                    | 11,956     |                        |       | 164,167          |       | —           |       | 193,242 |   |
| Long-term  debt                                        |       | —  |       |                                    | 685,000    |                        |       | —           |       | —           |       | 685,000 |   |
| Deferred income  taxes                                 |       | 6,577   |       |                                    | 126,139    |                        |       | 7,948            |       | —           |       | 140,664 |   |
| Coal supply  agreements, net                           |       | —  |       |                                    | —     |                        |       | 119,824          |       | —           |       | 119,824 |   |
| Other noncurrent  liabilities                          |       | 103,896 |       |                                    | (438,097   | )                           |       | 1,625,338        |       | (621,178         | )          | 669,959 |   |
| Total liabilities                                      |       | 127,592 |       |                                    | 384,998    |                        |       | 1,917,277        |       | (621,178         | )          | 1,808,689 |   |
| Stockholder  equity                                    |       | 295,034 |       |                                    | 95,513     |                        |       | 700,278          |       | (795,791         | )          | 295,034 |   |
| Total liabilities and  stockholder equity              |       | $       | 422,626    |                                    |       | $                           | 480,511    |             |       | $                | 2,617,555  |   | $ | (1,416,969 | ) | $ | 2,103,723 |   |

 

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**Foundation Coal Corporation, Inc. andSubsidiaries(An Indirect Wholly Owned Subsidiary of Foundation Coal Holdings, Inc.)Notes to Consolidated Financial Statements (Continued)(Unaudited, dollars in thousands)**

**SuccessorUnaudited Supplemental Condensed Consolidated Statements of Cash FlowsFor the Six Months Ended June 30, 2005**
| ** **                                                  | ** ** | **FCC** | ** ** | **Non-Guarantor  Subsidiary (Issuer)** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Consolidated** | ** ** |
|-------------------------------------------------------------|------------|---------|------------|---------------------------------------------|------------|-----------------------------|------------|------------------|------------|
| Net cash provided  by operating activities                  |       | $       | 29,474     |                                        |       | $                           | —     |             |       |   | $ | 33,008 |   |   |   | $ | 62,482 |   |   |
| Investing activities                                        |       |    |       |                                        |       |                        |       |             |       |   |   |   |   |   |   |
| Purchases of  property, plant and equipment                 |       | —  |       |                                        | —     |                        |       |             | (65,093    | ) |   |   | (65,093 | ) |   |
| Proceeds from  disposition of property, plant and equipment |       | —  |       |                                        | —     |                        |       |             | 4,774      |   |   |   | 4,774 |   |   |
| Net cash used in  investing activities                      |       | —  |       |                                        | —     |                        |       |             | (60,319    | ) |   |   | (60,319 | ) |   |
| Financing activities:                                       |       |    |       |                                        |       |                        |       |             |       |   |   |   |   |   |   |
| Proceeds from revolving credit line                         |       | —  |       |                                        | 60,000     |                        |       |             | —     |   |   |   | 60,000 |   |   |
| Repayment of revolving credit line                          |       | —  |       |                                        | (60,000    | )                           |       |             | —     |   |   |   | (60,000 | ) |   |
| Net cash provided  by (used in) financing activities        |       | —  |       |                                        | —     |                        |       |             | —     |   |   |   | — |   |   |
| Net increase  (decrease) in cash and cash equivalents       |       | 29,474  |       |                                        | —     |                        |       |             | (27,311    | ) |   |   | 2,163 |   |   |
| Cash and cash  equivalents at beginning of period           |       | (2,290  | )          |                                        | —     |                        |       |             | 27,333     |   |   |   | 25,043 |   |   |
| Cash and cash  equivalents at end of period                 |       | $       | 27,184     |                                        |       | $                           | —     |             |       |   | $ | 22 |   |   |   | $ | 27,206 |   |   |

 

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**ITEM 2.**                MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

**SPECIALNOTE REGARDING FORWARD-LOOKING STATEMENTS**

This Form 10-Q contains forward-lookingstatements that are not statements of historical fact and may involve a numberof risks and uncertainties. These statements relate to analyses and otherinformation that are based on forecasts of future results and estimates ofamounts not yet determinable. These statements may also relate to our futureprospects, developments and business strategies.

We have used thewords “anticipate,” “believe,” “could,” “estimate,” “expect,” “intend,” “may,” “plan,”“predict,” “project” and similar terms and phrases, including references toassumptions, in this Form 10-Q to identify forward-lookingstatements. These forward-looking statements are made based onexpectations and beliefs concerning future events affecting us and are subjectto 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-lookingstatements. The factors, described below and elsewhere in this Form 10-Q,and in other documents we file with the SEC from time to time, are among thosethat may cause actual results to differ materially from our forward-lookingstatements:

·       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.

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You should keep in mindthat any forward-looking statement made by us in this Form 10-Qor elsewhere speaks only as of the date on which we make it. New risks anduncertainties come up from time to time, and it is impossible for us to predictthese events or how they may affect us. We have no duty to, and do not intendto, update or revise the forward-looking statements in this Form 10-Qafter the date of this Form 10-Q, except as may be required by law.In light of these risks and uncertainties, you should keep in mind that anyforward-looking statement made in this Form 10-Q or elsewheremight not occur.

**Overview**

We are the fifth largest coal company in the UnitedStates operating nine mining complexes that consist of thirteen individual coalmines. Our mining operations are located in southwest Pennsylvania, southernWest Virginia, southern Illinois and the southern Powder River Basin region ofWyoming. Three of our mining complexes are surface mines, two of our complexesare underground mines using highly efficient longwall mining technology and theremaining four complexes are underground mines that utilize continuous miners.In addition to mining coal, we also purchase coal from other producers andutilize it with our own production in coal brokering and trading activities.

Our primary product is steam coal, sold primarily toelectric power generators located in the United States. Approximately 9% of ourcoal sales revenue for the six months ended June 30, 2005 and 8% of ourpro-forma 2004 sales revenue was made from the sale of metallurgical coal tothe domestic and export metallurgical coal markets where it is used to makecoke for steel production.

While the majority of our revenues are derived fromthe sale of coal, we also realize revenues from coal production royalties,override royalty payments from a coal supply agreement now fulfilled by anotherproducer, fees from the processing of our production by a synfuel facility, feesto transload coal through our Rivereagle facility on the Big Sandy River andrevenues from the sale of coalbed methane.

From July 1, 1999 through July 29, 2004, wewere a stand-alone wholly owned subsidiary of RAG Coal International AG (“RAG”)headquartered in Essen, Germany. In October 2003, RAG announced itsintention to divest its international mining subsidiaries. In addition to RAGAmerican Coal Holding, Inc., these international mining subsidiariesconsisted of operations in Australia and Venezuela. On February 29, 2004,RAG announced the sale of four of our subsidiaries, collectively known as theRAG Colorado Business Unit, to a third party. The subsidiaries comprisingthe RAG Colorado Business Unit owned an underground longwall mine located inRoutt County, Colorado, an idled underground longwall mine located in MoffatCounty, Colorado and surface lands located in northwest Colorado and southernWyoming. The transaction closed on April 15, 2004. In the financialstatements of the Predecessor for the first quarter of 2004, the RAG ColoradoBusiness Unit was classified as a discontinued operation.

On May 24, 2004, RAG,entered into a definitive agreement with Foundation Coal Corporation, which wasowned by affiliates of First Reserve, Blackstone and AMCI, to sell all of itsoperations except the RAG Colorado Business Unit which was sold on April 15,2004. The transaction closed on July 30, 2004.

**Results of Continuing Operations**

**Basis of Presentation:**

RAG American Coal Holding, Inc. and itssubsidiaries, excluding the subsidiaries comprising the RAG Colorado BusinessUnit which were sold on April 15, 2004, were acquired by Foundation CoalCorporation on July 30, 2004. Due to the change in ownership, and theresultant application of purchase accounting, the historical financialstatements of the Predecessor and the Successor included in this Form 10-Qhave been prepared on different bases for the periods presented and are notcomparable.

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

**Successor**—representsthe consolidated financial position of Foundation Coal Corporation as of December 31,2004 and June 30, 2005, our consolidated results of operations for thequarter ended June 30, 2005 and our consolidated results of operations andcash flows for the six months ended June 30, 2005. Our consolidatedfinancial position at December 31, 2004 and June 30, 2005, and ourconsolidated results of operations for the quarter and six months ended June 30,2005 reflect 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 from the information presented in the consolidated balance sheets asof December 31, 2004 and June 30, 2005, and the consolidatedstatements of operations for the quarter and six months ended June 30,2005. The application of purchase accounting to the acquired assets of RAGAmerican Coal Holding, Inc. resulted in increases to owned and leasedmineral rights, surface lands, coal inventories, and the asset arising fromrecognition of asset retirement obligations. It resulted in decreases to plantand equipment and current deferred taxes. In addition, the historical costassigned to deferred overburden in the acquired asset balance sheet waseliminated. The values assigned to uncovered and partially covered coal landsconsidered the stage of the mining process in which these two groups of coallands were at the acquisition date. The application of purchase accounting tothe acquired liabilities of RAG American Coal Holding, Inc. resulted inincreases to postretirement health care obligations, pension obligations, blacklung obligations, 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 price curves.With regard to consolidated results of operations for the quarter and sixmonths ended June 30, 2005, the principal effects of the application ofpurchase accounting, in comparison to reporting for historical periods, were todecrease the cost of coal sold due to lower expenses for postretirement healthcare and pensions, to decrease the cost of coal sold for net deferrals ofdeferred overburden costs, to decrease net amortization expense for coal supplyagreements which is now a credit because our contracts at acquisitionrepresented a net liability, and to increase the cost of depletion expense forowned 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 millionin pre-tax charges related to termination of hedge accounting for interest rateswaps since it became probable during the three month period that theunderlying variable rate bank debt would be repaid early rather than held tomaturity; and (b) $3.1 million in pre-tax mark-to-market losses for theone month portion of the three months that the interest swaps did not qualifyfor hedge accounting.

**Pro forma**—Tofacilitate second quarter to second quarter ans six months to six months comparisons throughout management’sdiscussion and analysis, we discuss “pro forma” results for the quarter and sixmonths ended June 30, 2004. The pro forma results present the secondquarter and first six months of 2004 as if Foundation Coal Corporation: (a) acquiredRAG American Coal Holding, Inc. on January 1, 2004; (b) completedthe Initial Public Offering on January 1, 2004; and transacted the sale ofthe 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 not recognized measures under GAAP and do notpurport to be alternatives to GAAP operating measures. Management believes thatthe discussion of pro forma operating results is important to the readers ofthe financial statements to understand key 

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operating trends incomparing the second quarter of 2005 to the second quarter of 2004 and the six monthsended June 30, 2005 to the six months ended June 30, 2004. In thefollowing sections tables present unaudited results of operations for theSuccessor for the quarter ended June 30, 2005, unaudited results ofoperations for the Predecessor on a pro forma basis as described above for thequarter ended June 30, 2004, unaudited results of operations for theSuccessor for the six months ended June 30, 2005, and unaudited results ofoperations for the Predecessor on a pro forma basis as described above for thesix months ended June 30, 2004

***Quarter ended June 30, 2005—Successor compared toquarter ended June 30, 2004—Predecessor***

As previously described there are significantdifferences in the basis of financial reporting between the Successor andPredecessor periods as a result of the purchase of RAG American Coal Holding, Inc.by Foundation Coal Corporation on July 30, 2004, and the resultantapplication of purchase accounting to the assets and liabilities acquired. TheSuccessor reported income from continuing operations of $20.2 million for thequarter ended June 30, 2005 whereas the Predecessor reported a loss fromcontinuing operations of $2.2 million for the quarter ended June 30, 2004.

During the prior year second quarter the Predecessorexperienced below normal coal production from our Northern Appalachia mineswhich was the primary reason for the loss from continuing operations. Theimpact of below normal production was partly offset by a mark-to-market gainfrom interest rate swaps of approximately $4.2 million after income tax.

During the second quarter of 2005, the Successorachieved stronger production and tons sold, enjoyed significantly higher perton sales realizations and received the benefit of a net credit fromamortization of coal supply agreements, reflecting amortization of a netliability established for below market contracts in purchase accounting.Year-to-year increases in cost of coal sales and depreciation, depletion andamortization were more than absorbed by higher coal sales revenues. Theoperating trends discussed in the following section, *Historicalquarter ended June 30, 2005 compared to pro forma quarter ended June 30,2004*, also apply to comparisons of the Successor and Predecessorperiods for the quarters ended June 30, 2005 and 2004, respectively.

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**Historical and Pro FormaConsolidated Condensed Statements of Operations(Dollars in millions)(Unaudited)**
| ** **                                                            | ** ** | **Successor**                               | ** ** | **Predecessor**                             | ** ** | ** **                      | ** ** | **Pro Forma**                          | ** ** |
|-----------------------------------------------------------------------|------------|---------------------------------------------|------------|---------------------------------------------|------------|---------------------------------|------------|---------------------------------------------|------------|
| ** **                                                            | ** ** | **Quarter  Ended  June 30, 2005** | ** ** | **Quarter  Ended  June 30, 2004** | ** ** | **Pro Forma  Adjustments** | ** ** | **Quarter  Ended  June 30, 2004** | ** ** |
| Revenues                                                              |       |                                        | $          | 329.5                                       |       |                            |       | $                                           | 252.1      |   |   |   | $ | (0.2 | )(a) |   |   | $ | 251.9 |   |   |
| Cost of coal  sales                                                   |       |                                        | 241.3      |                                        |       |                            | 216.3      |                                        |       |   | (13.9 | )(b) |   |   | 202.4 |   |   |
| Selling,  general & administrative expense                   |       |                                        | 9.0        |                                        |       |                            | 10.5       |                                        |       |   | (1.3 | )(c) |   |   | 9.2 |   |   |
| Accretion on asset  retirement obligations                            |       |                                        | 2.0        |                                        |       |                            | 1.7        |                                        |       |   | 0.4 | (d) |   |   | 2.1 |   |   |
| Depreciation,  depletion & amortization                      |       |                                        | 52.7       |                                        |       |                            | 27.4       |                                        |       |   | 24.9 | (e) |   |   | 52.3 |   |   |
| Amortization of  coal supply agreements                               |       |                                        | (23.1      | )                                           |       |                            | 3.8        |                                        |       |   | (45.4 | )(f) |   |   | (41.6 | ) |   |
| Income (loss)  from operations                                        |       |                                        | 47.6       |                                        |       |                            | (7.6       | )                                           |       |   | 35.1 |   |   |   | 27.5 |   |   |
| Interest expense                                                      |       |                                        | (14.4      | )                                           |       |                            | (6.3       | )                                           |       |   | (6.7 | )(g) |   |   | (13.0 | ) |   |
| Interest income                                                       |       |                                        | 0.2        |                                        |       |                            | 0.4        |                                        |       |   | — |   |   |   | 0.4 |   |   |
| Loss on  termination of hedge accounting for interest rate swaps |       |                                        | —     |                                        |       |                            | (0.1       | )                                           |       |   | 0.1 | (h) |   |   | — |   |   |
| Mark-to-market  gain on interest rate swaps                           |       |                                        | —     |                                        |       |                            | 9.0        |                                        |       |   | (9.0 | )(h) |   |   | — |   |   |
| Income (loss)  before income taxes                                    |       |                                        | 33.4       |                                        |       |                            | (4.6       | )                                           |       |   | 19.5 |   |   |   | 14.9 |   |   |
| Income tax  (expense) benefit                                         |       |                                        | (13.0      | )                                           |       |                            | 2.4        |                                        |       |   | (9.6 | )(i) |   |   | (7.2 | ) |   |
| Income (loss)  from continuing operations                             |       |                                        | 20.4       |                                        |       |                            | (2.2       | )                                           |       |   | 9.9 |   |   |   | 7.7 |   |   |
| Income from  discontinued operations, net of income tax expense  |       |                                        | —     |                                        |       |                            | 20.3       |                                        |       |   | (20.3 | )(h) |   |   | — |   |   |
| Net income (loss)                                                     |       |                                        | $          | 20.4                                        |       |                            |       | $                                           | 18.1       |   |   |   | $ | (10.4 | ) |   |   | $ | 7.7 |   |   |

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(a)           Reflects theelimination of royalty income as a result of purchase accounting

(b)          Reflects an adjustmentof $9.2 million of overburden removal costs reflected on depreciation,depletion and amortization as a result of purchase accounting, $4.7 million ofelimination of actuarial losses on pension and other postretirement benefits asa result of purchase accounting.

(c)           Reflects an adjustmentof $1.1 million for expense arising from a management incentive plan eliminatedwhen RAG American Coal holding, Inc. was acquired by Foundation CoalCorporation and $0.2 million of elimination of actuarial losses on pensions,other postretirement benefits and black lung benefits as a result of purchaseaccounting.

(d)          Reflects accretionexpense on the additional asset retirement obligation recognized in purchaseaccounting.

(e)           Reflects increaseddepreciation, depletion and amortization, primarily cost depletion on mineralrights, as a result of purchase accounting.

(f)             Reflects net creditto amortization of coal supply agreements as a result of purchase accounting.

(g)           Reflects adjustment tointerest expense based on capital structure put in place by the acquisition.

(h)          Reflects adjustments toeliminate debt extinguishment charges and income from discontinued operationsarising from sale of the Colorado Business Unit.

(i)             Representsthe tax effect of the pro forma adjustments computed such that the pro formaincome tax benefit is recognized at the effective income tax rate recorded inthe Successor period of 2004.

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***Historical quarter ended June 30, 2005 comparedto pro forma quarter ended June 30, 2004***

Coal sales realization perton sold represents the average revenue realized on each ton of coal sold. Itis calculated by dividing coal sales revenues by tons sold.

***Revenues***
| ** **                           | ** ** | **Successor**                                                                   | ** ** | **Pro Forma**          | ** ** | ** **                   | ** ** |
|--------------------------------------|------------|---------------------------------------------------------------------------------|------------|-----------------------------|------------|------------------------------|------------|
| ** **                           | ** ** | **Quarter**                                                                     | ** ** | **Quarter**                 | ** ** | ** **                   | ** ** |
| ** **                           | ** ** | **Ended**                                                                       | ** ** | **Ended**                   | ** ** | **Increase (Decrease)** | ** ** |
| ** **                           | ** ** | **June 30, 2005**                                                     | ** ** | **June 30, 2004** | ** ** | ** Amount **       | ** ** | **Percent** | ** ** |
| ** **                           | ** ** | **(Unaudited, in millions, except per ton data)** | ** ** |
| Coal sales                           |       |                                                                            | $          | 324.5                       |       |                         |       | $ | 252.1 |   |   |   | $ | 72.4 |   |   | 28.7 | % |
| Other revenue                        |       |                                                                            | 5.0        |                        |       |                         | (0.2       | ) |   |   | 5.2 |   |   | 260.0 | % |
| Total revenues                       |       |                                                                            | $          | 329.5                       |       |                         |       | $ | 251.9 |   |   |   | $ | 77.6 |   |   | 30.8 | % |
| Tons sold                            |       |                                                                            | 16.1       |                        |       |                         | 15.9       |   |   |   | 0.2 |   |   | 1.3 | % |
| Coal sales realization  per ton sold |       |                                                                            | $          | 20.10                       |       |                         |       | $ | 15.89 |   |   |   | $ | 4.21 |   |   | 26.5 | % |

 

Coal sales revenues for the quarter ended June 30,2005 increased by 28.7% compared to the pro forma coal sales revenues for thequarter ended June 30, 2004 as a result of a 1.3% increase in tons soldand a 26.5% increase in average coal sales realization per ton.

Coal sales volumes in Northern Appalachia increased by0.5 million tons (17%) primarily as a result of increased production from theCumberland Mine, partly offset by lower production from the Emerald Mine due toadverse mining conditions experienced while mining the last portion of the panelprior to the scheduled longwall move. Coal sale volumes in Northern Appalachiain the second quarter of 2004 were decreased by interruptions to operationscaused by the idling of the Cumberland Mine longwall for approximately thefirst five weeks of the quarter. From February 17 through May 7,2004, the longwall mining equipment at the Cumberland Mine was idled due toalleged violations resulting from a revised interpretation of regulationsissued by MSHA regarding the ventilation system at the Mine. In response, werevised the ventilation system to minimize any future business disruption andon May 7, 2004 we resumed longwall operations at the Cumberland Mine.There was no interruption of production due to ventilation issues during thesecond quarter of 2005. Coal sales volumes in Central Appalachia increased by0.3 million tons (15%) due to higher production at the Kingston, Pioneer/Paxand Rockspring mines plus increased sales of purchased coal partly offset bylower production from the Laurel Creek complex. Production capacity at Kingstonwas expanded in early 2005 by the addition of a continuous miner unit. The Paxsurface mine has been increasing its production as the mine becomes more fullydeveloped. The Pax mine, which replaces the Simmons Fork mine that depleted itsreserves in 2004, produced at an annualized rate of 0.5 million tons during thesecond quarter of 2005. When fully developed in 2006, it is expected to produceapproximately one million tons of coal per year. Coal sales volumes in thePowder River Basin decreased by 0.4 million tons (4%) primarily as a result ofworse than expected levels of rail service brought on by unusually inclementweather during May and resultant repairs to the rail lines, particularlythe UP/BNSF joint line south of Gillette. The repair program on the joint lineis expected to impact rail service through November 2005. Coal salesvolumes from the Illinois Basin increased by 0.1 million tons (13%) reflectingshipments made to fulfill new contract obligations. Purchased coal activitiesby our trading group decreased by approximately 0.3 million tons, compared tothe comparable quarter of the prior year due to the timing of purchased coaltransactions.

Coal sales realization per ton sold in Northern andCentral Appalachia increased by 31% and 39%, respectively in 2005 due tosubstitution of higher priced contracts which took effect in late 2004 andearly 2005 for lower priced contracts that expired.  An additional factor in Northern Appalachiawas higher coal quality premiums for sulfur content as a result of recordprices for sulfur dioxide allowances and lower sulfur content of shipped coal.In the Powder River Basin, coal sales realizations per ton declined by 2% 

30

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due to expiration at theend of 2004 of higher priced contracts signed during the 2001 market increase,partly offset by higher sulfur premiums. The weighted average coal salesrealization per ton sold of $20.10 for the second quarter of 2005 alsobenefited from a larger proportion of higher priced Northern Appalachia andCentral Appalachia tons sold relative to the lower priced tons from the PowderRiver Basin.

Other revenues for thequarter ended June 30, 2005 increased by $5.2 million compared to the proforma other revenues for the quarter ended June 30, 2004. The increase waspartly due to charges totaling $3.7 million during the 2004 period forsettlement of future coal sales commitments that did not recur in 2005 combinedwith higher revenues for synfuel fees and coal mine methane sales during the2005 quarter.

***Costs and Expenses***
| ** **                                                                                         | ** ** | **Successor**                          | ** ** | **Pro Forma**          | ** ** | ** **                   | ** ** | ** **  | ** ** |
|----------------------------------------------------------------------------------------------------|------------|----------------------------------------|------------|-----------------------------|------------|------------------------------|------------|-------------|------------|
| ** **                                                                                         | ** ** | **Quarter**                            | ** ** | **Quarter**                 | ** ** | ** **                   | ** ** | ** **  | ** ** |
| ** **                                                                                         | ** ** | **Ended**                              | ** ** | **Ended**                   | ** ** | **Increase (Decrease)** | ** ** |
| ** **                                                                                         | ** ** | **June 30, 2005**            | ** ** | **June 30, 2004** | ** ** | **Amount**                   | ** ** | **Percent** | ** ** |
| ** **                                                                                         | ** ** | **(Unaudited, in millions)** | ** ** |
| Cost of coal  sales (excludes depreciation, depletion and amortization)                       |       |                                   | $          | 241.3                       |       |                         |       | $           | 202.4      |   |   |   | $ | 38.9 |   |   |   | 19.2 | % |   |
| Selling, general  and administrative expenses (excludes depreciation, depletion and  amortization) |       |                                   | 9.0        |                        |       |                         | 9.2        |        |       |   | (0.2 | ) |   |   | (2.2 | )% |   |
| Accretion on  asset retirement obligations                                                         |       |                                   | 2.0        |                        |       |                         | 2.0        |        |       |   | — |   |   |   | — |   |   |
| Depreciation,  depletion and amortization                                                          |       |                                   | 52.7       |                        |       |                         | 52.3       |        |       |   | 0.4 |   |   |   | 0.8 | % |   |
| Amortization of  coal supply agreements                                                            |       |                                   | (23.1      | )                           |       |                         | (41.6      | )           |       |   | 18.5 |   |   |   | 44.5 | % |   |
| Total costs and expenses                                                                           |       |                                   | $          | 281.9                       |       |                         |       | $           | 224.3      |   |   |   | $ | 57.6 |   |   |   | 25.7 | % |   |

 

***Cost of coal sales.  ***Thecost of coal sales for the quarter ended June 30, 2005 increased from thepro forma cost of coal sales for the quarter ended June 30, 2004 due to: (a) increasesin labor costs as a result of both compensation increases and hiring of additionalpersonnel ($12.0 million); (b) increases in many categories of materialsand services as a result of significantly higher commodity prices particularlyfor steel products and diesel fuel ($18.5 million); (c) increases inroyalties and coal production taxes as a result of higher revenues ($2.0million); (d) increases in purchased coal costs mainly as a result ofhigher prices ($3.6 million), and (e) increased operating levelsparticularly at the Cumberland Mine. Cost of coal sales per ton were $14.94 forthe quarter ended June 30, 2005 compared to a pro forma figure of $12.68for the quarter ended June 30, 2004, an increase of 17.8%.

***Selling, general andadministrative expenses.  ***Selling, general andadministrative expenses for the quarter ended June 30, 2005 totaled $9.2million compared to pro forma expense of $9.2 million for the quarter ended June 30,2004. Increases in the current year quarter due to additional expenses incurredas a public company in the areas of directors and officers’ insurance premiums($0.5 million), audit fees ($0.8 million) and information technology costs($0.3 million) were offset by approximately $1.6 million in reduced medicalexpense.

***Accretion on assetretirement obligation.  ***Accretion on assetretirement obligation is a component of accounting for asset retirementobligations under SFAS No. 143. Accretion represents the increase in theasset retirement liability to reflect the change in the liability for thepassage of time. Accretion expense was comparable between the two periods.

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***Depreciation, depletion andamortization.  ***Depreciation, depletion andamortization includes depreciation of plant and equipment, cost depletion ofamounts assigned to coal lands and mining rights and amortization of minedevelopment costs and leasehold improvements. Expense increased slightly in thequarter ended June 30, 2005 compared to the pro forma expense for thequarter ended June 30, 2004 due to higher cost depletion resulting fromslightly increased production.

***Coal supply agreement amortization.  ***Applicationof purchase accounting resulted in recognition of a significant liability forbelow market priced coal supply agreements as well as a significant asset forabove market priced coal supply agreements, both in relation to market pricesat the acquisition date. Amortization of the liability for below market pricedcoal supply agreements during the quarter ended June 30, 2005 totals$28.6 million of credit to expense. Amortization of the asset for abovemarket priced coal supply agreements during the same period totals$5.5 million of charges to expense. The decrease in the net credit foramortization of coal supply agreements compared to the pro forma amount for thequarter ended June 30, 2004 is primarily due to reduced amortization ofbelow market priced coal supply agreements due to expiration of lower pricedcontracts in Northern and Central Appalachia.

**Segment Analysis**
| ** **                         | ** ** | **Successor**               | ** ** | **Pro Forma**          | ** ** | ** **                   | ** ** | ** **  | ** ** |
|------------------------------------|------------|-----------------------------|------------|-----------------------------|------------|------------------------------|------------|-------------|------------|
| ** **                         | ** ** | **Quarter ended**      | ** ** | **Quarter ended**      | ** ** | **Increase (Decrease)** | ** ** |
| ** **                         | ** ** | **June 30, 2005** | ** ** | **June 30, 2004** | ** ** | **Tons/$**                   | ** ** | **Percent** | ** ** |
| ** **                         | ** ** | **(in Millions)**      | ** ** |
| ***Powder  River Basin***          |       |                        |       |                        |       |                         |       |        |       |   |   |   |   |   |   |
| Tons sold                          |       |                        | 9.7        |                        |       |                         | 10.1       |        |       | (0.4 | ) |   | (4.0 | )% |   |
| Average sales  realization per ton |       |                        | $          | 7.35                        |       |                         |       | $           | 7.53       |   |   | $ | (0.18 | ) |   | (2.4 | )% |   |
| Revenues                           |       |                        | $          | 72.1                        |       |                         |       | $           | 76.1       |   |   | $ | (4.0 | ) |   | (5.3 | )% |   |
| Income (loss)  from operations     |       |                        | $          | (2.2                        | )          |                         |       | $           | 2.0        |   |   | $ | (4.2 | ) |   | (210.0 | )% |   |
| ***Northern Appalachia***          |       |                        |       |                        |       |                         |       |        |       |   |   |   |   |   |   |
| Tons sold                          |       |                        | 3.5        |                        |       |                         | 3.0        |        |       | 0.5 |   |   | 16.7 | % |   |
| Average sales  realization per ton |       |                        | $          | 35.45                       |       |                         |       | $           | 27.06      |   |   | $ | 8.39 |   |   | 31.0 | % |   |
| Revenues                           |       |                        | $          | 124.2                       |       |                         |       | $           | 82.1       |   |   | $ | 42.1 |   |   | 51.3 | % |   |
| Income from  operations            |       |                        | $          | 39.4                        |       |                         |       | $           | 29.0       |   |   | $ | 10.4 |   |   | 35.9 | % |   |
| ***Central Appalachia***           |       |                        |       |                        |       |                         |       |        |       |   |   |   |   |   |   |
| Tons sold                          |       |                        | 2.3        |                        |       |                         | 2.0        |        |       | 0.3 |   |   | 15.0 | % |   |
| Average sales  realization per ton |       |                        | $          | 47.24                       |       |                         |       | $           | 33.95      |   |   | $ | 13.29 |   |   | 39.1 | % |   |
| Revenues                           |       |                        | $          | 113.8                       |       |                         |       | $           | 73.1       |   |   | $ | 40.7 |   |   | 55.7 | % |   |
| Income from operations             |       |                        | $          | 30.3                        |       |                         |       | $           | 12.3       |   |   | $ | 18.0 |   |   | 146.3 | % |   |

 

***Powder River Basin***—Lossfrom operations for the quarter ended June 30, 2005 was $2.2 million. Thepro forma income from operations for the quarter ended June 30, 2004 was $2.0million. The decrease in operating income is due to lower tons sold of 0.4million, primarily as a result of the worse than expected level of rail servicediscussed previously and lower average per ton sales realizations partly offsetby reduced expense from amortization of coal sales agreements as a result ofthe expiration of several above market contracts at year-end 2004. Cost of coalsales per ton sold increased approximately 19% year over year as fixedoperating costs were spread over less tons shipped. During the second quarterof 2005, the company estimates that worse than expected rail service resultedin lower shipments of approximately 1.0 million tons and reduced incomefrom operations in the range of $0.8 million to $1.3 million.

***Northern Appalachia***—Incomefrom operations for the quarter ended June 30, 2005 was $39.4 millioncompared with pro forma income from operations of $29.0 million for the quarterended June 30, 2004. The significant improvement is primarily due toincreased revenues of $42.1 million resulting from a 17% 

32

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increase in tons sold anda 31% increase in average sales realization per ton. Higher production fromCumberland was partly offset by lower production from Emerald due to adversemining conditions experienced while mining the last portion of the panel priorto the scheduled longwall move in June. Emerald partly mitigated the revenueimpact of its reduced production by maintaining shipments from inventoriesduring the longwall move. During the second quarter of 2004, Cumberland’slongwall was idle for approximately five weeks for reasons previouslydescribed. Higher revenues were partly offset by increases in labor costs($3.7 million), active and retiree medical benefits ($2.0 million),materials and supplies ($4.9 million), coal production taxes($0.2 million) and a reduced credit for amortization of coal supplyagreements ($15.5 million). Cost of coal sales per ton increasedapproximately 10% year over year.

***Central Appalachia***—Income fromoperations for the quarter ended June 30, 2005 was $30.3 millioncompared with pro forma operating income of $12.3 million for the quarter endedJune 30, 2004. Revenues increased by $40.7 million primarily due to a 15%increase in tons sold and a 39% increase in average sales realizations per ton.Tons sold increased due to higher production from the Kingston, Rockspring andPax mines partly offset by lower production from the Pioneer and Laurel Creekmines. Higher revenues were partly offset by increased expenses for: (a) laborand fringe benefits ($3.2 million); (b) materials and supplies, led byincreases for roof control materials and diesel fuel ($7.8 million); (c) purchasedcoal ($5.5 million); (d) royalties and severance taxes driven by highersales revenues ($2.4 million); (e) cost depletion ($1.7 million); and (f) amortizationof coal supply agreements, representing a smaller net credit due to theexpiration of lower priced sales contracts valued in the purchase accounting ($9.7million). Cost of coal sales per ton increased approximately 16% year overyear.

***Interest Expense,Net***
| ** **                                                     | ** ** | **Successor**                          | ** ** | **Pro Forma**          | ** ** | ** **                   | ** ** | ** **  | ** ** |
|----------------------------------------------------------------|------------|----------------------------------------|------------|-----------------------------|------------|------------------------------|------------|-------------|------------|
| ** **                                                     | ** ** | **Quarter**                            | ** ** | **Quarter**                 | ** ** | ** **                   | ** ** | ** **  | ** ** |
| ** **                                                     | ** ** | **Ended**                              | ** ** | **Ended**                   | ** ** | **Increase (Decrease)** | ** ** |
| ** **                                                     | ** ** | **June 30, 2005**            | ** ** | **June 30, 2004** | ** ** | **Amount**                   | ** ** | **Percent** | ** ** |
| ** **                                                     | ** ** | **(Unaudited, in millions)** | ** ** |
| Interest  expense—debt related                            |       |                                   | $          | (11.2                       | )          |                         |       | $           | (9.5       | ) |   |   | $ | 1.7 |   |   |   | 17.9 | % |   |
| Interest  expense—amortization of deferred financing fees |       |                                   | (0.7       | )                           |       |                         | (0.9       | )           |       |   | (0.2 | ) |   |   | (22.2 | )% |   |
| Interest  expense—surety bond and letter of credit fees   |       |                                   | (2.5       | )                           |       |                         | (2.6       | )           |       |   | (0.1 | ) |   |   | (3.8 | )% |   |
| Interest income                                                |       |                                   | 0.2        |                        |       |                         | 0.4        |        |       |   | 0.2 |   |   |   | 50.0 | % |   |
| Interest expense, net                                          |       |                                   | $          | (14.2                       | )          |                         |       | $           | (12.6      | ) |   |   | $ | 1.6 |   |   |   | 12.7 | % |   |

 

Debt related interestexpense for the quarter ended June 30, 2005 was higher than the pro formadebt related interest expense for quarter ended June 30, 2004 due to: (a) anapproximate 100 basis point increase in the interest rate on variable ratedebt; (b) imputed interest charges that began in the second half of 2004and (c) greater utilization of the revolving credit agreement. Thesefactors were partly offset by the impact of repaying approximately $39 millionof variable rate debt from cash on hand at December 31, 2004. Theremaining portion of the $85 million prepayment made on December 31, 2004was funded by proceeds from the Initial Public Offering (“IPO”) and has beenconsidered in calculating the pro forma interest expense for the quarter ended June 30,2004. Amortization of deferred financing fees for the quarter ended June 30,2005 is slightly lower than the pro forma amortization of deferred financingfees for the corresponding prior year quarter due to the debt prepayment on December 31,2004. The decrease in surety bond and letter of credit fees in the secondquarter 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. The reduction in interest incomebetween quarters is primarily due to lower cash balances available forinvestment in the quarter ended June 30, 2005.

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***Income Tax Expense(Benefit)***
| ** **                    | ** ** | **Successor**                          | ** ** | **Pro Forma**          | ** ** | ** **                   | ** ** | ** **  | ** ** |
|-------------------------------|------------|----------------------------------------|------------|-----------------------------|------------|------------------------------|------------|-------------|------------|
| ** **                    | ** ** | **Quarter**                            | ** ** | **Quarter**                 | ** ** | ** **                   | ** ** | ** **  | ** ** |
| ** **                    | ** ** | **Ended**                              | ** ** | **Ended**                   | ** ** | **Increase (Decrease)** | ** ** |
| ** **                    | ** ** | **June 30, 2005**            | ** ** | **June 30, 2004** | ** ** | **Amount**                   | ** ** | **Percent** | ** ** |
| ** **                    | ** ** | **(Unaudited, in millions)** | ** ** |
| Income tax  (expense) benefit |       |                                   | $          | (13.0                       | )          |                         |       | $           | (7.2       | ) |   |   | $ | 5.8 |   |   |   | 80.6 | % |   |
|                               |            |                                        |            |                             |            |                              |            |             |            |  |  |  |  |  |  |  |  |  |  |  |

 

For the quarter ended June 30,2005, income taxes are provided at an effective rate of 39.2% based onprojected full year taxable income and projected full year temporarydifferences. Current tax expense, which represents taxes currently payable onoperations, was approximately 30.7% of pre-tax income. We are providing a fullvaluation allowance against deferred tax assets attributable to AMT taxcredits. For the quarter ended June 30, 2004, pro forma income tax expensewas recognized at an effective rate of 48.3%, the same effective rate used toprovide taxes on the Successor’s pre-tax income for the five months ended December 31,2004.

***Six months ended June 30, 2005—Successor comparedto six months ended June 30, 2004—Predecessor***

As previously described there are significantdifferences in the basis of financial reporting between the Successor andPredecessor periods as a result of the purchase of RAG American Coal Holding, Inc.by Foundation Coal Corporation on July 30, 2004, and the resultantapplication of purchase accounting to the assets and liabilities acquired. TheSuccessor reported income from continuing operations of $39.1 million for thesix months ended June 30, 2005 whereas the Predecessor reported a lossfrom continuing operations of $48.3 million for the six months ended June 30,2004.

During the prior year six months the Predecessorincurred approximately $26.7, net of income taxes, of non-cash charges relatedto termination of hedge accounting for interest rate swaps, partly offset by anet mark-to-market gain on the interest rate swaps These charges in combinationwith below normal coal production from our Northern Appalachia mines which wasthe primary reason for the loss from continuing operations.

During the six monthsended June 30, 2005, the Successor achieved stronger production and tonssold, enjoyed significantly higher per ton sales realizations and received thebenefit of a net credit from amortization of coal supply agreements, reflectingamortization of a liability established for below market contracts in purchaseaccounting. Year-to-year increases in cost of coal sales and depreciation,depletion and amortization were more than absorbed by higher coal salesrevenues. The operating trends discussed in the following section, *Historical six months ended June 30, 2005 compared to pro formasix months ended June 30, 2004*, also apply to comparisons ofthe Successor and Predecessor periods for the six months ended June 30,2005 and 2004, respectively.

34

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**Historicaland Pro FormaConsolidated Condensed Statements of Operations(Dollars in millions)(Unaudited)**
| ** **                                                            | ** ** | **Successor**                                       | ** ** | **Predecessor**                                     | ** ** | ** **                      | ** ** | **Pro Forma**                                  | ** ** |
|-----------------------------------------------------------------------|------------|-----------------------------------------------------|------------|-----------------------------------------------------|------------|---------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                            | ** ** | **Six Months  Ended  June 30, 2005** | ** ** | **Six Months  Ended  June 30, 2004** | ** ** | **Pro Forma  Adjustments** | ** ** | **Six Months  Ended  June 30, 2004** | ** ** |
| Revenues                                                              |       |                                                | $          | 635.0                                               |       |                            |       | $                                                   | 478.5      |   |   |   | $ | (0.8 | )(a) |   |   | $ | 477.7 |   |   |
| Cost of coal  sales                                                   |       |                                                | 456.5      |                                                |       |                            | 413.5      |                                                |       |   | (23.1 | )(b) |   |   | 390.4 |   |   |
| Selling,  general & administrative expense                   |       |                                                | 20.4       |                                                |       |                            | 20.9       |                                                |       |   | (2.6 | )(c) |   |   | 18.3 |   |   |
| Accretion on asset  retirement obligations                            |       |                                                | 4.1        |                                                |       |                            | 3.4        |                                                |       |   | 0.6 | (d) |   |   | 4.0 |   |   |
| Depreciation,  depletion & amortization                      |       |                                                | 107.5      |                                                |       |                            | 52.5       |                                                |       |   | 51.0 | (e) |   |   | 103.5 |   |   |
| Amortization of  coal supply agreements                               |       |                                                | (46.5      | )                                                   |       |                            | 7.8        |                                                |       |   | (80.9 | )(f) |   |   | (73.1 | ) |   |
| Income (loss)  from operations                                        |       |                                                | 93.0       |                                                |       |                            | (19.6      | )                                                   |       |   | 54.2 |   |   |   | 34.6 |   |   |
| Interest expense                                                      |       |                                                | (28.7      | )                                                   |       |                            | (16.3      | )                                                   |       |   | (12.2 | )(g) |   |   | (28.5 | ) |   |
| Interest income                                                       |       |                                                | 0.3        |                                                |       |                            | 1.2        |                                                |       |   | — |   |   |   | 1.2 |   |   |
| Loss on  termination of hedge accounting for interest rate swaps |       |                                                | —     |                                                |       |                            | (48.8      | )                                                   |       |   | 48.8 | (h) |   |   | — |   |   |
| Mark-to-market  gain on interest rate swaps                           |       |                                                | —     |                                                |       |                            | 5.8        |                                                |       |   | (5.8 | )(h) |   |   | — |   |   |
| Income (loss)  before income taxes                                    |       |                                                | 64.6       |                                                |       |                            | (77.7      | )                                                   |       |   | 85.0 |   |   |   | 7.3 |   |   |
| Income tax  (expense) benefit                                         |       |                                                | (25.2      | )                                                   |       |                            | 29.4       |                                                |       |   | (32.9 | )(i) |   |   | (3.5 | ) |   |
| Income (loss)  from continuing operations                             |       |                                                | 39.4       |                                                |       |                            | (48.3      | )                                                   |       |   | 52.1 |   |   |   | 3.8 |   |   |
| Income from  discontinued operations, net of income tax expense  |       |                                                | —     |                                                |       |                            | 23.1       |                                                |       |   | (23.1 | )(h) |   |   | — |   |   |
| Net income (loss)                                                     |       |                                                | $          | 39.4                                                |       |                            |       | $                                                   | (25.2      | ) |   |   | $ | 29.0 |   |   |   | $ | 3.8 |   |   |

----

(a)           Reflects theelimination of royalty income as a result of purchase accounting.

(b)          Reflects an adjustmentof $18.4 million of overburden removal costs reflected on depreciation,depletion and amortization as a result of purchase accounting, $8.5 million ofelimination of actuarial losses on pension and other postretirement benefits asa result of purchase accounting and $3.8 million of additional costs due tocoal inventories written up to fair value in purchase accounting.

(c)           Reflects an adjustmentof $2.2 million for expense arising from a management incentive plan eliminatedwhen RAG American Coal holding, Inc. was acquired by Foundation CoalCorporation and $0.4 million of elimination of actuarial losses on pensions,other postretirement benefits and black lung benefits as a result of purchase accounting.

(d)          Reflects accretionexpense on the additional asset retirement obligation recognized in purchaseaccounting.

(e)           Reflects increaseddepreciation, depletion and amortization, primarily cost depletion on mineralrights, as a result of purchase accounting.

(f)             Reflects net creditto amortization of coal supply agreements as a result of purchase accounting.

(g)           Reflects adjustment tointerest expense based on capital structure put in place by the acquisition.

(h)          Reflects adjustments toeliminate debt extinguishment charges and income from discontinued operationsarising from sale of the Colorado Business Unit.

(i)             Representsthe tax effect of the pro forma adjustments computed such that the pro formaincome tax benefit is recognized at the effective income tax rate recorded inthe Successor period of 2004.

35

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***Historical six months ended June 30, 2005compared to pro forma six months ended June 30, 2004***

Coal sales realization perton sold represents the average revenue realized on each ton of coal sold. Itis calculated by dividing coal sales revenues by tons sold.

***Revenues***
| ** **                           | ** ** | **Successor**                                                                   | ** ** | **Pro Forma**          | ** ** | ** **                   | ** ** | ** **              | ** ** |
|--------------------------------------|------------|---------------------------------------------------------------------------------|------------|-----------------------------|------------|------------------------------|------------|-------------------------|------------|
| ** **                           | ** ** | **Six Months**                                                             | ** ** | **Six Months**         | ** ** | ** **                   | ** ** | ** **              | ** ** |
| ** **                           | ** ** | **Ended**                                                                       | ** ** | **Ended**                   | ** ** | **Increase (Decrease)** | ** ** |
| ** **                           | ** ** | **June 30, 2005**                                                     | ** ** | **June 30, 2004** | ** ** | **Amount**                   | ** ** | ** Percent ** | ** ** |
| ** **                           | ** ** | **(Unaudited, in millions, except per ton data)** | ** ** |
| Coal sales                           |       |                                                                            | $          | 624.5                       |       |                         |       | $                       | 474.1      |   |   | $ | 150.4 |   |   | 31.7 | % |   |
| Other revenue                        |       |                                                                            | 10.5       |                        |       |                         | 3.6        |                    |       | 6.9 |   |   | 191.7 | % |   |
| Total revenues                       |       |                                                                            | $          | 635.0                       |       |                         |       | $                       | 477.7      |   |   | $ | 157.3 |   |   | 32.9 | % |   |
| Tons sold                            |       |                                                                            | 33.4       |                        |       |                         | 31.3       |                    |       | 2.1 |   |   | 6.7 | % |   |
| Coal sales realization  per ton sold |       |                                                                            | $          | 18.70                       |       |                         |       | $                       | 15.18      |   |   | $ | 3.52 |   |   | 23.2 | % |   |

 

Coal sales revenues for the six months ended June 30,2005 increased by 31.7% compared to the pro forma coal sales revenues for thesix months ended June 30, 2004 as a result of a 6.7% increase in tons soldand a 23.2% increase in average coal sales realization per ton.

Coal sales volumes in Northern Appalachia increased by1.8 million tons (36%) primarily as a result of increased production from theCumberland Mine. Coal sales volumes in Northern Appalachia in the six months of2004 were decreased by interruptions to operations caused by the idling of theCumberland Mine longwall for approximately eleven weeks during the prior yearperiod and an extended duration longwall move at the Emerald mine during thefirst quarter of 2004. The scheduled longwall move at Emerald during the secondquarter of 2005 was of shorter duration. From February 17 through May 7,2004, the longwall mining equipment at the Cumberland Mine was idled due toalleged violations resulting from a revised interpretation of regulationsissued by MSHA regarding the ventilation system at the Mine. In response, werevised the ventilation system to minimize any future business disruption andon May 7, 2004 we resumed longwall operations at the Cumberland Mine.There was no interruption of production due to ventilation issues during thesecond quarter of 2005.

Coal sales volumes in Central Appalachia increased by0.4 million tons (10%) due to higher production at the Kingston and Rockspringmines plus increased sales of purchased coal partly offset by lower productionfrom the Laurel Creek complex. Production capacity at Kingston was expanded inearly 2005 by the addition of a continuous miner unit. Production from thePioneer/Pax surface mine complex was similar to the prior year as the closureof the Simmons Fork mine was offset by production from the developing Pax mine.The Pax Mine produced at an annualized rate of 0.5 million tons during thesecond quarter of 2005. When fully developed in 2006, it is expected to produceapproximately one million tons of coal per year. Coal sales volumes in thePowder River Basin increased by 0.2 million tons (1%) as a higher level ofcommitted sales was mostly offset by worse than expected levels of rail servicebrought on by unusually inclement weather during May and resultant repairsto the rail lines, particularly the UP/BNSF joint line south of Gillette. Therepair program on the joint line is expected to impact rail service through November 2005.Coal sales volumes from the Illinois Basin increased by 0.1 million tons (13%)reflecting shipments made to fulfill new contract obligations. Purchased coalactivities by our trading group decreased by approximately 0.4 million tons,compared to the comparable six months of the prior year due to the timing ofpurchased coal transactions.

Coal sales realization per ton sold in Northern andCentral Appalachia increased by 28% and 33%, respectively in 2005 due tosubstitution of higher priced contracts which took effect in late 2004 andearly 2005 for lower priced contracts that rolled off. An additional factor inNorthern Appalachia was higher 

36

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coal quality premiums forsulfur content as a result of record prices for sulfur dioxide allowances andlower sulfur content of shipped coal. In the Powder River Basin, coal salesrealizations per ton declined by 2% due to expiration at the end of 2004 ofhigher priced contracts signed during the 2001 market increase, partly offsetby higher sulfur premiums. The weighted average coal sales realization per tonsold of $18.70 for the six months of 2005 also benefited from a largerproportion of higher priced Northern Appalachia and Central Appalachia tonssold relative to the lower priced tons from the Powder River Basin.

Approximately 99% of our 2005 projected production iscommitted and priced. As of July 19, 2005, uncommitted and unpricedtonnage was 10% , 27% and 49% of planned production in 2006, 2007 and 2008,respectively. Higher value eastern coals account for the majority ofuncommitted tonnage as 20% , 35% and 68% of the Company’s planned easternproduction remains uncommitted and unpriced in 2006, 2007 and 2008,respectively, including 44% , 61% and 60%, respectively, of the Company’splanned metallurgical coal production in those years.

Other revenues for the sixmonths ended June 30, 2005 increased by $6.9 million compared to the proforma other revenues for the six months ended June 30, 2004. The increasewas partly due to charges totaling $4.6 million during the 2004 period forsettlement of future coal sales commitments that did not recur in 2005,combined with higher revenues for synfuel fees and coal mine methane salesduring the 2005 period.

***Costs and Expenses***
| ** **                                                                                         | ** ** | **Successor**                          | ** ** | **Pro Forma**          | ** ** | ** **                   | ** ** |
|----------------------------------------------------------------------------------------------------|------------|----------------------------------------|------------|-----------------------------|------------|------------------------------|------------|
| ** **                                                                                         | ** ** | **Six Months  Ended**             | ** ** | **Six Months  Ended**  | ** ** | **Increase (Decrease)** | ** ** |
| ** **                                                                                         | ** ** | **June 30, 2005**            | ** ** | **June 30, 2004** | ** ** | **Amount**                   | ** ** | **Percent** | ** ** |
| ** **                                                                                         | ** ** | **(Unaudited, in millions)** | ** ** |
| Cost of coal  sales (excludes depreciation, depletion and amortization)                            |       |                                   | $          | 456.5                       |       |                         |       | $ | 390.4 |   |   |   | $ | 66.1 |   |   |   | 16.9 | % |   |
| Selling, general  and administrative expenses (excludes depreciation, depletion and  amortization) |       |                                   | 20.4       |                        |       |                         | 18.3       |   |   |   | 2.1 |   |   |   | 11.5 | % |   |
| Accretion on  asset retirement obligations                                                         |       |                                   | 4.1        |                        |       |                         | 4.0        |   |   |   | 0.1 |   |   |   | 2.5 | % |   |
| Depreciation,  depletion and amortization                                                          |       |                                   | 107.5      |                        |       |                         | 103.5      |   |   |   | 4.0 |   |   |   | 3.9 | % |   |
| Amortization of  coal supply agreements                                                            |       |                                   | (46.5      | )                           |       |                         | (73.1      | ) |   |   | 26.6 |   |   |   | 36.3 | % |   |
| Total costs and expenses                                                                           |       |                                   | $          | 542.0                       |       |                         |       | $ | 443.1 |   |   |   | $ | 98.9 |   |   |   | 22.3 | % |   |

 

***Cost of coal sales.  ***Thecost of coal sales for the six months ended June 30, 2005 increased fromthe pro forma cost of coal sales for the six months ended June 30, 2004due to: (a) increases in labor costs as a result of both compensationincreases and hiring of additional personnel ($24.6 million); (b) increasesin many categories of materials and services as a result of significantlyhigher commodity prices particularly for steel products and diesel fuel ($36.9million); (c) increases in royalties and coal production taxes as a resultof higher revenues ($5.0 million); (d) increases in purchased coal costsmainly as a result of higher prices ($5.8 million), and (e) increasedoperating levels particularly at the Cumberland Mine. Cost of coal sales perton were $13.66 for the six months ended June 30, 2005 compared to a proforma figure of $12.47 for the six months ended June 30, 2004, an increaseof 9.5%.

***Selling, generaland administrative expenses.  ***Selling, general andadministrative expenses for the six months ended June 30, 2005 totaled$20.4 million compared to pro forma expense of $18.3 million for the six monthsended June 30, 2004. Increases in the current year period due toadditional expenses incurred as a public company in the areas of directors andofficers’ insurance premiums ($1.0 million), audit fees ($1.0 million) andcompensation expenses ($2.1 million), including bonus accruals, were partlyoffset by reduced medical expenses ($1.6 million).

37

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***Accretion on assetretirement obligation.  ***Accretion on assetretirement obligation is a component of accounting for asset retirementobligations under SFAS No. 143. Accretion represents the increase in theasset retirement liability to reflect the change in the liability for thepassage of time. Accretion expense was comparable between the two periods.

***Depreciation, depletion andamortization.  ***Depreciation, depletion andamortization includes depreciation of plant and equipment, cost depletion ofamounts assigned to coal lands and mining rights and amortization of minedevelopment costs and leasehold improvements. Expense increased slightly in thesix months ended June 30, 2005 compared to the pro forma expense for thesix months ended June 30, 2004 due to higher cost depletion resulting fromincreased volumes of coal mined as well as higher depreciation from equipmentadditions during the past year.

***Coal supply agreement amortization.  ***Applicationof purchase accounting resulted in recognition of a significant liability forbelow market priced coal supply agreements as well as a significant asset forabove market priced coal supply agreements, both in relation to market pricesat the acquisition date. Amortization of the liability for below market pricedcoal supply agreements during the six months ended June 30, 2005 totals$59.6 million of credit to expense. Amortization of the asset for abovemarket priced coal supply agreements during the same period totals$13.1 million of charges to expense. The decrease in the net credit foramortization of coal supply agreements compared to the pro forma amount for thesix months ended June 30, 2004 is primarily due to reduced amortization ofbelow market priced coal supply agreements due to expiration of lower pricedcontracts in Northern and Central Appalachia.

**Segment Analysis**
| ** **                         | ** ** | **Successor**                  | ** ** | **Pro Forma**             | ** ** | ** **                   | ** ** |
|------------------------------------|------------|--------------------------------|------------|--------------------------------|------------|------------------------------|------------|
| ** **                         | ** ** | **Six months ended** | ** ** | **Six months ended** | ** ** | **Increase (Decrease)** | ** ** |
| ** **                         | ** ** | **June 30, 2005**    | ** ** | **June 30, 2004**    | ** ** | **Tons/$**                   | ** ** | **Percent** | ** ** |
| ** **                         | ** ** | **(in Millions)**         | ** ** |
| ***Powder  River Basin***          |       |                           |       |                           |       |                         |       |   |   |   |   |   |   |   |   |   |   |
| Tons sold                          |       |                           | 20.9       |                           |       |                         | 20.7       |   |   |   | 0.2 |   |   |   | 1.0 | % |   |
| Average sales  realization per ton |       |                           | $          | 7.33                           |       |                         |       | $ | 7.49 |   |   |   | $ | (0.16 | ) |   |   | (2.1 | )% |   |
| Revenues                           |       |                           | $          | 154.7                          |       |                         |       | $ | 155.9 |   |   |   | $ | (1.2 | ) |   |   | (0.8 | )% |   |
| Income from  operations            |       |                           | $          | 3.3                            |       |                         |       | $ | 1.2 |   |   |   | $ | 2.1 |   |   |   | 175.0 | % |   |
| ***Northern  Appalachia***         |       |                           |       |                           |       |                         |       |   |   |   |   |   |   |   |   |   |   |
| Tons sold                          |       |                           | 6.8        |                           |       |                         | 5.0        |   |   |   | 1.8 |   |   |   | 36.0 | % |   |
| Average sales  realization per ton |       |                           | $          | 34.48                          |       |                         |       | $ | 26.96 |   |   |   | $ | 7.52 |   |   |   | 27.9 | % |   |
| Revenues                           |       |                           | $          | 238.2                          |       |                         |       | $ | 136.6 |   |   |   | $ | 101.6 |   |   |   | 74.4 | % |   |
| Income from  operations            |       |                           | $          | 81.8                           |       |                         |       | $ | 33.8 |   |   |   | $ | 48.0 |   |   |   | 142.0 | % |   |
| ***Central  Appalachia***          |       |                           |       |                           |       |                         |       |   |   |   |   |   |   |   |   |   |   |
| Tons sold                          |       |                           | 4.4        |                           |       |                         | 4.0        |   |   |   | 0.4 |   |   |   | 10.0 | % |   |
| Average sales  realization per ton |       |                           | $          | 44.66                          |       |                         |       | $ | 33.54 |   |   |   | $ | 11.12 |   |   |   | 33.2 | % |   |
| Revenues                           |       |                           | $          | 199.4                          |       |                         |       | $ | 140.1 |   |   |   | $ | 59.3 |   |   |   | 42.3 | % |   |
| Income from operations             |       |                           | $          | 43.2                           |       |                         |       | $ | 23.9 |   |   |   | $ | 19.3 |   |   |   | 80.8 | % |   |

 

***Powder River Basin***—Incomefrom operations for the six months ended June 30, 2005 was $3.3 millioncompared to pro forma income from operations of $1.2 million for the six monthsended June 30, 2004. The increase in operating income is due to highertons sold of 0.2 million, lower net expense for amortization of coal supply agreementsas a result of the expiration of several above market contracts at year end2004, and higher coal quality premiums, partly offset by lower salesrealizations per ton also reflecting the expiration of above market contracts.Cost of coal sales per ton sold increased approximately 9% year over year. Duringthe six months ended June 30, 2005, the Company estimates that worse than 

38

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expected levels of railservice resulted in reduced shipments of approximately 1.0 million tons andreduced income from operations in the range of $0.8 million to$1.3 million.

***Northern Appalachia***—Incomefrom operations for the six months ended June 30, 2005 was $81.8 millioncompared to pro forma income from operations of $33.8 million for the sixmonths ended June 30, 2004. The significant improvement is primarily dueto increased revenues of $101.6 million resulting from a 36% increase in tonssold and a 28% increase in average sales realization per ton. Production fromthe Cumberland Mine increased substantially during the first six months of 2005.During the first half of 2004, Cumberland’s longwall was idle from February 17to May 7 for reasons previously described. Emerald had longwall moves inboth six month periods, but the 2005 longwall move was of shorter duration andits impact on revenues was mitigated by shipments from inventories. Higherrevenues were partly offset by increases in labor costs ($6.9 million),active and retiree medical benefits ($4.8 million), materials and supplies($13.5 million), coal production taxes ($1.6 million), cost depletion($2.4 million), depreciation ($0.5 million) and a reduced credit foramortization of coal supply agreements ($19.3 million). Cost of coal salesper ton decreased approximately 7% year over year.

***Central Appalachia***—Income fromoperations for the six months ended June 30, 2005 was $43.2 millioncompared with pro forma operating income of $23.9 million for the six monthsended June 30, 2004. Revenues increased by $59.3 million primarily due toa 10% increase in tons sold, driven by higher production at the Kingston,Rockspring and Pax mines, and a 33% increase in average sales realizations perton. Higher revenues were partly offset by increased expenses for: (a) laborand fringe benefits ($7.8 million); (b) materials and supplies, led byincreases for roof control materials and diesel fuel ($13.5 million); (c) purchasedcoal ($8.1 million); (d) royalties and severance taxes driven by highersales revenues ($3.5 million); (e) cost depletion ($2.4 million); and (f) amortizationof coal supply agreements, representing a smaller net credit due to theexpiration of lower priced sales contracts valued in the purchase accounting($18.3 million). Also, the pro forma operating income for the six months ended June 30,2004 included a $1.5 million charge for settlement of litigation. Cost of coalsales per ton increased approximately 19% year over year.

***Interest Expense,Net***
| ** **                                                     | ** ** | **Successor**                          | ** ** | **Pro Forma**          | ** ** | ** **                                     | ** ** |
|----------------------------------------------------------------|------------|----------------------------------------|------------|-----------------------------|------------|------------------------------------------------|------------|
| ** **                                                     | ** ** | **Six Months **              | ** ** | **Six Months **   | ** ** | ** **                                     | ** ** |
| ** **                                                     | ** ** | **Ended**                              | ** ** | **Ended**                   | ** ** | **Increase (Decrease)**                   | ** ** |
| ** **                                                     | ** ** | **June 30, 2005**            | ** ** | **June 30, 2004** | ** ** | **   Amount   ** | ** ** | **   Percent   ** | ** ** |
| ** **                                                     | ** ** | **(Unaudited, in millions)** | ** ** |
| Interest  expense—debt related                            |       |                                   | $          | (22.2                       | )          |                                           |       | $ | (19.8 | ) |   |   | $ | 2.4 |   |   |   | 12.1 | % |   |
| Interest  expense—amortization of deferred financing fees |       |                                   | (1.5       | )                           |       |                                           | (3.5       | ) |   |   | (2.0 | ) |   |   | (57.1 | )% |   |
| Interest  expense—surety bond and letter of credit fees   |       |                                   | (5.0       | )                           |       |                                           | (5.2       | ) |   |   | (0.2 | ) |   |   | (3.8 | )% |   |
| Interest income                                                |       |                                   | 0.3        |                        |       |                                           | 1.2        |   |   |   | 0.9 |   |   |   | 75.0 | % |   |
| Interest expense, net                                          |       |                                   | $          | (28.4                       | )          |                                           |       | $ | (27.3 | ) |   |   | $ | 1.1 |   |   |   | 4.0 | % |   |

 

Debt related interestexpense for the six months ended June 30, 2005 was higher than the proforma debt related interest expense for six months ended June 30, 2004 dueto: (a) about a 100 basis point increase in the interest rate on variablerate debt; (b) imputed interest charges that began in the second half of2004 and (c) greater utilization of the revolving credit agreement. Thesefactors were partly offset by the impact of repaying approximately $39 millionof variable rate debt from cash on hand at December 31, 2004. Theremaining portion of the $85 million prepayment made on December 31, 2004was funded by proceeds from the Initial Public Offering (“IPO”) and has beenconsidered in calculating the pro forma interest expense for the six monthsended June 30, 2004. Pro forma amortization of deferred 

39

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financingfees for the six months ended June 30, 2004 includes $1.7 million ofaccelerated amortization from the repayment of variable rate debt with IPOproceeds; there is no accelerated amortization in the six months ended June 30,2005 . The decrease in surety bond and letter of credit fees in the six monthperiod of 2005 is due to reductions in the amounts of these financial assuranceinstruments compared to the period immediately following the purchase of RAGAmerican Coal Holding, Inc. The reduction in interest income between sixmonth periods is primarily due to lower cash balances available for investmentin the six months ended June 30, 2005.

***Income Tax Expense(Benefit)***
| ** **                    | ** ** | **Successor**                          | ** ** | **Pro Forma**          | ** ** | ** **                   | ** ** |
|-------------------------------|------------|----------------------------------------|------------|-----------------------------|------------|------------------------------|------------|
| ** **                    | ** ** | **Six Months**                    | ** ** | **Six Months**         | ** ** | ** **                   | ** ** |
| ** **                    | ** ** | **Ended**                              | ** ** | **Ended**                   | ** ** | **Increase (Decrease)** | ** ** |
| ** **                    | ** ** | **June 30, 2005**            | ** ** | **June 30, 2004** | ** ** | ** Amount **       | ** ** | ** Percent ** | ** ** |
| ** **                    | ** ** | **(Unaudited, in millions)** | ** ** |
| Income tax  (expense) benefit |       |                                   | $          | (25.2                       | )          |                         |       | $ | (3.5 | ) |   |   | $ | 21.7 |   |   |   | 620.0 | % |   |
|                               |            |                                        |            |                             |            |                              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

For the six months ended June 30,2005, income taxes are provided at an effective rate of 39.2% based onprojected full year taxable income and projected full year temporarydifferences. Current tax expense, which represents taxes currently payable onoperations, was approximately 29% of pre-tax income. We are providing a fullvaluation allowance against deferred tax assets attributable to AMT taxcredits. For the six months ended June 30, 2004, pro forma income taxexpense was recognized at an effective rate of 48.3%, the same effective rateused to provide taxes on the Successor’s pre-tax income for the five monthsended December 31, 2004.

**Liquidity and Capital Resources**

Our primary sources of cash have been sales of ourcoal production and purchased coal to customers, plus cash from sales ofnon-core assets and miscellaneous revenues.

Our primary uses of cash have been our cash costs ofcoal production, the cash cost of purchased coal, capital expenditures,interest costs, cash payments for employee benefit obligations such as definedbenefit pensions and retiree health care benefits, cash outlays related to postmining asset retirement obligations and support of working capital requirementssuch as coal inventories and trade accounts receivable. Our ability to serviceour debt (principal and interest) and acquire new productive assets for use inour operations 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 ofour day-to-day operating requirements were placed on deposit with RAG wherecash balances could be aggregated to earn better investment returns. This cashon deposit was available to us on a one day turn-around. Increases in the cashon deposit with RAG have been classified under financing activities as uses ofcash in the consolidated cash flow statements. Decreases in cash on depositwith RAG have been classified under financing activities as cash provided.

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Thefollowing is a summary of cash provided by or used in each of the indicatedcategories of activities during six months ended June 30, 2005 and 2004,respectively.
| ** **                                         | ** ** | **Successor**                          | ** ** | **Predecessor**                | ** ** | ** **     | ** ** |
|----------------------------------------------------|------------|----------------------------------------|------------|--------------------------------|------------|----------------|------------|
| ** **                                         | ** ** | **Six Months Ended**         | ** ** | **Six Months Ended** | ** ** | **Increase**   | ** ** |
| ** **                                         | ** ** | **June 30, 2005**            | ** ** | **June 30, 2004**    | ** ** | **(Decrease)** | ** ** |
| ** **                                         | ** ** | **(Unaudited, in millions)** | ** ** |
| Cash provided by (used  in):                       |       |                                   |       |                           |       |           |       |   |   |   |   |   |   |
| Operating  activities—continuing operations   |       |                                   | $          | 62.5                           |       |           |       | $ | 25.1 |   |   |   | $ | 37.4 |   |   |
| Operating  activities—discontinued operations |       |                                   | —     |                           |       |           | 7.0        |   |   |   | (7.0 | ) |   |
| Investing  activities—continuing operations   |       |                                   | (60.3      | )                              |       |           | (48.4      | ) |   |   | (11.9 | ) |   |
| Investing  activities—discontinued operations |       |                                   | —     |                           |       |           | 185.0      |   |   |   | (185.0 | ) |   |
| Financing  activities—borrowings(2)           |       |                                   | 60.0       |                           |       |           | —     |   |   |   | 60.0 |   |   |
| Financing  activities—repayments(2)           |       |                                   | (60.0      | )                              |       |           | (358.9     | ) |   |   | 298.9 |   |   |
| Financing  activities—other                   |       |                                   | —     |                           |       |           | (48.9      | ) |   |   | 48.9 |   |   |
| Financing  activities—pledged cash            |       |                                   | —     |                           |       |           | 20.0       |   |   |   | (20.0 | ) |   |
| Financing  activities—on deposit with RAG(1)  |       |                                   | —     |                           |       |           | 233.0      |   |   |   | (233.0 | ) |   |
| Change in cash  and cash equivalents               |       |                                   | $          | 2.2                            |       |           |       | $ | 13.9 |   |   |   | $ | (11.7 | ) |   |

----

(1)          Represents the decreasein the balance of cash on deposit with RAG.

(2)          The borrowings andrepayments during the six months ended June 30, 2005 represent use of theRevolving Credit facility to maintain day-to-day liquidity.

Cash provided by operating activities from continuingoperations increased in the six months ended June 30, 2005 as compared tothe Predecessor results for the six months ended June 30, 2004 primarilydue to higher net income from continuing operations partly offset by increasesin working capital, mainly trade accounts receivable and inventories.

Cash used in investing activities for continuingoperations increased in the six months ended June 30, 2005 as compared tothe Predecessor results for the six months ended June 30, 2004 mainly dueto higher capital expenditures. Capital expenditures for the six months ended June 30,2005 totaled $65.1 million, including $27.6 million of expenditures related tothe expansion of the Belle Ayr mine in the Powder River Basin, development ofthe Pax surface mine in Central Appalachia, addition of a continuous miningunit to the Kingston mine in Central Appalachia, the widening of the Emeraldmine longwall face to 1,450 feet from 1,250 feet and upgrades to the railloading facility at Emerald. Capital expenditures for the six months ended June 30,2004 of $50.5 million were mainly for replacement of equipment and otherexpenditures necessary to sustain mine operations.

Our primary source of liquidity will continue to becash from sales of our coal production and purchased coal to customers. We haveavailability under our revolving credit facility, subject to certainconditions.

As of June 30, 2005, we have outstanding$685.0 million in aggregate indebtedness, with an additional$156.5 million of available borrowings under our revolving credit facility(after giving effect to $193.5 million of letters of credit outstanding asof June 30, 2005). On August 4, 2005, we prepaid, withoutpenalty,  $20 million of bank term debtfrom cash on hand. This prepayment will result in the write-off ofapproximately $0.7 million of deferred debt issuance costs in the thirdquarter. Our liquidity requirements will be significant, primarily due to debtservice requirements. Of the $28.7 million of interest expense for the sixmonths ended June 30, 2005, approximately $26.4 million has or willbe paid in cash.

Based on our current levels of operations, we believethat remaining cash on hand, cash flow from operations and available borrowingsunder the revolving credit portion of our Senior Credit Facilities will 

41

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enable us to meet ourworking capital, capital expenditure, debt service and other fundingrequirements for at least the next twelve months.

As a regular part of ourbusiness, we review opportunities for, and engage in discussions andnegotiations concerning, the acquisition of coal mining assets, including LBAbids, and acquisitions of, or combinations with, coal mining companies. When webelieve that these opportunities are consistent with our growth plans and ouracquisition criteria, we will make bids or proposals and/or enter into lettersof intent and other similar agreements, which may be binding or nonbinding,that are customarily subject to a variety of conditions and usually permit usto terminate the discussions and any related agreements if, among other things,we are not satisfied with the results of our due diligence investigation. Anyacquisition opportunities we pursue could materially affect our liquidity andcapital resources and may require us to incur indebtedness, seek equity capitalor both.

**Covenant Compliance**

We believe that our Senior Credit Facilities and theindenture governing our outstanding 71¤4% Senior Notes are materialagreements, that the covenants are material terms of these agreements and thatinformation about the covenants is material to an investor’s understanding ofour financial condition and liquidity. The breach of covenants in the SeniorCredit Facilities that are tied to ratios based on Adjusted EBITDA, as definedbelow, could result in a default under the Senior Credit Facilities and thelenders could elect to declare all amounts borrowed due and payable. Any suchacceleration would also result in a default under our indenture. Additionally,under the Senior Credit Facilities and indenture, our ability to engage inactivities such as incurring additional indebtedness, making investments andpaying dividends is also tied to ratios based on Adjusted EBITDA.

Covenantlevels and Adjusted EBITDA ratios for the four quarters ended June 30,2005 are as follows:
| ** **                                                                                                     | ** ** | **Covenant   Level** | ** ** | **Adjusted EBITDA  June 30,  2005 Ratios** | ** ** |
|----------------------------------------------------------------------------------------------------------------|------------|---------------------------|------------|-----------------------------------------------------------|------------|
| **Senior  Credit Facilities(1)**                                                                               |       |                      |       |                                                      |       |   |   |   |   |
| Minimum Adjusted  EBITDA to cash interest ratio                                                                |       |                      | 1.875      | X                                                         |       |   | 4.3 | X |   |
| Maximum total  debt to Adjusted EBITDA ratio                                                                   |       |                      | 5.75       | X                                                         |       |   | 3.2 | X |   |
| **Indenture(2)**                                                                                               |       |                      |       |                                                      |       |   |   |   |   |
| Minimum Adjusted EBITDA  to fixed charge ratio required to incur additional debt pursuant to ratio  provisions |       |                      | 2.0        | X                                                         |       |   | 4.3 | 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.

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AdjustedEBITDA is defined as EBITDA further adjusted to exclude non-recurring items,non-cash items and other adjustments permitted in calculating covenantcompliance under the indenture, and the Senior Credit Facilities, as shown inthe table below. We believe that the inclusion of supplementary adjustments toEBITDA applied in presenting Adjusted EBITDA is appropriate to provideadditional information to investors to demonstrate compliance with financingcovenants.
| ** **                         | ** ** | ** **                                                 | ** ** | **Deduct:**                                         | ** ** | **Add:**                                            | ** ** | ** **                                             | ** ** |
|------------------------------------|------------|------------------------------------------------------------|------------|-----------------------------------------------------|------------|-----------------------------------------------------|------------|--------------------------------------------------------|------------|
| ** **                         | ** ** | **Four Quarters  Ended  December 31, 2004** | ** ** | **Six Months  Ended  June 30, 2004** | ** ** | **Six Months  Ended  June 30, 2005** | ** ** | **Four Quarters  Ended  June 30, 2005** | ** ** |
| ** **                         | ** ** | **(Unaudited, in millions)**                     | ** ** |
| EBITDA(1)                          |       |                                                       | $          | 15.6                                                |       |                                                |       | $                                                      | (2.3       | ) |   |   | $ | 154.0 |   |   |   | $ | 171.9 |   |   |
| Non-cash  charges (income)(2)      |       |                                                       | 70.4       |                                                |       |                                                | 55.5       |                                                   |       |   | (7.2 | ) |   |   | 7.7 |   |   |
| Unusual or non-recurring  items(3) |       |                                                       | 35.9       |                                                |       |                                                | 3.2        |                                                   |       |   | — |   |   |   | 32.7 |   |   |
| Cumberland Mine  force majeure(4)  |       |                                                       | 31.1       |                                                |       |                                                | 31.1       |                                                   |       |   | — |   |   |   | — |   |   |
| Other  adjustments(5)              |       |                                                       | (0.5       | )                                                   |       |                                                | (1.1       | )                                                      |       |   | 0.5 |   |   |   | 1.1 |   |   |
| Adjusted EBITDA                    |       |                                                       | $          | 152.5                                               |       |                                                |       | $                                                      | 86.4       |   |   |   | $ | 147.3 |   |   |   | $ | 213.4 |   |   |

----

(1)          EBITDAis calculated in the table below:
| ** **                                           | ** ** | ** **                                                 | ** ** | **Deduct:**                                         | ** ** | **Add:**                                            | ** ** | ** **                                             | ** ** |
|------------------------------------------------------|------------|------------------------------------------------------------|------------|-----------------------------------------------------|------------|-----------------------------------------------------|------------|--------------------------------------------------------|------------|
| ** **                                           | ** ** | **Four Quarters  Ended  December 31, 2004** | ** ** | **Six Months  Ended  June 30, 2004** | ** ** | **Six Months  Ended  June 30, 2005** | ** ** | **Four Quarters  Ended  June 30, 2005** | ** ** |
| ** **                                           | ** ** | **(Unaudited, in millions)**                     | ** ** |
| Income (loss)  from continuing operations            |       |                                                       | $          | (76.6                                               | )          |                                                |       | $                                                      | (48.3      | ) |   |   | $ | 39.4 |   |   |   | $ | 11.1 |   |   |
| Interest expense                                     |       |                                                       | 44.7       |                                                |       |                                                | 16.3       |                                                   |       |   | 28.7 |   |   |   | 57.1 |   |   |
| Interest income                                      |       |                                                       | (1.8       | )                                                   |       |                                                | (1.2       | )                                                      |       |   | (0.3 | ) |   |   | (0.9 | ) |   |
| Income tax  expense (benefit)                        |       |                                                       | (38.2      | )                                                   |       |                                                | (29.4      | )                                                      |       |   | 25.2 |   |   |   | 16.4 |   |   |
| Depreciation,  depletion and amortization            |       |                                                       | 146.0      |                                                |       |                                                | 52.5       |                                                   |       |   | 107.5 |   |   |   | 201.0 |   |   |
| Amortization of  above market coal supply agreements |       |                                                       | (58.5      | )                                                   |       |                                                | 7.8        |                                                   |       |   | (46.5 | ) |   |   | (112.8 | ) |   |
| EBITDA                                               |       |                                                       | $          | 15.6                                                |       |                                                |       | $                                                      | (2.3       | ) |   |   | $ | 154.0 |   |   |   | $ | 171.9 |   |   |

 

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(2)          Weare required to adjust EBITDA, as defined above, for the following non-cashcharges (income):
| ** **                                                                  | ** ** | ** **                                                 | ** ** | **Deduct:**                                         | ** ** | **Add:**                                            | ** ** | ** **                                             | ** ** |
|-----------------------------------------------------------------------------|------------|------------------------------------------------------------|------------|-----------------------------------------------------|------------|-----------------------------------------------------|------------|--------------------------------------------------------|------------|
| ** **                                                                  | ** ** | **Four Quarters  Ended  December 31, 2004** | ** ** | **Six Months  Ended  June 30, 2004** | ** ** | **Six Months  Ended  June 30, 2005** | ** ** | **Four Quarters  Ended  June 30, 2005** | ** ** |
| ** **                                                                  | ** ** | **(Unaudited, in millions)**                     | ** ** |
| Interest rate  swaps(a)                                                     |       |                                                       | $          | 42.6                                                |       |                                                |       | $                                                      | 43.0       |   |   |   | $ | — |   |   |   | $ | (0.4 | ) |   |
| 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      | )                                                   |       |                                                | —     |                                                   |       |   | (11.6 | ) |   |   | (26.9 | ) |   |
| Accretion on  asset retirement obligations/reclamation expense              |       |                                                       | 7.3        |                                                |       |                                                | 3.4        |                                                   |       |   | 4.0 |   |   |   | 7.9 |   |   |
| Stock based  compensation expense(d)                                        |       |                                                       | —     |                                                |       |                                                | —     |                                                   |       |   | 0.4 |   |   |   | 0.4 |   |   |
| Asset impairment  charges                                                   |       |                                                       | —     |                                                |       |                                                | —     |                                                   |       |   | — |   |   |   | — |   |   |
| Amortization  included in benefits expense(e)                               |       |                                                       | 10.3       |                                                |       |                                                | 9.1        |                                                   |       |   | — |   |   |   | 1.2 |   |   |
| Total                                                                       |       |                                                       | $          | 70.4                                                |       |                                                |       | $                                                      | 55.5       |   |   |   | $ | (7.2 | ) |   |   | $ | 7.7 |   |   |

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

(b)         Represents incrementalcost of sales recorded in the period arising from the preliminary estimate ofmanufacturing profit added to inventory in purchase accounting.

(c)          In purchase accounting,the fair value of partially and fully uncovered coal included consideration ofthe effort spent prior to the purchase date to remove overburden and get thecoal to its partially or fully uncovered state. Therefore, the fair valueassigned to partially or fully uncovered coal reserves was higher than thatassigned to other coal reserves. Depletion of coal reserves, including theincremental fair value related to pre-acquisition overburden removalefforts, is included in depreciation, depletion and amortization. Subsequent tothe acquisition date, the costs associated with removal of overburden touncover coal reserves is inventoried as work-in-process until therelated coal is mined and the inventoried cost charged to cost of coal saleswhen the coal is sold. Until coal valued as partially or fully uncovered at theacquisition date is fully depleted, depreciation, depletion and amortizationwill include the value of overburden removal performed prior to the acquisitiondate which if incurred subsequent to the acquisition date would have beenincluded in cost of coal sales.

(d)         Represents an accrual forcompensation expense attributable to restricted stock performance units andrestricted stock awarded to certain directors.

(e)          Represents the portionof pension, other postretirement and black lung expense resulting from theamortization of unrecognized actuarial losses, prior service costs andtransition obligations. Unrecognized actuarial losses, prior service costs andtransition obligations were eliminated when the pension, other postretirementand black lung obligations were fair valued in purchase accounting.

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(3)          Weare also required by the credit agreement to adjust EBITDA, as defined above, forthe following unusual (income) expense:
| ** **                                           | ** ** | ** **                                                 | ** ** | **Deduct:**                                         | ** ** | **Add:**                                            | ** ** | ** **                                             | ** ** |
|------------------------------------------------------|------------|------------------------------------------------------------|------------|-----------------------------------------------------|------------|-----------------------------------------------------|------------|--------------------------------------------------------|------------|
| ** **                                           | ** ** | **Four Quarters  Ended  December 31, 2004** | ** ** | **Six Months  Ended  June 30, 2004** | ** ** | **Six Months  Ended  June 30, 2005** | ** ** | **Four Quarters  Ended  June 30, 2005** | ** ** |
| ** **                                           | ** ** | **(Unaudited, in millions)**                     | ** ** |
| Litigation/arbitration/contract  settlements, net(a) |       |                                                       | $          | 28.9                                                |       |                                                |       | $                                                      | 1.7        |   |   |   | $ | — |   |   |   | $ | 27.2 |   |   |
| Transaction  bonus(b)                                |       |                                                       | 1.8        |                                                |       |                                                | —     |                                                   |       |   | — |   |   |   | 1.8 |   |   |
| Long-term  incentive plan expense(c)            |       |                                                       | 2.4        |                                                |       |                                                | 2.2        |                                                   |       |   | — |   |   |   | 0.2 |   |   |
| Gain on asset  sales                                 |       |                                                       | (1.0       | )                                                   |       |                                                | (0.7       | )                                                      |       |   | — |   |   |   | (0.3 | ) |   |
| Other(d)                                             |       |                                                       | 3.8        |                                                |       |                                                | —     |                                                   |       |   | — |   |   |   | 3.8 |   |   |
| Total                                                |       |                                                       | $          | 35.9                                                |       |                                                |       | $                                                      | 3.2        |   |   |   | $ | — |   |   |   | $ | 32.7 |   |   |

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(a)          Represents arbitrationawards, litigation and contract settlements, net of related legal and tax fees.

(b)         Represents the cost of aone-time bonus awarded to certain employees in connection with the sale of RAGAmerican Coal Holding, Inc.

(c)          Represents the cost of along-term incentive plan instituted by RAG American Coal Holding, Inc. in2001 that was terminated prior to closing as required by the change in controlprovisions in the plan agreement. We have implemented a management equityprogram that will not result in a cash cost to us.

(d)         Represents$2.0 million from a sponsor monitoring fee and $1.8 million from atax allowance related to the IPO in the 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 required tomake adjustments to EBITDA for items such as incremental insurance costs andfranchise taxes not included in income tax expense.

Pro-formacash interest for the four quarters ended June 30, 2005 is calculated asfollows (unaudited, in millions):
| Cash interest  amounts stipulated in Credit Agreement for period July 1 through  July 29, 2004 |                                                                                           | $      | 4.0    |   |
|----------------------------------------------------------------------------------------------------------|------------------------------------------------------------------------------------------------|--------|--------|--------|
| Cash interest  expense for eight month period July 30, 2004 through March 31, 2005             |                                                                                           | 33.2   |   |
| Interest expense  for three months ended June 30, 2005                                              |                                                                                           | 14.4   |   |
| Less:                                                                                                    | Amortization of  deferred financing costs for three month period ended June 30, 2005 |   | (0.8   | )      |
| Less:                                                                                                    | Cash interest income  for the three month period ended June 30, 2005                      |   | (0.2   | )      |
| Less:                                                                                                    | Other non cash  interest expense for three months ended June 30, 2005                     |   | (0.4   | )      |
|                                                                                                     |                                                                                           | $50.2  |   |

 

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In future periods, adjustments to EBITDA that could beused to calculate compliance with the debt covenants are: (a) accretion onasset retirement obligations, (b) credits from deferral of overburdenremoval costs, (c) any non-cash expenses or charges arising as a result ofthe application 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 SFAS No. 144,(f) amortization of intangibles pursuant to SFAS No. 141, and (g) anylong term incentive plan accruals or any non-cash compensation expense realizedfrom grants of stock appreciation or similar rights, stock options or otherrights to officers, directors and employees.

In future periods, cashinterest is expected to be calculated by adding back amortization of deferreddebt issuance costs and deducting cash interest income from the interestexpense reported in the Statement of Operations.

**Contractual Obligations**

Thefollowing is a summary of our significant future contractual obligations byyear as of December 31, 2004. There were no significant changes to ourcontractual obligations during the six months ended June 30, 2005. On July 20,2005, we committed to a forward contract to purchase approximately $11 millionof diesel fuel for 2006 delivery at our Powder River Basin mines. On August 4,2005, we prepaid $20 million of the long term debt from cash on hand.
| ** **                                      | ** ** | **2005**                               | ** ** | **2006-2007** | ** ** | **2008-2009** | ** ** | **After 2009** | ** ** | **Total** | ** ** |
|-------------------------------------------------|------------|----------------------------------------|------------|---------------|------------|---------------|------------|---------------------|------------|-----------|------------|
| ** **                                      | ** ** | **(Unaudited, in millions)** | ** ** |
| Long-term  debt and capital leases(a)           |       | $                                      | —     |          |       | $             | —     |                |       |      | $          | — |   |   |   | $ | 665.0 |   |   | $ | 665.0 |   |
| 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 |   |   |   | $ | 986.8 |   |   | $ | 1,300.6 |   |

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(a)           reflects the $20million debt repayment made on August 4. 2005.

We expect to invest in therange of $150.0 to $160.0 million in capital expenditures during calendaryear 2005 of which approximately $100.0 million is to maintain productionand replace mining equipment. The additional $50.0 to $60.0 million isexpected to be directed toward selective expansions of production andimprovements in productivity. Approximately $34 million of expected 2005capital expenditures are included in unconditional purchase commitments shownabove. The remaining 2005 unconditional purchase commitments and$3 million of the 2006-2007 unconditional purchase commitmentsrelate to forward contracts to purchase diesel fuel and explosives in normalquantities for use at our surface mines. The remaining unconditional purchasecommitments, totaling $4.4 million in 2006-2007 and$17.2 million in 2008-2009, relate to a contractual commitment topurchase underground mining equipment. We expect to contribute approximately$7.7 million to our defined benefit retirement plans and to payapproximately $23.0 million of retiree health care benefits in calendaryear 2005. We also expect to incur approximately $9.0 million per year forsurety bond premiums and letters of credit fees. We believe that cash balancesplus cash generated by operations will be sufficient to meet these obligationsplus fund requirements for working capital and capital expenditures withoutincurring additional borrowings.

**Off-Balance Sheet Arrangements**

In the normal course of business, we are a party tocertain off-balance sheet arrangements. These arrangements include guarantees,indemnifications and financial instruments with off-balance sheet risk, 

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such as bank letters ofcredit and performance or surety bonds. Liabilities related to thesearrangements are not reflected in our consolidated balance sheets. However, theunderlying obligations that they secure, such as asset retirement obligations,self-insured workers’ compensation liabilities, royalty obligations and certainretiree medical obligations, are reflected in our consolidated balance sheets.

We are required to provide financial assurance inorder to perform the post-mining reclamation required by our mining permits,pay our federal production royalties, pay workers’ compensation claims underself-insured workers’ compensation laws in the various states, pay federalblack lung benefits, pay retiree health care benefits to certain retired UMWAemployees and perform certain other obligations.

In order to provide the required financial assurance,we generally use surety bonds for post-mining reclamation and royalty paymentobligations and bank letters of credit for self-insured workers’ compensationobligations and UMWA retiree health care obligations. Federal black lungbenefits are paid from a dedicated trust fund that has sufficient assets tofund these obligations for the next several years. Bank letters of credit arealso used to collateralize a portion of the surety bonds.

We had outstanding suretybonds with a total face amount of $252.2 million as of June 30, 2005,of which $229.6 million secured reclamation obligations,$10.7 million secured coal lease obligations and $9.6 million securedself-insured workers’ compensation obligations. In addition, we had$193.5 million of letters of credit in place for the following purposes:$33.4 million for workers’ compensation, including collateral for workers’compensation bonds; $23.4 million for UMWA retiree health careobligations; $130.5 million for collateral for reclamation surety bonds,$3.0 million for minimum royalty payment obligations for a closed mine inUtah; and $3.2 million for other miscellaneous obligations. Recently,surety bond costs have increased, while the market terms under which suretybonds can be obtained have generally become less favorable to all miningcompanies. In the event that additional surety bonds become unavailable, wewould seek to secure our obligations with letters of credit, cash deposits orother suitable forms of collateral.

**Certain Trends and Uncertainties**

Our revenues depend on theprice at which we are able to sell our coal. The current pricing environmentfor United States coal is strong. Any decrease in coal prices due to, amongother reasons, the supply of domestic and foreign coal, the demand forelectricity and the price and availability of alternative fuels for electricitygeneration could adversely affect our revenues and our ability to generate cashflows. In addition, our results of operations depend on the cost of coalproduction. We are experiencing increased operating costs for fuel andexplosives, steel products, health care, wages, salaries, contract labor, andincreased interest expenses for surety bonds and letters of credit. Inaddition, historically low interest rates have had a negative impact onexpenses related to our actuarially determined employee-relatedliabilities.

**Recent Accounting Pronouncements**

In December 2004, the Financial AccountingStandards Board (“FASB”) issued SFAS No. 123 (revised 2004), *Share-Based Payment* (“SFAS No. 123R”),which replaces SFAS No. 123, and supersedes APB No. 25. SFAS No. 123Rrequires all share-based payments to employees, including grants ofemployee stock options, to be recognized in the financial statements based ontheir fair value at the grant date. SFAS No. 123R generally requirescompanies to measure the cost of employee services received in exchange for anaward of equity instruments (such as stock options and restricted stock) basedon the grant-date fair value of the award, and to recognize that cost over theperiod during which the employee is required to provide service (usually thevesting period of the award). FAS 123R also requires the benefits of taxdeductions 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 pro forma 

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disclosures previouslypermitted under SFAS No. 123 no longer will be an alternative to financialstatement recognition. On April 14, 2005, the Securities and ExchangeCommission (“SEC”) delayed the implementation of SFAS No. 123R from itsoriginal implementation date by six months for most registrants, requiring allpublic companies to adopt FAS 123R no later than the beginning of the firstfiscal year beginning after June 15, 2005. The impact of adopting SFAS No. 123Rcannot be predicted at this time because it will depend on levels of share-basedpayments granted in the future. However, had the Company adopted SFAS No. 123Rduring the prior period, the results are expected to be consistent with the proforma disclosure under SFAS No. 123, except that forfeitures will beconsidered in the calculation of compensation expense under SFAS No. 123R.When adopted, the Company may elect to change the valuation method orassumptions and such changes could have a material impact on the amount ofstock-based compensation the Company records.

In March 2005, the Emerging Issues Task Forcereached consensus on Issue No. 04-6, *Accountingfor Stripping 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, post production stripping costs are considered costsof the 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 after December 15,2005, with early adoption permitted. The Company is currently evaluating thisconsensus and has not determined its impact to the consolidated financialstatements.

The FASB issued FASB Interpretation(“FIN”) No. 47, “Accounting for Conditional Asset Retirement Obligations”in March of 2005. FIN 47 clarifies that an entity must record a liabilityfor a conditional asset retirement obligation if the fair value of theobligation can be reasonably estimated. This interpretation also clarifies thecircumstances under which an entity would have sufficient information toreasonably estimate the fair value of an asset retirement obligation. ThisInterpretation is effective no later than the end of fiscal years ending after December 15,2005. The Company does not expect this guidance to have a material impact onits financial statements.

**ITEM 3.**                QUANTITATIVEAND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

**Commodity Price Risk**

We manage our commodityprice risk for coal sales through the use of long-term coal supply agreementsrather than through the use of derivative instruments. As of June 30,2005, we had sales commitments for approximately 99% of our planned 2005production. Some of the products used in our mining activities, such as dieselfuel, explosives, steel products and electricity, are subject to pricevolatility. Through our suppliers, we utilize forward purchase contracts tomanage the exposure related to this volatility.

**Credit Risk**

Our credit risk is primarily with electric powergenerators and, to a lesser extent, steel producers. Most electric powergenerators to whom we sell have investment grade credit ratings. Our policy isto independently evaluate each customer’s creditworthiness prior to enteringinto transactions and to constantly monitor outstanding accounts receivableagainst established credit limits. When appropriate (as determined by ourcredit management function), we have taken steps to reduce our credit exposureto customers that do not meet our credit standards or whose credit hasdeteriorated. These steps include 

48

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obtaining letters ofcredit or cash collateral, requiring prepayments for shipments or establishingcustomer trust accounts held for our benefit in the event of a failure to pay.

Counterparty risk withrespect to interest rate swaps is not considered to be significant based uponthe creditworthiness of the participating financial institutions.

**Interest Rate Risk**

Historically, we have had exposure to changes in interestrates on a portion of our existing level of indebtedness under the Predecessor.This exposure had been completely hedged for the life of the debt usingpay-fixed, receive-variable interest rate swaps. From July 30, 2004forward, we have exposure to changes in interest rates through our bank termloan and our revolving credit facility. As described below, we have usedinterest rate swaps to manage this risk.

Weentered into swap contracts for the purpose of complying with certain financialcovenants in our senior secured credit facility that require fixing theinterest rate for at least three years on a minimum of 50% of our totaloutstanding debt. The swap contracts cover $85 million through September 2007.The following table summarizes our outstanding swap contracts at June 30,2004.
| **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 June 30, 2005,after giving effect to the $85 million of interest rate swaps that wereentered into, we had $300 million of variable rate indebtedness,representing approximately 44% of our outstanding indebtedness. The amount wasreduced to $280 million with the debt repayment on August 4, 2005. A 1%change in interest rates would affect the interest expense on such indebtednessby $3.0 million. At June 30, 2005, the fair value of these swapagreements was an unrealized gain of $1.2 million. Effective January 1,2005, these swaps were designated as hedges. The increase in the unrealizedgain of $0.7 million pre-tax ($0.4 million, net of tax) for the six monthsended June 30, 2005 was reported as a component of comprehensive income(loss).

**ITEM 4.**                CONTROLSAND PROCEDURES.

*Evaluation ofDisclosure Controls and Procedures*

We maintain disclosurecontrols and procedures and internal controls designed to ensure thatinformation 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 evaluatingthe disclosure controls and procedures, our management recognized that anycontrols and procedures, no matter how well designed and operated, can provideonly reasonable assurance of achieving the desired control objectives andmanagement necessarily was required to apply its judgment in evaluating thecost-benefit relationship of possible controls and procedures. Anevaluation was performed under the supervision and with the participation ofmanagement, including the Chief Executive Officer (CEO) and Chief FinancialOfficer (CFO), of the effectiveness of the design and operations of ourdisclosure controls and procedures pursuant to Exchange Act Rule 13a-14.Based upon that evaluation as of the end of the period covered by this report,the CEO and CFO concluded that our disclosure controls and procedures areeffective in timely alerting them to material information required to beincluded in our periodic SEC filings. The conclusions of the CEO and CFO fromthis evaluation were communicated to the Audit 

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Committee.In connection with this evaluation, there were no breaches of such controlsthat would require disclosure to the Audit Committee or our auditors.

*Changes in DisclosureControls*

There were no significantchanges in our disclosure controls or in other factors that could significantlyaffect these disclosure controls in the fiscal quarter ended June 30,2005. Management is not aware of any material weaknesses; therefore, there wereno corrective actions to be taken.

*Sarbanes-OxleyAct of 2002 Section 404*

During the year ended December 31, 2004, we didnot meet the definition of an Accelerated Filer because we have been a publiccompany subject to the reporting requirements of Sections 13(a) and 15(d) ofthe Securities Exchange Act of 1934, as amended, for less than twelve monthsand we have not previously filed an Annual Report on Form 10-K. Weare required to comply with the final Section 404 Rule of theSarbanes-Oxley Act of 2002 in our Annual Report on Form 10-Kfor the fiscal year ended December 31, 2005.

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**PART II—OTHER INFORMATION**

**Item 1.**                        LegalProceedings.

Information required bythis Item is contained in Note 17, “Commitments and Contingencies”, to theconsolidated financial statements contained in this Report and is incorporatedherein by reference.

**Item 2.**                        UnregisteredSales of Equity Securities and Use of Proceeds.

None.

**Item 3.**                        DefaultsUpon Senior Securities.

None.

**Item 4.**                        Submissionof Matters to a Vote of Security Holders.

None.

**Item 5.**                        OtherInformation.

None.

**Item 6.**                        Exhibits.

The exhibits to this report are listed in the Exhibit Index.

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**SIGNATURES**

Pursuantto the requirements of the Securities Exchange Act of 1934, the registrant hasduly caused this report to be signed on its behalf by the undersigned thereuntoduly authorized.
| Date: August 15, 2005 | FOUNDATION COAL CORPORATION |
|----------------------------|-----------------------------|
|                       | (Registrant)                |

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

 

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**EXHIBIT INDEX**
| Exhibit  No. | ** ** | ** **                                                                                                                                                                                                                                                                                                                             | ** ** | **Description of Exhibit** |
|--------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------|
| 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 |
| 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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*                    Incorporatedby reference to the same numbered exhibit previously filed with Foundation’sregistration statement on Form S-1 (SEC File No. 333-118427).

**             Previously filed asan exhibit to Foundation Coal Corporation’s Registration Statement on Form S-4(File No. 333-20979) and incorporated herein by reference.

***  Filed herewith.

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