| PEABODY ENERGY CORP Item 1A Risk Factors |
| If a substantial portion of our long-term coal supply agreements terminate, our revenues and operating profits could suffer if we were unable to find alternate buyers willing to purchase our coal on comparable terms to those in our contracts |
| Most of our sales are made under coal supply agreements, which are important to the stability and profitability of our operations |
| The execution of a satisfactory coal supply agreement is frequently the basis on which we undertake the development of coal reserves required to be supplied under the contract |
| For the year ended December 31, 2005, 90prca of our sales volume was sold under long-term coal supply agreements |
| At December 31, 2005, our coal supply agreements had remaining terms ranging from one to 19 years and an average volume-weighted remaining term of approximately 3dtta2 years |
| Many of our coal supply agreements contain provisions that permit the parties to adjust the contract price upward or downward at specified times |
| We may adjust these contract prices based on inflation or deflation and/or changes in the factors affecting the cost of producing coal, such as taxes, fees, royalties and changes in the laws regulating the mining, production, sale or use of coal |
| In a limited number of contracts, failure of the parties to agree on a price under those provisions may allow either party to terminate the contract |
| We sometimes experience a reduction in coal prices in new long-term coal supply agreements replacing some of our expiring contracts |
| Coal supply agreements also typically contain force majeure provisions allowing temporary suspension of performance by us or the customer during the duration of specified events beyond the control of the affected party |
| Most coal supply agreements contain provisions requiring us to deliver coal meeting quality thresholds for certain characteristics such as Btu, sulfur content, ash content, grindability and ash fusion temperature |
| Failure to meet these specifications could result in economic penalties, including price adjustments, the rejection of deliveries or termination of the contracts |
| Moreover, some of these agreements permit the customer to terminate the contract if transportation costs, which our customers typically bear, increase substantially |
| In addition, some of these contracts allow our customers to terminate their contracts in the event of changes in regulations affecting our industry that increase the price of coal beyond specified limits |
| The operating profits we realize from coal sold under supply agreements depend on a variety of factors |
| In addition, price adjustment and other provisions may increase our exposure to short-term coal price volatility provided by those contracts |
| If a substantial portion of our coal supply agreements were modified or terminated, we could be materially adversely affected to the extent that we are unable to find 27 _________________________________________________________________ [83]Table of Contents alternate buyers for our coal at the same level of profitability |
| Market prices for coal vary by mining region and country |
| As a result, we cannot predict the future strength of the coal market overall or by mining region and cannot assure you that we will be able to replace existing long-term coal supply agreements at the same prices or with similar profit margins when they expire |
| In addition, one of our largest coal supply agreements is the subject of ongoing litigation and arbitration |
| The loss of, or significant reduction in, purchases by our largest customers could adversely affect our revenues |
| For the year ended December 31, 2005, we derived 21prca of our total coal revenues from sales to our five largest customers |
| At December 31, 2005, we had 79 coal supply agreements with these customers expiring at various times from 2006 to 2011 |
| We are currently discussing the extension of existing agreements or entering into new long-term agreements with some of these customers, but these negotiations may not be successful and those customers may not continue to purchase coal from us under long-term coal supply agreements |
| If a number of these customers were to significantly reduce their purchases of coal from us, or if we were unable to sell coal to them on terms as favorable to us as the terms under our current agreements, our financial condition and results of operations could suffer materially |
| We had been supplying coal to the Mohave Generating Station pursuant to a long-term coal supply agreement through our Black Mesa Mine |
| The mine suspended its operations on December 31, 2005, and the coal supply agreement expired on that date |
| As a part of an alternate dispute resolution, Peabody Western has been participating in mediation with the owners of the Mohave Generating Station and the Navajo Generating Station, and the two tribes to resolve the complex issues surrounding groundwater and other disputes involving the two generating stations |
| Resolution of these issues is critical to the operation of the Mohave Generating Station after December 31, 2005 |
| There is no assurance that these issues will be resolved |
| The Mohave plant was the sole customer of the Black Mesa Mine, which sold 4dtta6 million tons of coal in 2005 |
| During 2005, the mine generated dlra29dtta8 million of Adjusted EBITDA (reconciled to its most comparable measure under generally accepted accounting principles in Note 27 of the consolidated financial statements), which represented 3dtta4prca of our total EBITDA of dlra870dtta4 million |
| Our financial performance could be adversely affected by our debt |
| Our financial performance could be affected by our indebtedness |
| As of December 31, 2005, our total indebtedness was approximately dlra1cmam405dtta5 million, and we had dlra493dtta3 million of available borrowing capacity under our revolving credit facility |
| We may also incur additional indebtedness in the future |
| The degree to which we are leveraged could have important consequences, including, but not limited to: • making it more difficult for us to pay interest and satisfy our debt obligations; • increasing our vulnerability to general adverse economic and industry conditions; • requiring the dedication of a substantial portion of our cash flow from operations to the payment of principal of, and interest on, our indebtedness, thereby reducing the availability of the cash flow to fund working capital, capital expenditures or other general corporate uses; • limiting our ability to obtain additional financing to fund future working capital, capital expenditures or other general corporate requirements; • limiting our flexibility in planning for, or reacting to, changes in our business and in the coal industry; and • placing us at a competitive disadvantage compared to less leveraged competitors |
| In addition, our indebtedness subjects us to financial and other restrictive covenants |
| Failure by us to comply with these covenants could result in an event of default which, if not cured or waived, could have 28 _________________________________________________________________ [84]Table of Contents a material adverse effect on us |
| Furthermore, substantially all of our assets secure our indebtedness under our credit facility |
| If our cash flows and capital resources are insufficient to fund our debt service obligations, we may be forced to sell assets, seek additional capital or seek to restructure or refinance our indebtedness, including the notes |
| These alternative measures may not be successful and may not permit us to meet our scheduled debt service obligations |
| In the absence of sufficient operating results and resources, we could face substantial liquidity problems and might be required to sell material assets or operations to attempt to meet our debt service and other obligations |
| The credit facility and indentures governing the notes restrict our ability to sell assets and use the proceeds from the sales |
| We may not be able to consummate those sales or to obtain the proceeds which we could realize from them and these proceeds may not be adequate to meet any debt service obligations then due |
| If transportation for our coal becomes unavailable or uneconomic for our customers, our ability to sell coal could suffer |
| Transportation costs represent a significant portion of the total cost of coal and, as a result, the cost of transportation is a critical factor in a customer’s purchasing decision |
| Increases in transportation costs could make coal a less competitive source of energy or could make some of our operations less competitive than other sources of coal |
| Certain coal supply agreements, which account for less than 5prca of our tons sold, permit the customer to terminate the contract if the cost of transportation increases by an amount ranging from 10prca to 20prca in any given 12-month period |
| Coal producers depend upon rail, barge, trucking, overland conveyor, pipeline and ocean-going vessels to deliver coal to markets |
| While our coal customers typically arrange and pay for transportation of coal from the mine or port to the point of use, disruption of these transportation services because of weather-related problems, infrastructure damage, strikes, lock-outs, lack of fuel or maintenance items, transportation delays or other events could temporarily impair our ability to supply coal to our customers and thus could adversely affect our results of operations |
| For example, two primary lines serve the Powder River Basin mines |
| Due to the high volume of coal shipped from all Powder River Basin mines, the loss of one, or both, of those lines due to damage or labor strike could create temporary congestion on the rail systems servicing that region |
| Continued increases in coal demand, combined with inventories at electricity generators that are lower than historical averages, created periodic regional rail and port congestion in 2005 |
| To the extent rail or port congestion constrains our operations’ ability to successfully ship coal to our customers, our operating results will be reduced |
| Risks inherent to mining could increase the cost of operating our business |
| Our mining operations are subject to conditions that can impact the safety of our workforce, or delay coal deliveries or increase the cost of mining at particular mines for varying lengths of time |
| These conditions include fires and explosions from methane gas or coal dust; accidental minewater discharges; weather, flooding and natural disasters; unexpected maintenance problems; key equipment failures; variations in coal seam thickness; variations in the amount of rock and soil overlying the coal deposit; variations in rock and other natural materials and variations in geologic conditions |
| We maintain insurance policies that provide limited coverage for some of these risks, although there can be no assurance that these risks would be fully covered by our insurance policies |
| Despite our efforts, significant mine accidents could occur and have a substantial impact |
| Our mining operations are extensively regulated, which imposes significant costs on us, and future regulations could increase those costs or limit our ability to produce coal |
| Federal, state and local authorities regulate the coal mining industry with respect to matters such as employee health and safety, permitting and licensing requirements, air quality standards, water pollution, plant and wildlife protection, reclamation and restoration of mining properties after mining is completed, 29 _________________________________________________________________ [85]Table of Contents the discharge of materials into the environment, surface subsidence from underground mining and the effects that mining has on groundwater quality and availability |
| In addition, significant legislation mandating specified benefits for retired coal miners affects our industry |
| Numerous governmental permits and approvals are required for mining operations |
| We are required to prepare and present to federal, state or local authorities data pertaining to the effect or impact that any proposed exploration for or production of coal may have upon the environment |
| The costs, liabilities and requirements associated with these regulations may be costly and time-consuming and may delay commencement or continuation of exploration or production |
| The possibility exists that new legislation and/or regulations and orders related to the environment or employee health and safety may be adopted and may materially adversely affect our mining operations, our cost structure and/or our customers’ ability to use coal |
| New legislation or administrative regulations (or judicial interpretations of existing laws and regulations), including proposals related to the protection of the environment that would further regulate and tax the coal industry, may also require us or our customers to change operations significantly or incur increased costs |
| The majority of our coal supply agreements contain provisions that allow a purchaser to terminate its contract if legislation is passed that either restricts the use or type of coal permissible at the purchaser’s plant or results in specified increases in the cost of coal or its use |
| These factors and legislation, if enacted, could have a material adverse effect on our financial condition and results of operations |
| In addition, the United States, Australia and more than 160 other nations are signatories to the 1992 Framework Convention on Climate Change, which addresses emissions of greenhouse gases, such as carbon dioxide |
| In December 1997, in Kyoto, Japan, the signatories to the convention established a binding set of emission targets for developed nations |
| Although the specific emission targets vary from country to country, the United States would be required to reduce emissions to 93prca of 1990 levels over a five-year budget period from 2008 through 2012 |
| Although the United States has not ratified the emission targets and no comprehensive regulations focusing on greenhouse gas emissions are in place in the US, these restrictions, whether through ratification of the emission targets or other efforts to stabilize or reduce greenhouse gas emissions, could adversely affect the price and demand for coal |
| According to the Department of Energy’s Energy Information Administration, “Emissions of Greenhouse Gases in the United States 2003,” coal accounts for 31prca of greenhouse gas emissions in the United States, and efforts to control greenhouse gas emissions could result in reduced use of coal if electricity generators switch to lower carbon sources of fuel |
| Further developments in connection with regulations or other limits on carbon dioxide emissions could have a material adverse effect on our financial condition or results of operations |
| Our expenditures for postretirement benefit and pension obligations could be materially higher than we have predicted if our underlying assumptions prove to be incorrect |
| We provide postretirement health and life insurance benefits to eligible union and non-union employees |
| We calculated the total accumulated postretirement benefit obligation under SFAS Nodtta 106, “Employers’ Accounting for Postretirement Benefits Other Than Pensions,” which we estimate had a present value of dlra1cmam034dtta3 million as of December 31, 2005, dlra75dtta0 million of which was a current liability |
| We have estimated these unfunded obligations based on assumptions described in the notes to our consolidated financial statements |
| If our assumptions do not materialize as expected, cash expenditures and costs that we incur could be materially higher |
| Moreover, regulatory changes could increase our obligations to provide these or additional benefits |
| We are party to an agreement with the Pension Benefit Guaranty Corporation (the “PBGC”) and TXU Europe Limited, an affiliate of our former parent corporation, under which we are required to make specified contributions to two of our defined benefit pension plans and to maintain a dlra37dtta0 million letter of credit in favor of the PBGC If we or the PBGC give notice of an intent to terminate one or more of the covered pension plans in which liabilities are not fully funded, or if we fail to maintain the letter of credit, the PBGC may draw down on the letter of credit and use the proceeds to satisfy liabilities under the Employee Retirement Income Security Act of 1974, as amended |
| The PBGC, however, is required to first apply amounts received from a dlra110dtta0 million guaranty in place from TXU Europe Limited in favor of the 30 _________________________________________________________________ [86]Table of Contents PBGC before it draws on our letter of credit |
| On November 19, 2002 TXU Europe Limited was placed under the administration process in the United Kingdom (a process similar to bankruptcy proceedings in the United States) and continues under this process as of December 31, 2005 |
| In addition, certain of our subsidiaries participate in two defined benefit multi-employer pension funds that were established as a result of collective bargaining with the UMWA pursuant to the National Bituminous Coal Wage Agreement as periodically negotiated |
| The UMWA 1950 Pension Plan provides pension and disability pension benefits to qualifying represented employees retiring from a participating employer where the employee last worked prior to January 1, 1976 |
| This is a closed group of beneficiaries with no new entrants |
| The UMWA 1974 Pension Plan provides pension and disability pension benefits to qualifying represented employees retiring from a participating employer where the employee last worked after December 31, 1975 |
| Contributions to these funds could increase as a result of future collective bargaining with the UMWA, a shrinking contribution base as a result of the insolvency of other coal companies who currently contribute to these funds, lower than expected returns on pension fund assets, higher medical and drug costs or other funding deficiencies |
| The United Mine Workers of America Combined Fund was created by federal law in 1992 |
| This multi-employer fund provides health care benefits to a closed group of our retired former employees who last worked prior to 1976, as well as orphaned beneficiaries of bankrupt companies who were receiving benefits as orphans prior to the 1992 law |
| No new retirees will be added to this group |
| The liability is subject to increases or decreases in per capita health care costs, offset by the mortality curve in this aging population of beneficiaries |
| Another fund, the 1992 Benefit Plan created by the same federal law in 1992, provides benefits to qualifying retired former employees of bankrupt companies who have defaulted in providing their former employees with retiree medical benefits |
| Beneficiaries continue to be added to this fund as employers default in providing their former employees with retiree medical benefits, but the overall exposure for new beneficiaries into this fund is limited to retirees covered under their employer’s plan who retired prior to October 1, 1994 |
| A third fund, the 1993 Benefit Fund, was established through collective bargaining and provides benefits to qualifying retired former employees who retired after September 30, 1994 of certain signatory companies who have gone out of business and have defaulted in providing their former employees with retiree medical benefits |
| Beneficiaries continue to be added to this fund as employers go out of business |
| Based upon the enactment of the Medicare Prescription Drug, Improvement and Modernization Act of 2003, we assumed future cash savings which allowed us to reduce our projected postretirement benefit obligations and related expense |
| Failure to achieve these assumed future savings under all benefit plans could adversely affect our financial condition, results of operations and cash flows |
| A decrease in the availability or increase in costs of key supplies or commodities such as diesel fuel, steel, explosives and tires could decrease our anticipated profitability |
| Our mining operations require a reliable supply of replacement parts, explosives, fuel, tires, steel-related products (including roof control) and lubricants |
| If the cost of any of these inputs increased significantly, or if a source for these supplies or mining equipment were unavailable to meet our replacement demands, our profitability could be reduced from our current expectations |
| Recent consolidation of suppliers of explosives has limited the number of sources for these materials, and our current supply of explosives is concentrated with one supplier |
| Further, our purchases of some items of underground mining equipment are concentrated with one principal supplier |
| In the past year, industry-wide demand growth has exceeded supply growth for certain surface and underground mining equipment and off-the-road tires |
| As a result, lead times for some items has generally increased by up to several months |
| 31 _________________________________________________________________ [87]Table of Contents Our future success depends upon our ability to continue acquiring and developing coal reserves that are economically recoverable |
| Our recoverable reserves decline as we produce coal |
| We have not yet applied for the permits required or developed the mines necessary to use all of our reserves |
| Furthermore, we may not be able to mine all of our reserves as profitably as we do at our current operations |
| Our future success depends upon our conducting successful exploration and development activities or acquiring properties containing economically recoverable reserves |
| Our current strategy includes increasing our reserves through acquisitions of government and other leases and producing properties and continuing to use our existing properties |
| The federal government also leases natural gas and coalbed methane reserves in the West, including in the Powder River Basin |
| Some of these natural gas and coalbed methane reserves are located on, or adjacent to, some of our Powder River Basin reserves, potentially creating conflicting interests between us and lessees of those interests |
| Other lessees’ rights relating to these mineral interests could prevent, delay or increase the cost of developing our coal reserves |
| These lessees may also seek damages from us based on claims that our coal mining operations impair their interests |
| Additionally, the federal government limits the amount of federal land that may be leased by any company to 150cmam000 acres nationwide |
| As of December 31, 2005, we leased a total of 62cmam330 acres from the federal government |
| The limit could restrict our ability to lease additional federal |