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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K/A
AMENDMENT NO. 1
Annual Report Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
FOR THE FISCAL YEAR ENDED
SEPTEMBER 30, 1998
Commission file number
1-2918
ASHLAND INC.
(a Kentucky corporation)
I.R.S. No. 61-0122250
50 E. RiverCenter Boulevard
Covington, Kentucky 41012
Telephone Number: (606) 815-3333
Securities Registered Pursuant to Section 12(b):
Name of each exchange
Title of each class on which registered
------------------- ---------------------
Common Stock, par value $1.00 per share New York Stock Exchange
and Chicago Stock Exchange
Rights to Purchase Series A Participating New York Stock Exchange
Cumulative Preferred Stock and Chicago Stock Exchange
Securities Registered Pursuant to Section 12(g): None
Indicate by check mark whether the Registrant (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities
Exchange Act of 1934 during the preceding 12 months (or for such
shorter period that the Registrant was required to file such reports),
and (2) has been subject to such filing requirements for the past 90
days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers
pursuant to Item 405 of Regulation S-K is not contained herein, and
will not be contained, to the best of Registrant's knowledge, in
definitive proxy or information statements incorporated by reference
in Part III of this Form 10-K or any amendment to this Form 10-K. [X]
At October 30, 1998, based on the New York Stock Exchange closing
price, the aggregate market value of voting stock held by
non-affiliates of the Registrant was approximately $3,249,504,576. In
determining this amount, the Registrant has assumed that directors,
certain of its executive officers, and persons known to it to be the
beneficial owners of more than five percent of its common stock are
affiliates. Such assumption shall not be deemed conclusive for any
other purpose.
At October 30, 1998, there were 75,057,315 shares of Registrant's
common stock outstanding.
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<PAGE>
EXPLANATORY NOTE
This amendment to the Annual Report on Form 10-K for the fiscal year
ended September 30, 1998 of Ashland Inc. ("Ashland") is being filed by
Ashland to include the audited financial statements of Marathon Ashland
Petroleum LLC ("MAP") for the fiscal year ended December 31, 1998 and the
audited financial statements of Arch Coal, Inc. ("Arch") for the fiscal
year ended December 31, 1998 as required by Rule 3-09 of Regulation S-X.
Ashland has a 38% equity interest in MAP and a 56% equity interest in Arch
and accounts for these investments using the equity method of accounting.
In accordance with Rule 12b-15 under the Securities Exchange Act of 1934,
as amended, the text of the amended item is set forth in its entirety in
the pages attached hereto.
A consent of PricewaterhouseCoopers LLP, independent accountants for
MAP, and a consent of Ernst & Young, independent auditors for Arch, are
being filed as exhibits hereto.
2
<PAGE>
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) Documents filed as part of this Report
(1) and (2) Financial Statements and Financial Schedule
The consolidated financial statements and financial schedule of
Ashland presented or incorporated by reference in this report are
listed in the index on Page 19.
Audited financial statements of Marathon Ashland Petroleum LLC.
Financial statement schedules are omitted because they are not
applicable as the required information is contained in the
applicable financial statements or notes thereto.
Audited financial statements and schedule of Arch Coal, Inc.
(3) Exhibits
3.1 - Second Restated Articles of Incorporation of
Ashland, as amended to January 30, 1998 (filed as
Exhibit 3 to Ashland's Form 10-Q for the quarter
ended December 31, 1997, and incorporated herein by
reference).
3.2 - Bylaws of Ashland, as amended to March 19, 1998
(filed as Exhibit 3 to Ashland's Form 10-K/A
(Amendment No. 1) for the fiscal year ended September
30, 1997 filed on May 1, 1998, and incorporated
herein by reference).
4.1 - Ashland agrees to provide the SEC, upon request,
copies of instruments defining the rights of holders
of long-term debt of Ashland, and all of its
subsidiaries for which consolidated or unconsolidated
financial statements are required to be filed with
the SEC.
4.2 - Indenture, dated as of August 15, 1989, as amended
and restated as of August 15, 1990, between Ashland
and Citibank, N.A., as Trustee (filed as Exhibit 4(a)
to Ashland's Form 10-K for the fiscal year ended
September 30, 1991, and incorporated herein by
reference).
4.3 - Rights Agreement, dated as of May 16, 1996, between
Ashland Inc. and Harris Trust and Savings Bank,
together with Form of Right Certificate (filed as
Exhibits 4(a) and 4(c), respectively, to Ashland's
Form 8-A filed with the SEC on May 16, 1996, and
incorporated herein by reference).
The following Exhibits 10.1 through 10.18 are compensatory plans or
arrangements or management contracts required to be filed as exhibits pursuant
to Item 601(b)(10)(ii)(A) of Regulation S-K.
10.1 - Amended Stock Incentive Plan for Key Employees of
Ashland Inc. and its Subsidiaries (filed as Exhibit
10.1 to Ashland's Form 10-K for the fiscal year ended
September 30, 1996, and incorporated herein by
reference).
10.2 - Ashland Inc. Deferred Compensation and Stock
Incentive Plan for Non-Employee Directors.
10.3 - Ashland Inc. Director Retirement Plan (filed as
Exhibit 10(c).3 to Ashland's Form 10-K for the fiscal
year ended September 30, 1988, and incorporated
herein by reference).
10.4 - Ninth Amended and Restated Ashland Inc.
Supplemental Early Retirement Plan for Certain Key
Executive Employees.
3
<PAGE>
10.5 - Ashland Inc. Amended Performance Unit Plan (filed
as Exhibit 10.5 to Ashland's Form 10-K for the fiscal
year ended September 30, 1994, and incorporated
herein by reference).
10.6 - Ashland Inc. Incentive Compensation Plan (filed as
Exhibit 10.6 to Ashland's Form 10-K for the fiscal
year ended September 30, 1993, and incorporated
herein by reference).
10.7 - Ashland Inc. Director Death Benefit Program (filed
as Exhibit 10(c).10 to Ashland's Form 10-K for the
fiscal year ended September 30, 1990, and
incorporated herein by reference).
10.8 - Ashland Inc. Salary Continuation Plan (filed as
Exhibit 10(c).11 to Ashland's Form 10-K for the
fiscal year ended September 30, 1988, and
incorporated herein by reference).
10.9 - Forms of Ashland Inc. Executive Employment Contract
between Ashland Inc. and certain executive officers
of Ashland (filed as Exhibit 10(c).12 to Ashland's
Form 10-K for the fiscal year ended September 30,
1989, and incorporated herein by reference).
10.10 - Form of Indemnification Agreement between Ashland
Inc. and each member of its Board of Directors (filed
as Exhibit 10(c).13 to Ashland's Form 10-K for the
fiscal year ended September 30, 1990, and
incorporated herein by reference).
10.11 - Ashland Inc. Nonqualified Excess Benefit Pension
Plan.
10.12 - Ashland Inc. Long-Term Incentive Plan (filed as
Exhibit 10.12 to Ashland's Form 10-K for the fiscal
year ended September 30, 1996, and incorporated
herein by reference).
10.13 - Ashland Inc. Directors' Charitable Award Program
(filed as Exhibit 10.13 to Ashland's Form 10-K for
the fiscal year ended September 30, 1996, and
incorporated herein by reference).
10.14 - Ashland Inc. 1993 Stock Incentive Plan (filed as
Exhibit 10.14 to Ashland's Form 10-K for the fiscal
year ended September 30, 1996, and incorporated
herein by reference).
10.15 - Ashland Inc. 1995 Performance Unit Plan (filed as
Exhibit 10.15 to Ashland's Form 10-K for the fiscal
year ended September 30, 1996, and incorporated
herein by reference).
10.16 - Ashland Inc. Incentive Compensation Plan for Key
Executives (filed as Exhibit 10.16 to Ashland's Form
10-K for the fiscal year ended September 30, 1996,
and incorporated herein by reference).
10.17 - Ashland Inc. Deferred Compensation Plan (filed as
Exhibit 10.17 to Ashland's Form 10-K for the fiscal
year ended September 30, 1997, and incorporated
herein by reference).
10.18 - Ashland Inc. 1997 Stock Incentive Plan.
10.19 - Limited Liability Company Agreement of Marathon
Ashland Petroleum LLC dated as of January 1, 1998
(filed as Exhibit 10.1 to Ashland's Form 8-K, dated
January 1, 1998, and incorporated herein by
reference).
10.20 - Put/Call, Registration Rights and Standstill
Agreement dated as of January 1, 1998 among Marathon
Oil Company, USX Corporation, Ashland Inc. and
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<PAGE>
Marathon Ashland Petroleum LLC (filed as Exhibit 10.2
to Ashland's Form 8-K, dated January 1, 1998, and
incorporated herein by reference).
11 - Computation of Earnings Per Share (appearing on
Page 49 of Ashland's Annual Report to Shareholders,
incorporated by reference herein, for the fiscal year
ended September 30, 1998).
13 - Portions of Ashland's Annual Report to
Shareholders, incorporated by reference herein, for
the fiscal year ended September 30, 1998.
21 - List of subsidiaries.
23.1 - Consent of Ernst & Young LLP.
23.2 - Consent of PricewaterhouseCoopers LLP.
23.3 - Consent of Ernst & Young LLP.
24 - Power of Attorney, including resolutions of the
Board of Directors.
27.1 - Financial Data Schedule for the fiscal year ended
September 30, 1998.
27.2 - Restated Financial Data Schedule for the fiscal
year ended September 30, 1997.
27.3 - Restated Financial Data Schedule for the fiscal year
ended September 30, 1996.
Upon written or oral request, a copy of the above exhibits will be
furnished at cost.
(b) Reports on Form 8-K
None
5
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of
1934, the registrant has duly caused this Amendment to be signed on its
behalf by the undersigned thereunto duly authorized.
ASHLAND INC.
(Registrant)
Date: March 17, 1999 /s/ David L. Hausrath
----------------------------
Name: David L. Hausrath
Title: Vice President and
General Counsel
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<PAGE>
MARATHON ASHLAND PETROLEUM LLC AND SUBSIDIARIES
AUDITED CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1998
CONTENTS
Page
REPORT OF INDEPENDENT ACCOUNTANTS: 1
CONSOLIDATED FINANCIAL STATEMENTS:
CONSOLIDATED STATEMENT OF OPERATIONS ---------------------------- 2
CONSOLIDATED BALANCE SHEET -------------------------------------- 3
CONSOLIDATED STATEMENT OF CASH FLOWS ---------------------------- 4
CONSOLIDATED STATEMENT OF MEMBERS' CAPITAL ---------------------- 5
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS:
NOTE A - BUSINESS DESCRIPTION AND BASIS OF PRESENTATION ---- 6
NOTE B - SUMMARY OF PRINCIPAL ACCOUNTING POLICIES ---------- 6
NOTE C - NEW ACCOUNTING STANDARD --------------------------- 8
NOTE D - RELATED PARTY TRANSACTIONS ------------------------ 8
NOTE E - REVENUES ------------------------------------------ 9
NOTE F - OTHER ITEMS --------------------------------------- 9
NOTE G - PENSIONS AND OTHER POSTRETIREMENT BENEFITS -------- 9
NOTE H - INCOME TAXES -------------------------------------- 11
NOTE I - INVENTORIES --------------------------------------- 11
NOTE J - INVESTMENTS AND LONG-TERM RECEIVABLES ------------- 12
NOTE K - PROPERTY, PLANT AND EQUIPMENT --------------------- 12
NOTE L - LONG-TERM DEBT ------------------------------------ 13
NOTE M - SUPPLEMENTAL CASH FLOW INFORMATION ---------------- 13
NOTE N - LEASES -------------------------------------------- 14
NOTE O - DERIVATIVE INSTRUMENTS ---------------------------- 15
NOTE P - FAIR VALUE OF FINANCIAL INSTRUMENTS --------------- 16
NOTE Q - CONTINGENCIES AND COMMITMENTS --------------------- 16
NOTE R - SUBSEQUENT EVENT----------------------------------- 16
<PAGE>
Report of Independent Accountants
February 9, 1999, except as to Note R,
which is as of March 1, 1999
To the Board of Managers of
Marathon Ashland Petroleum LLC
In our opinion, the accompanying consolidated balance sheet and the related
consolidated statements of operations, of cash flows and of members'
capital present fairly, in all material respects, the financial position of
Marathon Ashland Petroleum LLC and its subsidiaries (MAP) at December 31,
1998, and the results of their operations and their cash flows for the year
then ended, in conformity with generally accepted accounting principles.
These financial statements are the responsibility of MAP's management; our
responsibility is to express an opinion on these financial statements based
on our audit. We conducted our audit of these financial statements in
accordance with generally accepted auditing standards which require that we
plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures
in the financial statements, assessing the accounting principles used and
significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audit provides a
reasonable basis for the opinion expressed above.
PricewaterhouseCoopers LLP
1
<PAGE>
CONSOLIDATED STATEMENT OF OPERATIONS (Dollars in millions)
MARATHON ASHLAND PETROLEUM LLC AND SUBSIDIARIES
<TABLE>
<CAPTION>
Year Ended
December 31, 1998
<S> <C>
Revenues:
Sales - Note E $ 19,300
Dividend and affiliate income 13
Gain on disposal of assets 6
Other income 20
--------
Total revenues 19,339
--------
Costs and expenses:
Cost of sales (excludes items shown below) 14,083
Selling, general and administrative expenses 387
Depreciation and amortization 275
Taxes other than income taxes 3,687
Inventory market valuation charge - Note I 269
--------
Total costs and expenses 18,701
--------
Income from operations 638
Net interest and other financial income - Note F 17
--------
Income before income taxes 655
Provision for estimated income taxes - Note H 1
--------
Net income $ 654
========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
2
<PAGE>
CONSOLIDATED BALANCE SHEET (Dollars in millions)
MARATHON ASHLAND PETROLEUM LLC AND SUBSIDIARIES
<TABLE>
<CAPTION>
December 31
1998
------------
<S> <C>
ASSETS
Current assets:
Cash and cash equivalents, including amounts invested with
related parties of $272 - Note D $ 272
Receivables, less allowance for doubtful accounts of $3 911
Inventories - Note I 1,264
Related party receivables - Note D 35
Other current assets 82
----------
Total current assets 2,564
Investments and long-term receivables - Note J 110
Long-term related party receivables - Note D 6
Property, plant and equipment - net - Note K 3,525
Prepaid pensions - Note G 44
Other noncurrent assets 81
----------
Total assets $ 6,330
==========
LIABILITIES
Current liabilities:
Accounts payable $ 1,467
Accounts payable to related parties - Note D 13
Distribution payable to related parties - Note D 272
Payroll and benefits payable 78
Accrued taxes 35
----------
Total current liabilities 1,865
Long-term debt - Note L 7
Long-term deferred income taxes - Note H 3
Employee benefits - Note G 250
Deferred credits and other liabilities 22
----------
Total liabilities 2,147
----------
MEMBERS' CAPITAL (details on page 5)
Members' contributed capital 4,188
Retained earnings --
Accumulated other comprehensive (losses) (5)
----------
Total members' capital 4,183
----------
Total liabilities and members' capital $ 6,330
=========
The accompanying notes are an integral part of these consolidated financial
statements.
3
<PAGE>
CONSOLIDATED STATEMENT OF CASH FLOWS (Dollars in millions)
MARATHON ASHLAND PETROLEUM LLC AND SUBSIDIARIES
</TABLE>
<TABLE>
Year Ended
December 31, 1998
-----------------
<S> <C>
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
OPERATING ACTIVITIES:
Net income $ 654
Adjustments to reconcile to net cash provided
from operating activities:
Depreciation and amortization 275
Inventory market valuation charge 269
Pensions and other postretirement benefits 22
Deferred income taxes (2)
Gain on disposal of assets (6)
Changes in:
Current receivables 194
Inventories (19)
Current accounts payable and accrued expenses (126)
Net receivables and payables with related parties 28
All other - net (69)
--------
Net cash provided from operating activities 1,220
--------
INVESTING ACTIVITIES:
Capital expenditures (400)
Disposal of assets 16
Affiliates - investments (22)
- repayments of advances 1
--------
Net cash used in investing activities (405)
--------
FINANCING ACTIVITIES:
Debt - additions 1
- repayments (24)
Member distributions (555)
--------
Net cash used in financing activities (578)
--------
NET INCREASE IN CASH AND CASH EQUIVALENTS 237
Cash and cash equivalents at beginning of year 35
--------
CASH AND CASH EQUIVALENTS AT END OF YEAR $ 272
========
See Note M for supplemental cash flow information.
The accompanying notes are an integral part of these consolidated financial
statements.
4
<PAGE>
CONSOLIDATED STATEMENT OF MEMBERS' CAPITAL (Dollars in millions)
MARATHON ASHLAND PETROLEUM LLC AND SUBSIDIARIES
</TABLE>
<TABLE>
<CAPTION>
Members' Capital Comprehensive Income
Year Ended Year Ended
December 31, 1998 December 31, 1998
------------------ --------------------
<S> <C>
Members' contributed capital:
Balance at beginning of year $ 4,361
Distribution to members (173)
---------
Balance at end of year 4,188
---------
Retained earnings:
Balance at beginning of year --
Net income 654 $ 654
Distributions to members (654)
---------
Balance at end of year --
---------
Accumulated other comprehensive (losses):
Minimum pension liability
adjustments:
Balance at beginning of year (4)
Changes during the year (1) (1)
--------- ---------
Balance at end of year (5)
---------
Total comprehensive income $ 653
=========
Total members' capital $ 4,183
=========
The accompanying notes are an integral part of these consolidated financial
statements.
5
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARATHON ASHLAND PETROLEUM LLC AND SUBSIDIARIES
NOTE A - BUSINESS DESCRIPTION AND BASIS OF PRESENTATION
On December 12, 1997 Marathon Oil Company (Marathon), a wholly owned
subsidiary of USX Corporation (USX), entered into an Asset Transfer and
Contribution Agreement with Ashland Inc. (Ashland) providing for the
formation of Marathon Ashland Petroleum LLC (MAP). Effective January 1,
1998, Marathon contributed substantially all of its refining, marketing and
transportation (RM&T) operations to MAP. Also, on January 1, 1998, Marathon
acquired certain RM&T net assets from Ashland in exchange for a 38%
interest in MAP. The purchase price was determined to be $1.9 billion,
based upon an external valuation. The acquisition of Ashland's net assets
was accounted for under the purchase method of accounting.
In connection with the formation of MAP, Marathon and Ashland entered into
a Limited Liability Company Agreement (LLC Agreement) dated January 1,
1998. The LLC Agreement provides for an initial term expiring on December
31, 2022 (25 years from its formation). The term will automatically be
extended for ten-year periods, unless a termination notice is given by
either party.
Also in connection with the formation of MAP, the parties entered into a
Put/Call, Registration Rights and Standstill Agreement (the Put/Call
Agreement). The Put/Call Agreement provides that at any time after December
31, 2004, Ashland will have the right to sell to Marathon all of Ashland's
ownership interest in MAP, for an amount in cash and/or Marathon or USX
debt or equity securities equal to the product of 85% (90% if equity
securities are used) of the fair market value of MAP at that time,
multiplied by Ashland's percentage interest in MAP. Payment could be made
at closing, or at Marathon's option, in three equal annual installments,
the first of which would be payable at closing. At any time after December
31, 2004, Marathon will have the right to purchase all of Ashland's
ownership interests in MAP, for an amount in cash equal to the product of
115% of the fair market value of MAP at that time, multiplied by Ashland's
percentage interest in MAP.
MAP is engaged in petroleum supply, refining, marketing & transportation
operations and includes Speedway SuperAmerica LLC, a wholly owned
subsidiary, which operates retail outlets for petroleum products. In
addition, MAP, through its wholly owned subsidiary, Scurlock Permian LLC,
is actively engaged in the purchasing, selling and trading of crude oil in
Texas, Oklahoma and Louisiana.
NOTE B - SUMMARY OF PRINCIPAL ACCOUNTING POLICIES
PRINCIPLES APPLIED IN CONSOLIDATION - The consolidated financial statements
include the accounts of MAP and the majority-owned subsidiaries which it
controls. Investments in undivided interest pipelines are consolidated on a
pro rata basis. Investments in other entities over which MAP has
significant influence are accounted for using the equity method of
accounting and are carried at MAP's share of net assets plus advances.
Investments in companies whose stocks have no readily determinable fair
value are carried at cost.
USE OF ESTIMATES - Generally accepted accounting principles require
management to make estimates and assumptions that affect the reported
amounts of assets and liabilities, the disclosure of contingent assets and
liabilities at year-end and the reported amounts of revenues and expenses
during the year. Significant items subject to such estimates and
assumptions include the carrying value of long-lived assets; valuation
allowances for receivables and inventories; environmental liabilities,
liabilities for potential tax deficiencies and potential litigation claims
and settlements; and assets and obligations related to employee benefits.
Additionally, certain estimated liabilities are recorded when management
commits to a plan to close an operating facility or to exit a business
activity. Actual results could differ from the estimates and assumptions
used.
REVENUE RECOGNITION - Revenues principally include sales, dividend and
affiliate income and gains or losses on the disposal of assets.
Sales are recognized when products are shipped or services are provided to
customers. Consumer excise taxes on petroleum products and merchandise and
matching crude oil and refined products buy/sell transactions settled in
cash are included in both revenues and costs and expenses, with no effect
on income.
6
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
NOTE B - SUMMARY OF PRINCIPAL ACCOUNTING POLICIES - Continued
Dividend and affiliate income includes MAP's proportionate share of income
from equity method investments and dividend income from other investments.
Dividend income is recognized when dividend payments are received.
When long-lived assets depreciated on an individual basis are sold or
otherwise disposed of, any gains or losses are reflected in income. Such
gains or losses on the disposal of long-lived assets are recognized when
title passes to the buyer and, if applicable, all significant regulatory
approvals are received. Proceeds from disposal of long-lived assets
depreciated on a group basis are credited to accumulated depreciation and
amortization with no immediate effect on income.
CASH AND CASH EQUIVALENTS - Cash and cash equivalents include cash on hand
and on deposit and investments with related parties in highly liquid debt
instruments with maturities of three months or less. See Note D for
information regarding investments with related parties.
INVENTORIES - Inventories are carried at lower of cost or market. Cost of
inventories is determined primarily under the last-in, first-out (LIFO)
method.
DERIVATIVE INSTRUMENTS - MAP engages in commodity risk management
activities within the normal course of its business as an end-user of
derivative instruments (see Note O). Management is authorized to manage
exposure to price fluctuations related to the purchase or sale of crude
oil, refined products and natural gas through the use of a variety of
derivative financial and nonfinancial instruments. Derivative financial
instruments require settlement in cash and include such instruments as
over-the-counter (OTC) commodity swap agreements and OTC commodity options.
Derivative nonfinancial instruments require or permit settlement by
delivery of commodities and include exchange-traded commodity futures
contracts and options. At times, derivative positions are closed, prior to
maturity, simultaneous with the underlying physical transaction, and the
effects are recognized in income accordingly. MAP's practice does not
permit derivative positions to remain open if the underlying physical
market risk has been removed. Changes in the market value of derivative
instruments are deferred, including both closed and open positions, and are
subsequently recognized in income, as sales or cost of sales, in the same
period as the underlying transaction. The effects of changes in the market
indices related to OTC swaps are recorded and recognized in income with the
underlying transaction. Premiums on all commodity-based option contracts
are initially recorded based on the amount paid or received; the options'
market value is subsequently recorded as a receivable or payable, as
appropriate. The margin receivable accounts required for open commodity
contracts reflect changes in the market prices of the underlying commodity
and are settled on a daily basis.
Recorded deferred gains or losses are reflected within other current assets
or accounts payable. Cash flows from the use of derivative instruments are
reported in the same category as the hedged item in the statement of cash
flows.
LONG-LIVED ASSETS - Property, plant and equipment are depreciated
principally by the straight-line method. Expenditures for refinery
turnarounds are expensed ratably in the calendar year in which they occur.
MAP evaluates impairment of its assets on an individual asset basis or by
logical groupings of assets. Assets deemed to be impaired are written down
to their fair value, including any related goodwill, using discounted
future cash flows and, if available, comparable market values.
ENVIRONMENTAL LIABILITIES - MAP provides for remediation costs and
penalties when the responsibility to remediate is probable and the amount
of associated costs is reasonably determinable. Generally, the timing of
remediation accruals coincides with completion of a feasibility study or
the commitment to a formal plan of action. Remediation liabilities are
accrued based on estimates of known environmental exposure and could be
discounted in certain instances. If recoveries of remediation costs from
third parties are probable, a receivable is recorded.
INSURANCE - MAP is insured for catastrophic casualty and certain property
and business interruption exposures, as well as those risks required to be
insured by law or contract. Costs resulting from noninsured losses are
charged against income upon occurrence.
INCOME TAXES - MAP is a limited liability company, and therefore, is not
subject to U.S. federal income taxes. Accordingly, the taxable income or
loss resulting from operations of MAP is ultimately included in the U.S.
federal income tax returns of USX and Ashland. MAP is, however, subject to
income taxes in certain state, local and foreign jurisdictions.
7
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
NOTE C - NEW ACCOUNTING STANDARD
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, "Accounting for Derivative
Instruments and Hedging Activities" (SFAS No. 133). This new Standard
requires recognition of all derivatives as either assets or liabilities at
fair value. SFAS No. 133 may result in additional volatility in both
current period earnings and other comprehensive income as a result of
recording recognized and unrecognized gains and losses resulting from
changes in the fair value of derivative instruments. SFAS 133 requires a
comprehensive review of all outstanding derivative instruments to determine
whether or not their use meets the hedge accounting criteria. It is
possible that there will be derivative instruments employed in MAP's
businesses that do not meet all of the designated hedge criteria, and they
will be reflected in income on a mark-to-market basis. Based upon the
strategies currently employed by MAP, the relatively short-term duration of
most of MAP's derivative strategies, and the level of activity related to
commodity-based derivative instruments in recent periods, MAP does not
anticipate the effect of adoption to have a material impact on either
financial position or results of operations. MAP plans to adopt SFAS No.
133 effective January 1, 2000, as required.
NOTE D - RELATED PARTY TRANSACTIONS
MAP sales in 1998 to Ashland and its affiliates were $185 million and sales
to USX and its affiliates were $10 million. MAP purchases from Ashland and
its affiliates totaled $18 million and purchases from USX and its
affiliates totaled $284 million. Such transactions were in the ordinary
course of business and include the purchase, sale and transportation of
crude oil and petroleum products. These transactions were conducted on an
arm's-length basis.
During the year ended December 31, 1998, Ashland and Marathon provided
computer, treasury, accounting, internal auditing and legal services and
facilities to MAP. Billings to MAP for these services and facilities for
the year ended December 31, 1998 from Ashland and Marathon totaled $27
million and $83 million, respectively.
As of December 31, 1998, related party receivables include $22 million of
accounts receivable due from Ashland and its affiliates and accounts
payable to related parties include $3 million due to Ashland and its
affiliates. As of December 31, 1998, related party receivables include $13
million of accounts receivable due from USX and its affiliates and accounts
payable to related parties include $10 million due to USX and its
affiliates.
As of December 31, 1998, the distribution payable to related parties
includes $169 million due to Marathon and $103 million due to Ashland.
In connection with the formation of MAP, certain Marathon debt was assigned
to MAP. Marathon agreed to reimburse MAP for this debt and related interest
expense. During the year, Marathon reimbursed MAP $24 million for debt
repayments. Long-term related party receivables at December 31, 1998,
included $6 million due from Marathon for future debt payment
reimbursements.
A revolving credit agreement was entered into as of January 1, 1998, among
Ashland and Marathon (collectively the Lenders) and MAP (Borrower). This
agreement provides that the Lenders may loan to the Borrower up to $500
million at defined short-term market rates. At December 31, 1998, there
were no borrowings against this facility.
On November 16, 1998, MAP entered into agreements with USX and Ashland,
which allow MAP to invest its surplus cash balances on a daily basis at
competitive interest rates with USX and Ashland in proportion to their
ownership interests in MAP. At December 31, 1998, amounts held by USX and
Ashland, which are included in cash and cash equivalents, were $169 million
and $103 million, respectively. The agreements provide that invested cash
balances are payable upon the demand of MAP or March 15, 1999, whichever is
earlier.
8
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
NOTE E - REVENUES
The items below are included in revenues and costs and expenses, with no
effect on income.
</TABLE>
<TABLE>
<CAPTION>
Year Ended
December 31, 1998
-----------------
(Millions)
<S> <C>
Consumer excise taxes on petroleum products and merchandise $ 3,581
Matching crude oil and refined product buy/sell transactions settled in cash 3,657
</TABLE>
<TABLE>
<CAPTION>
NOTE F - OTHER ITEMS Year Ended
December 31, 1998
-----------------
(Millions)
<S> <C>
NET INTEREST AND OTHER FINANCIAL INCOME
INTEREST AND OTHER FINANCIAL INCOME:
Interest income - third parties $ 22
Interest income - related parties 1
--------
Total 23
--------
INTEREST AND OTHER FINANCIAL COSTS:
Interest incurred 1
Other 5
--------
Total 6
--------
NET INTEREST AND OTHER FINANCIAL INCOME $ 17
========
</TABLE>
NOTE G - PENSIONS AND OTHER POSTRETIREMENT BENEFITS
MAP has noncontributory defined pension benefit plans covering
substantially all employees. Benefits under its final pay plans are based
primarily upon years of service and the highest three years earnings during
the last ten years before retirement. Benefits under its pension equity
plan are based primarily upon age and years of service at retirement.
Certain subsidiaries provide benefits for employees covered by other plans
based primarily upon employees' service and career earnings.
MAP also has defined benefit retiree health and life insurance plans (other
benefits) covering most employees upon their retirement. Health benefits
are provided, for the most part, through comprehensive hospital, surgical
and major medical benefit provisions subject to various cost sharing
features. Life insurance benefits are provided to certain nonunion and most
union represented retiree beneficiaries primarily based on employees'
annual base salary at retirement. Other benefits have not been prefunded.
<TABLE>
<CAPTION>
Pension Benefits Other Benefits
--------------------- -----------------
1998 1998
(Millions)
<S> <C> <C>
CHANGE IN PROJECTED BENEFIT OBLIGATION
Benefit obligation at January 1 $ 52 $ 6
Service cost 26 7
Interest cost 20 10
Plan amendments (10) (30)
Actuarial losses 57 66
Acquisition and merger 392 184
Benefits paid (12) (1)
---------- ----------
Benefit obligations at December 31 $ 525 $ 242
========== =========
</TABLE>
9
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
NOTE G - PENSIONS AND OTHER POSTRETIREMENT BENEFITS - Continued
<TABLE>
<CAPTION>
Pension Benefits Other Benefits
----------------------- --------------------
1998 1998
(Millions)
<S> <C> <C>
CHANGE IN PLAN ASSETS
Fair value of plan assets at January 1 $ 24
Actual return on plan assets 41
Acquisition and merger 467
Employer contributions 8
Benefits paid (12)
----------
Fair value of plan assets at December 31 $ 528
==========
FUNDED STATUS OF PLANS AT DECEMBER 31 (a) $ 3 $ (242)
Unrecognized net gain from transition (12) --
Unrecognized prior service cost (credit) 6 (35)
Unrecognized actuarial (gains) losses (4) 86
Additional minimum liability (b) (6) --
---------- ----------
Accrued benefit cost $ (13) $ (191)
========== ==========
(a) Includes several small plans that have accumulated benefit obligations
and no plan assets:
Projected benefit obligation $ (15)
(b) Additional minimum liability recorded was offset by the following:
Intangible asset $ 1
---------
Accumulated other comprehensive (losses):
Beginning of year $ (4)
Change during year (1)
----------
Balance at end of year $ (5)
==========
COMPONENTS OF NET PERIODIC
BENEFIT COST (CREDIT)
Service cost $ 26 $ 7
Interest cost 20 10
Return on plan assets - actual (41) --
- deferred gain 9 --
Other plans 2 --
---------- ----------
Net periodic benefit cost $ 16 $ 17
========== ==========
ACTUARIAL ASSUMPTIONS:
Discount rate 6.5% 6.5%
Expected annual return on plan assets 9.5% 9.5%
Increase in compensation rate 5.0% 5.0%
For measurement purposes, an 8% annual rate of increase in the per capita
cost of covered health care benefits was assumed for 1999. The rate was
assumed to decrease gradually to 5% for 2005 and remain at that level
thereafter.
A one-percentage-point change in assumed health care cost trend rates would
have the following effects:
</TABLE>
<TABLE>
<CAPTION>
1-Percentage- 1-Percentage-
Point Increase Point Decrease
-------------- ---------------
(Millions)
<S> <C> <C>
Effect on total of service and interest cost components $ 6 $ (4)
Effect on postretirement benefit obligation 47 (36)
</TABLE>
10
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
NOTE H - INCOME TAXES
The taxable income or loss resulting from operations of MAP is ultimately
included in the federal income tax returns of USX and Ashland. MAP is,
however, subject to taxation in certain state, local and foreign
jurisdictions.
<TABLE>
<CAPTION>
Provisions (credits) for estimated income taxes:
Year Ended December 31, 1998
----------------------------------------
Current Deferred Total
------- ---------- -----
(Millions)
<S> <C> <C> <C>
Total state and local taxes $ 3 $ (2) $ 1
========= ======== ========
</TABLE>
Deferred tax liabilities of $5 million principally arise from differences
between the book and tax basis of inventories and property, plant and
equipment. Pretax income included $1 million attributable to foreign
sources in 1998.
NOTE I - INVENTORIES
Inventories consist of the following:
December 31,
1998
------------
(Millions)
Crude oil and natural gas liquids $ 715
Refined products and merchandise 1,028
Supplies and sundry items 73
---------
Total (at cost) 1,816
Less inventory market valuation reserve 552
---------
Net inventory carrying value $ 1,264
=========
Inventories of crude oil and refined products are valued by the LIFO
method. The LIFO method accounted for 90% of total inventory at December
31, 1998.
The inventory market valuation reserve reflects the extent that the
recorded LIFO cost basis of crude oil and refined products inventories
exceeds net realizable value. The reserve is decreased to reflect increases
in market prices and inventory turnover and increased to reflect decreases
in market prices. Changes in the inventory market valuation reserve result
in noncash charges or credits to costs and expenses.
11
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
NOTE J - INVESTMENTS AND LONG-TERM RECEIVABLES
December 31,
1998
-------------
(Millions)
Equity method investments $ 106
Receivables due after one year 4
---------
Total $ 110
=========
The following represents summarized financial information of affiliates
accounted for by the equity method of accounting:
Year Ended
December 31
1998
-------------
(Millions)
Income data:
Revenues $ 171
Operating income 61
Net income 31
December 31
1998
-------------
(Millions)
Balance sheet data:
Current assets $ 57
Noncurrent assets 647
Current liabilities 84
Noncurrent liabilities 455
Dividends and partnership distributions received from equity affiliates
were $14 million in 1998. MAP purchases from equity affiliates totaled $63
million in 1998. MAP sales to equity affiliates were immaterial.
NOTE K - PROPERTY, PLANT AND EQUIPMENT
December 31,
1998
-------------
(Millions)
Refining $ 2,027
Marketing 1,945
Transportation 1,310
Other 5
---------
Total 5,287
Less accumulated depreciation and amortization 1,762
---------
Net $ 3,525
=========
12
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
NOTE L - LONG-TERM DEBT
<TABLE>
<CAPTION>
December 31,
1998
-------------
(Millions)
<S> <C>
Variable rate Michigan Underground Storage Tank Interest Rate Subsidy Loan
due 2000 (a) $ 6
5% Promissory Note due 2009 1
Revolving Credit Facilities (b) (c) --
---------
Total long-term debt due after one year $ 7
=========
</TABLE>
(a) This program was created in connection with the Michigan Underground
Storage Tank Assurance Act to assist owners in the clean up of
underground storage tank systems. MAP pays interest monthly, based on a
monthly LIBOR rate plus 5/8%. An interest subsidy is received quarterly
from the State of Michigan calculated at a rate of 6.1% per annum. The
effective rate of this loan during 1998, including the effect of the
interest subsidy was 1.6%. Marathon is obligated to reimburse MAP for
all payments with respect to this debt.
(b) In 1998, MAP entered into a revolving credit facility for $100 million
that terminates in July 1999 and a $400 million revolving credit
facility that terminates in July 2003. Interest is based on defined
short-term market rates for both facilities. During the terms of the
agreements, MAP is obligated to pay a variable facility fee on total
commitments. At December 31, 1998, the facility fee was 0.10% for the
$100 million facility and 0.125% for the $400 million facility. At
December 31, 1998, the unused and available credit was $500 million. In
the event MAP defaults on indebtedness (as defined in the agreement) in
excess of $100 million, USX has guaranteed the payment of any
outstanding obligations.
(c)In 1998, MAP entered into a revolving credit agreement with Marathon
and Ashland for $500 million that terminated on December 31, 1998, and
which was renewed on an uncommitted basis for 1999. Interest is based
on defined short-term market rates. At December 31, 1998, the unused
and available credit was $500 million.
NOTE M - SUPPLEMENTAL CASH FLOW INFORMATION
<TABLE>
<CAPTION>
Year Ended
December 31, 1998
-----------------
(Millions)
<S> <C>
CASH PROVIDED FROM OPERATING ACTIVITIES INCLUDES:
Interest and other financial costs paid $ (1)
Income taxes paid (3)
13
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
NOTE N - LEASES
Future minimum commitments for operating leases having remaining
noncancelable lease terms in excess of one year are as follows:
</TABLE>
<TABLE>
<CAPTION>
Operating
Leases
----------
(Millions)
<S> <C>
1999 $ 53
2000 49
2001 34
2002 20
2003 11
Later years 30
Sublease rentals (10)
--------
Total minimum lease payments $ 187
========
</TABLE>
<TABLE>
<CAPTION>
Operating lease rental expense:
Year Ended
December 31, 1998
-----------------
(Millions)
<S> <C>
Minimum rental $ 74
Contingent rental 11
Sublease rentals (1)
-------
Net rental expense $ 84
=======
</TABLE>
MAP leases a wide variety of facilities and equipment under operating
leases, including land and building space, office equipment, production
facilities and transportation equipment. Most long-term leases include
renewal options and, in certain leases, purchase options.
14
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
NOTE O - DERIVATIVE INSTRUMENTS
MAP uses commodity-based derivative instruments to manage exposure to price
fluctuations related to the anticipated purchase or sale of crude oil,
refined products, and natural gas. The derivative instruments used, as part
of an overall risk management program, include exchange-traded futures
contracts and options, and instruments which require settlement in cash
such as OTC commodity swaps and OTC options. While risk management
activities generally reduce market risk exposure due to unfavorable
commodity price changes for raw material purchases and products sold, such
activities can also encompass strategies which assume certain price risk in
isolated transactions.
MAP remains at risk for possible changes in the market value of the
derivative instrument; however, such risk should be mitigated by price
changes in the underlying hedged item. MAP is also exposed to credit risk
in the event of nonperformance by counterparties. The credit worthiness of
counterparties is subject to continuing review, including the use of master
netting agreements to the extent practical, and full performance is
anticipated.
The following table sets forth quantitative information by class of
derivative instrument:
<TABLE>
<CAPTION>
Fair Carrying Recorded
Value Amount Deferred Aggregate
Assets Assets Gain or Contract
(Liabilities) (a) (Liabilities) (Loss) Values (b)
------------- ------------- --------- -----------
(Millions)
<S> <C> <C> <C> <C>
December 31, 1998:
Exchange-traded commodity futures $ -- $ -- $ (3) $ 96
Exchange-traded commodity options 1 (c) 1 1 709
OTC commodity swaps (d) -- (e) -- -- 140
------- ------ ------- ------
Total commodities $ 1 $ 1 $ (2) $ 945
======= ====== ======= ======
</TABLE>
(a) The fair value amounts for OTC positions are based on various indices
or dealer quotes. The exchange-traded futures contracts and certain
option contracts do not have a corresponding fair value since changes
in the market prices are settled on a daily basis.
(b) Contract or notional amounts do not quantify risk exposure, but are
used in the calculation of cash settlements under the contracts. The
contract or notional amounts do not reflect the extent to which
positions may offset one another.
(c) Includes fair values as of December 31, 1998, for assets of $20
million and liabilities of ($19) million, respectively.
(d) The OTC swap arrangements vary in duration with certain contracts
extending into mid-1999.
(e) Includes fair values as of December 31, 1998, for assets of $25
million and for liabilities of ($25) million, respectively.
15
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
NOTE P - FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying value of most financial instruments are based on historical
costs. The carrying values of cash and cash equivalents, receivables,
payables, and debt approximate their fair value.
MAP's unrecognized financial instruments consist of financial guarantees.
It is not practicable to estimate the fair value of these forms of
financial instrument obligations because there are no quoted market prices
for transactions which are similar in nature. For details relating to
financial guarantees, see Note Q.
NOTE Q - CONTINGENCIES AND COMMITMENTS
MAP is the subject of, or party to, a number of pending or threatened legal
actions, contingencies and commitments involving a variety of matters,
including laws and regulations relating to the environment. Certain of
these matters are discussed below. The ultimate resolution of these
contingencies could, individually or in the aggregate, be material to the
MAP financial statements. However, management believes that MAP will remain
a viable and competitive enterprise even though it is possible that these
contingencies could be resolved unfavorably to MAP.
ENVIRONMENTAL MATTERS - MAP is subject to federal, state, local and foreign
laws and regulations relating to the environment. These laws generally
provide for control of pollutants released into the environment and require
responsible parties to undertake remediation of hazardous waste disposal
sites. Penalties may be imposed for noncompliance. Marathon and Ashland
have retained the liabilities subject to certain thresholds for costs
associated with remediating properties conveyed to MAP for conditions
existing prior to January 1, 1998. The costs associated with these
thresholds are not expected to be material to the MAP financial statements.
At December 31, 1998, MAP's accrued liabilities for remediation totaled $3
million. It is not presently possible to estimate the ultimate amount of
all remediation costs that might be incurred or the penalties that may be
imposed. Receivables for recoverable costs from certain states, under
programs to assist companies in clean up efforts related to underground
storage tanks at retail marketing outlets, were $1 million at December 31,
1998.
MAP has made substantial capital expenditures to bring existing facilities
into compliance with various laws relating to the environment. In 1998,
such capital expenditures for environmental controls totaled $82 million.
MAP anticipates making additional such expenditures in the future; however,
the exact amounts and timing of such expenditures are uncertain because of
the continuing evolution of specific regulatory requirements.
GUARANTEES - At December 31, 1998, MAP's pro rata share of obligations of
LOCAP INC. and Southcap Pipe Line Company secured by throughput and
deficiency agreements totaled $23 million. Under the agreements, MAP is
required to advance funds if the affiliates are unable to service debt. Any
such advances are treated as prepayments of future transportation charges.
COMMITMENTS - At December 31, 1998, MAP's contract commitments for capital
expenditures for property, plant and equipment totaled $38 million.
NOTE R - SUBSEQUENT EVENT
On March 1, 1999, MAP announced that it had signed a memorandum of
understanding to sell Scurlock Permian LLC, which is actively engaged in
the purchasing, selling and trading of crude oil. The transaction, subject
to customary closing conditions, is expected to close in the second quarter
of 1999.
16
<PAGE>
ARCH COAL, INC. AND SUBSIDIARIES
AUDITIED CONSOLIDATED FINANCIAL STATEMENTS
CONTENTS
Page*
CONSOLIDATED FINANCIAL STATEMENTS:
Report of Independent Auditors 40
Consolidated Statements of Income -- Years Ended December 42
31, 1998, 1997 and 1996
Consolidated Balance Sheets -- December 31, 1998 and 1997 43
Consolidated Statements of Stockholders' Equity -- Years
Ended December 31, 1998, 1997 and 1996 44
Consolidated Statements of Cash Flows -- Years Ended
December 31, 1998, 1997 and 1996 45
Notes to Consolidated Financial Statements 46
CONSOLIDATED FINANCIAL STATEMENT SCHEDULE
Schedule II -- Valuation and Qualifying Accounts 23
All other schedules for which provision is made in the
applicable accounting regulations of the Securities and
Exchange Commission are not required under the related
instructions or are inapplicable and, therefore, have been
omitted.
*Page numbers correspond to Arch Coal's 1998 Annual Report to
Stockholders or Form 10-K, as appropriate.
<PAGE>
To the Stockholders and Board of Directors
Arch Coal, Inc.
We have audited the accompanying consolidated balance sheets of Arch
Coal, Inc. and subsidiaries as of December 31, 1998 and 1997 and the
related consolidated statements of income, stockholders' equity, and cash
flows for the years then ended. These financial statements are the
responsibility of the Company's management. Our responsibility is to
express an opinion on these financial statements based on our audits. The
consolidated financial statements of Arch Coal, Inc. as of December 31,
1996 and for the year then ended were audited by other auditors whose
report dated January 16, 1997, expressed an unqualified opinion on those
statements.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used
and significant estimates made by management, as well as evaluating the
overall financial statement presentation. We believe that our audits
provide a reasonable basis for our opinion.
In our opinion, the 1998 and 1997 financial statements referred to
above (appearing on pages 42 to 64 of this Annual Report) present fairly,
in all material respects, the consolidated financial position of Arch Coal,
Inc. and subsidiaries at December 31, 1998 and 1997, and the consolidated
results of their operations and their cash flows for the years then ended,
in conformity with generally accepted accounting principles.
Ernst & Young LLP
Louisville, Kentucky
January 22, 1999
40
<PAGE>
CONSOLIDATED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
Year Ended December 31
------------------------------------------
(In thousands of dollars except per share data) 1998 1997 1996
------------------------------------------
<S> <C> <C> <C>
REVENUES
Coal sales ........................................................... $ 1,428,171 $ 1,034,813 $ 750,123
Income from equity investment ........................................ 6,786 -- --
Other revenues ....................................................... 70,678 32,062 30,498
-----------------------------------------
1,505,635 1,066,875 780,621
-----------------------------------------
COSTS AND EXPENSES
Cost of coal sales ................................................... 1,313,400 916,802 669,295
Selling, general and administrative expenses ......................... 44,767 28,885 20,435
Amortization of coal supply agreements ............................... 34,551 18,063 12,604
Merger-related expenses .............................................. -- 39,132 --
Other expenses ....................................................... 25,070 22,111 22,175
-----------------------------------------
1,417,788 1,024,993 724,509
-----------------------------------------
Income from operations ............................................... 87,847 41,882 56,112
-----------------------------------------
Interest expense, net:
Interest expense ..................................................... (62,202) (17,822) (18,783)
Interest income ...................................................... 756 721 1,191
-----------------------------------------
(61,446) (17,101) (17,592)
-----------------------------------------
Income before income taxes and extraordinary item .................... 26,401 24,781 38,520
Provision (benefit) for income taxes ...................................... (5,100) (5,500) 5,500
-----------------------------------------
Income before extraordinary item ..................................... 31,501 30,281 33,020
Extraordinary item from the extinguishment of debt ........................ (1,488) -- --
-----------------------------------------
NET INCOME ........................................................... $ 30,013 $ 30,281 $ 33,020
=========================================
Basic and diluted earnings per common share before extraordinary item ..... $ 0.79 $ 1.00 $ 1.58
=========================================
Basic and diluted earnings per common share ............................... $ 0.76 $ 1.00 $ 1.58
=========================================
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
42
<PAGE>
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
December 31
--------------------------
(In thousands of dollars except share and per share data) 1998 1997
--------------------------
<S> <C> <C>
ASSETS
Current assets
Cash and cash equivalents ....................................... $ 27,414 $ 9,177
Trade accounts receivable ....................................... 202,871 133,810
Other receivables ............................................... 24,584 14,046
Inventories ..................................................... 68,455 50,419
Prepaid royalties ............................................... 13,559 17,745
Deferred income taxes ........................................... 8,694 8,506
Other ........................................................... 7,757 9,475
--------------------------
Total current assets ........................................ 353,334 243,178
--------------------------
Property, plant and equipment
Coal lands and mineral rights ................................... 1,476,703 853,053
Plant and equipment ............................................. 1,111,120 890,303
Deferred mine development ....................................... 80,926 102,909
--------------------------
2,668,749 1,846,265
Less accumulated depreciation, depletion and amortization ....... (732,005) (696,339)
--------------------------
Property, plant and equipment, net .......................... 1,936,744 1,149,926
--------------------------
Other assets
Prepaid royalties ............................................... 31,570 20,826
Coal supply agreements .......................................... 201,965 185,306
Deferred income taxes ........................................... 83,209 44,023
Investment in Canyon Fuel ....................................... 272,149 --
Other ........................................................... 39,249 13,065
--------------------------
Total other assets .......................................... 628,142 263,220
--------------------------
Total assets ................................................ $ 2,918,220 $ 1,656,324
==========================
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities
Accounts payable ................................................ $ 129,528 $ 84,692
Accrued expenses ................................................ 142,630 88,082
Current portion of debt ......................................... 61,000 29,500
--------------------------
Total current liabilities ................................... 333,158 202,274
Long-term debt ....................................................... 1,309,087 248,425
Accrued postretirement benefits other than pension ................... 343,553 323,115
Accrued reclamation and mine closure ................................. 150,636 116,199
Accrued workers' compensation ........................................ 105,333 97,759
Accrued pension cost ................................................. 18,524 21,730
Other noncurrent liabilities ......................................... 39,713 35,324
--------------------------
Total liabilities ........................................... 2,300,004 1,044,826
--------------------------
Stockholders' equity
Common stock, $.01 par value, 100,000,000 shares authorized,
39,371,581 issued and outstanding in 1998 and 39,657,898
issued and outstanding in 1997 ................................ 397 397
Paid-in capital ................................................. 473,116 472,425
Retained earnings ............................................... 150,423 138,676
Treasury stock, at cost (333,952 shares) ........................ (5,720) --
--------------------------
Total stockholders' equity .................................. 618,216 611,498
--------------------------
Total liabilities and stockholders' equity .................. $ 2,918,220 $ 1,656,324
==========================
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
43
<PAGE>
CONSOLIDATED STATEMENTS OF
STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
Three Years Ended December 31, 1998
----------------------------------------------------------------
Treasury
(In thousands of dollars except share and per share data) Common Paid-In Retained Stock
Stock Capital Earnings at cost Total
----------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Balance at December 31, 1995 .................................... $ 209 $ 8,392 $ 105,091 $ -- $ 113,692
Net income ................................................. 33,020 33,020
Dividends paid ($.38 per share) ............................ (8,000) (8,000)
Income tax charge related to assets acquired
from related parties .................................... (8,086) (8,086)
----------------------------------------------------------------
Balance at December 31, 1996 .................................... 209 8,392 122,025 -- 130,626
Net income ................................................. 30,281 30,281
Dividends paid ($.445 per share) ........................... (13,630) (13,630)
Issuance of 18,660,054 shares of common stock
to stockholders of Ashland Coal, Inc. pursuant
to the merger agreement ................................ 187 462,984 463,171
Issuance of 49,400 shares of common stock
under the stock incentive plan ......................... 1 1,049 1,050
----------------------------------------------------------------
Balance at December 31, 1997 .................................... 397 472,425 138,676 -- 611,498
Net income ................................................. 30,013 30,013
Dividends paid ($.46 per share) ............................ (18,266) (18,266)
Issuance of 47,635 shares of common stock
under the stock incentive plan ......................... 691 691
Treasury stock purchases (333,952 shares) .................. (5,720) (5,720)
----------------------------------------------------------------
Balance at December 31, 1998 .................................... $ 397 $ 473,116 $ 150,423 $ (5,720) $ 618,216
================================================================
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
44
<PAGE>
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
Year Ended December 31
------------------------------------------
(In thousands of dollars) 1998 1997 1996
------------------------------------------
<S> <C> <C> <C>
OPERATING ACTIVITIES
Net income ................................................................ $ 30,013 $ 30,281 $ 33,020
Adjustments to reconcile to cash provided by operating activities:
Depreciation, depletion and amortization ............................. 204,307 143,632 114,703
Prepaid royalties expensed ........................................... 19,694 8,216 4,754
Net gain on disposition of assets .................................... (41,512) (4,802) (7,959)
Income from equity investment ........................................ (6,786) -- --
Distributions from equity investment ................................. 18,850 -- --
Merger-related expenses .............................................. -- 33,096 --
Changes in operating assets and liabilities .......................... (24,671) (28,842) (551)
Other ................................................................ (11,872) 8,682 (5,496)
-----------------------------------------
Cash provided by operating activities ......................... 188,023 190,263 138,471
-----------------------------------------
INVESTING ACTIVITIES
Payments for acquisition .................................................. (1,126,706) -- --
Additions to property, plant and equipment ................................ (141,737) (77,309) (62,490)
Additions to coal supply agreements ....................................... -- -- (7,150)
Additions to prepaid royalties ............................................ (26,252) (7,967) (7,071)
Additions to notes receivable ............................................. (10,906) -- --
Proceeds from dispositions of property, plant and equipment ............... 34,230 5,267 4,073
-----------------------------------------
Cash used in investing activities ................................ (1,271,371) (80,009) (72,638)
-----------------------------------------
FINANCING ACTIVITIES
Proceeds from (payments on) revolver and lines of credit .................. 176,582 78,897 (11,000)
Net proceeds from term loans .............................................. 958,441 -- --
Payments on notes ......................................................... (42,860) (181,110) (50,619)
Payments for debt issuance costs .......................................... (12,725) -- --
Proceeds from sale and leaseback of equipment ............................. 45,442 -- --
Dividends paid ............................................................ (18,266) (13,630) (8,000)
Proceeds from sale of common stock 691 1,050 --
Purchases of treasury stock ............................................... (5,720) -- --
-----------------------------------------
Cash provided (used) in financing activities .................. 1,101,585 (114,793) (69,619)
-----------------------------------------
Increase (decrease) in cash and cash equivalents .............. 18,237 (4,539) (3,786)
Cash and cash equivalents, beginning of year .............................. 9,177 13,716 17,502
-----------------------------------------
Cash and cash equivalents, end of year .................................... $ 27,414 $ 9,177 $ 13,716
=========================================
SUPPLEMENTAL CASH FLOW INFORMATION
Cash paid during the year for interest .................................... $ 48,760 $ 18,593 $ 20,294
Cash paid during the year for income taxes, net of refunds ................ $ 29,090 $ 21,918 $ 14,731
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
45
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands of dollars except share and per share data)
1. ACCOUNTING POLICIES
Principles of Consolidation
The consolidated financial statements include the accounts of Arch Coal,
Inc. and its subsidiaries ("the Company"), which operate in the coal mining
industry. The Company operates one reportable segment: the production of
steam and metallurgical coal from surface and deep mines throughout the
United States, for sale to utility, industrial and export markets. The
Company's mines are primarily located in the central Appalachian and
western regions of the United States. All subsidiaries (except as noted
below) are wholly owned. Significant intercompany transactions and accounts
have been eliminated in consolidation.
The Company's 65% ownership of Canyon Fuel, LLC (Canyon Fuel) is
accounted for on the equity method in the consolidated financial statements
as a result of certain super-majority voting rights in the joint venture
agreement. Income from Canyon Fuel is reflected in the consolidated
statements of income as income from equity investment. (See additional
discussion in "Investment in Canyon Fuel" in Note 3).
The Company's 17.5% partnership interest in Dominion Terminal
Associates is accounted for on the equity method in the consolidated
balance sheets. Allocable costs of the partnership for coal loading and
storage are included in other expenses in the consolidated statements of
income.
Accounting Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the
financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those
estimates.
Cash and Cash Equivalents
Cash and cash equivalents are stated at cost. Cash equivalents consist of
highly liquid investments with an original maturity of three months or less
when purchased.
Inventories
Inventories are comprised of the following:
<TABLE>
<CAPTION>
December 31
------------------
1998 1997
------------------
<S> <C> <C>
Coal .......... $25,789 $25,359
Supplies ...... 42,666 25,060
-----------------
$68,455 $50,419
=================
</TABLE>
Coal and supplies inventories are valued at the lower of average cost or
market. The Company has recorded a valuation allowance for slow-moving and
obsolete supplies inventories of $23.9 million and $17.7 million at
December 31, 1998 and 1997, respectively.
Coal Acquisition Costs and Prepaid Royalties
Coal lease rights obtained through acquisitions are capitalized and
amortized primarily by the units-of-production method over the estimated
recoverable reserves.
Rights to leased coal lands are often acquired through royalty
payments. Where royalty payments represent prepayments recoupable against
production, they are capitalized, and amounts expected to be recouped
within one year are classified as a current asset. As mining occurs on
these leases, the prepayment is offset against earned royalties and is
included in the cost of coal sales.
Coal Supply Agreements
Acquisition costs related to coal supply agreements (sales contracts) are
capitalized and amortized on the basis of coal to be shipped over the term
of the contract. Accumulated amortization for sales contracts was $94.8
million and $60.3 million at December 31, 1998 and 1997, respectively.
46
<PAGE>
Exploration Costs
Costs related to locating coal deposits and determining the economic
mineability of such deposits are expensed as incurred.
Property, Plant and Equipment
Property, plant and equipment are recorded at cost. Interest costs
applicable to major asset additions are capitalized during the construction
period. Expenditures which extend the useful lives of existing plant and
equipment are capitalized. Costs of purchasing rights to coal reserves and
developing new mines or significantly expanding the capacity of existing
mines are capitalized and amortized using the units-of-production method
over the estimated recoverable reserves. Plant and equipment are
depreciated principally on the straight-line method over the estimated
useful lives of the assets, which range from three to 20 years.
Asset Impairment
If facts and circumstances suggest that a long-lived asset may be impaired,
the carrying value is reviewed. If this review indicates that the value of
the asset will not be recoverable, as determined based on projected
undiscounted cash flows related to the asset over its remaining life, then
the carrying value of the asset is reduced to its estimated fair value.
Revenue Recognition
Coal sales revenues include sales to customers of coal produced at Company
operations and purchased from other companies. The Company recognizes
revenue from coal sales at the time title passes to the customer. Revenues
from sources other than coal sales, including gains and losses from
dispositions of long-term assets, are included in other revenues and are
recognized as services are performed or otherwise earned.
Interest Rate Swap Agreements
The Company enters into interest-rate swap agreements to modify the
interest characteristics of outstanding Company debt. The swap agreements
essentially convert variable-rate debt to fixed-rate debt. These agreements
require the exchange of amounts based on variable interest rates for
amounts based on fixed interest rates over the life of the agreement. The
Company accrues amounts to be paid or received under interest-rate swap
agreements over the lives of the agreements. Such amounts are recognized as
adjustments to interest expense over the lives of agreements, thereby
adjusting the effective interest rate on the Company's debt. The fair
values of the swap agreements are not recognized in the financial
statements. Gains and losses on terminations of interest-rate swap
agreements would be deferred on the balance sheet (in other long-term
liabilities) and amortized as an adjustment to interest expense over the
remaining term of the terminated swap agreement.
Income Taxes
Deferred income taxes are based on temporary differences between the
financial statement and tax basis of assets and liabilities existing at
each balance sheet date using enacted tax rates for years during which
taxes are expected to be paid or recovered.
Stock Based Compensation
These financial statements include the disclosure requirements of Financial
Accounting Standards Board Statement No. 123 ("FAS 123"), Accounting for
Stock-Based Compensation. With respect to accounting for its stock options,
as permitted under FAS 123, the Company has retained the intrinsic value
method prescribed by Accounting Principles Board Opinion No. 25 ("APB 25"),
Accounting for Stock Issued to Employees, and related Interpretations.
Earnings Per Common Share
In 1997, FAS 128, Earnings per Share, was issued. FAS 128 replaced the
calculation of primary and fully diluted earnings per share ("EPS") with
basic and diluted EPS. Unlike primary, basic EPS excludes any dilutive
effects of
47
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands of dollars except per share and per share data)
options, warrants and convertible securities. Diluted EPS is very similar
to the previously reported fully diluted EPS. The adoption of the
provisions of FAS 128 did not have any effect on previously reported EPS
amounts.
Reclassifications
Certain amounts in the 1997 and 1996 financial statements have been
reclassified to conform with the classifications in the 1998 financial
statements with no effect on previously reported net income or
stockholders' equity.
2. MERGER AND ACQUISITION
On June 1, 1998, the Company acquired the Colorado and Utah coal operations
of Atlantic Richfield Company ("ARCO") and simultaneously combined the
acquired ARCO operations and the Company's Wyoming operations with ARCO's
Wyoming operations in a new joint venture named Arch Western Resources, LLC
("Arch Western"). The principal operating units of Arch Western are Thunder
Basin Coal Company, L.L.C., owned 100% by Arch Western, which operates two
coal mines in the Southern Powder River Basin in Wyoming; Mountain Coal
Company, L.L.C., owned 100% by Arch Western, which operates one coal mine
in Colorado; Canyon Fuel Company, LLC ("Canyon Fuel"), 65% owned by Arch
Western and 35% by ITOCHU Coal International, Inc., a subsidiary of ITOCHU
Corporation, which operates three coal mines in Utah; and Arch of Wyoming,
LLC, owned 100% by Arch Western, which operates two coal mines in the Hanna
Basin of Wyoming.
Arch Western is 99% owned by the Company and 1% owned by ARCO. The
transaction is valued at approximately $1.14 billion and a wholly owned
subsidiary of the Company is the managing member of Arch Western. The
transaction has been accounted for under the purchase method of accounting.
Accordingly, the cost to acquire ARCO's U.S. coal operations has been
allocated to the assets acquired and liabilities assumed according to their
respective estimated fair values. Results of operations of the acquired
operations are included in the consolidated statements of income effective
June 1, 1998. The acquired ARCO operations will continue to produce
low-sulfur coal for sale to primarily domestic utility customers.
On July 1, 1997, Ashland Coal, Inc. ("Ashland Coal") merged with a
subsidiary of the Company. Under the terms of the merger, Ashland Coal's
stockholders received one share of the Company's common stock for each
common share of Ashland Coal and 20,500 shares of the Company's common
stock for each share of Ashland Coal preferred stock. A total of 18,660,054
shares of Company common stock were issued in the merger, resulting in a
total purchase price (including fair value of stock options and transaction
related fees) of approximately $464.8 million. The merger was accounted for
under the purchase method of accounting. Results of operations of Ashland
Coal are included in the consolidated statements of income effective July
1, 1997.
Summarized below are the unaudited pro forma combined results of
operations for the years ended December 31, 1998 and 1997. These results
reflect the July 1, 1997 Ashland Coal merger as if it had occurred on
January 1, 1997 and the June 1, 1998 Arch Western transaction as if it had
occurred on January 1, 1998 and 1997.
<TABLE>
<CAPTION>
1998 1997
- --------------------------------------------------------
<S> <C> <C>
Revenues ..................... $1,669,824 $1,792,582
Income before
extraordinary item ...... 22,994 36,175
Net income ................... 21,506 36,175
Earnings per share before
extraordinary item ...... $ .58 $ .91
Earnings per share ........... $ .54 $ .91
</TABLE>
In the opinion of the management of the Company, all adjustments necessary
to present pro forma results of operations have been made. The unaudited
pro forma results of operations do not purport to be indicative of
48
<PAGE>
the results that would have occurred had these transactions actually
occurred at the beginning of the relevant periods or of the results of
operations that may be achieved in the future.
3. INVESTMENT IN CANYON FUEL
The following tables present unaudited summarized financial information for
Canyon Fuel which, as part of the June 1, 1998 Arch Western transaction
(described in Note 2), was acquired by the Company and is accounted for on
the equity method.
<TABLE>
<CAPTION>
SEVEN MONTHS
ENDED
DECEMBER 31,
CONDENSED INCOME STATEMENT INFORMATION 1998
- -------------------------------------------------------
<S> <C>
Revenues ............................... $155,634
Total costs and expenses ............... 153,039
--------
Net income ............................. 2,595
Effect of purchase adjustments ......... 4,191
--------
Arch Coal's income from its equity
investment in Canyon Fuel ......... $ 6,786
========
</TABLE>
The Company's income from its equity investment in Canyon Fuel represents
65% of Canyon Fuel's net income after adjusting for the effect of its
investment in Canyon Fuel. The Company's investment in Canyon Fuel reflects
purchase adjustments primarily related to sales contracts, mineral reserves
and other property, plant and equipment. The condensed balance sheet
information below reflects Canyon Fuel Company LLC's asset and liability
values and does not reflect the Company's investment in Canyon Fuel.
<TABLE>
<CAPTION>
AT DECEMBER
CONDENSED BALANCE SHEET INFORMATION 31, 1998
- -------------------------------------------------------
<S> <C>
Current assets ............................. $ 87,620
Noncurrent assets .......................... 532,119
Current liabilities ........................ 31,459
Noncurrent liabilities ..................... 19,247
Members' equity............................. 569,033
</TABLE>
4. ACCRUED EXPENSES
Accrued expenses consist of the following:
<TABLE>
<CAPTION>
December 31
------------------
1998 1997
- ---------------------------------------------------
<S> <C> <C>
Accrued payroll and
related benefits ........ $ 29,878 $17,314
Accrued taxes other than
income taxes ............ 44,665 22,259
Accrued postretirement
benefits other than
pension ................. 15,555 14,390
Accrued workers'
compensation ............ 15,869 12,649
Accrued interest ............. 17,007 3,566
Other accrued expenses ....... 19,656 17,904
------------------
$142,630 $88,082
==================
</TABLE>
5. INCOME TAXES
Significant components of the provision (benefit) for income taxes are as
follows:
<TABLE>
<CAPTION>
1998 1997 1996
- -------------------------------------------------------
<S> <C> <C> <C>
Current:
Federal .......... $ 8,467 $ 8,250 $ 9,200
State ............ (650) (250) 1,050
--------------------------------
Total current ....... 7,817 8,000 10,250
Deferred:
Federal .......... (12,517) (13,100) (4,050)
State ............ (400) (400) (700)
--------------------------------
Total deferred ...... (12,917) (13,500) (4,750)
--------------------------------
$ (5,100) $ (5,500) $ 5,500
================================
</TABLE>
49
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands of dollars except share and per share data)
A reconciliation of the statutory federal income tax expense (benefit) on
the Company's pretax income before extraordinary item to the actual
provision (benefit) for income taxes follows:
<TABLE>
<CAPTION>
1998 1997 1996
- ---------------------------------------------------------------------------
<S> <C> <C> <C>
Income tax expense
at statutory rate ......... $ 9,240 $ 8,673 $ 13,482
Percentage depletion
allowance ................. (14,437) (13,543) (10,431)
State taxes, net of effect
of federal taxes .......... (594) (570) 350
Non-deductible
expenses .................. 621 236 1,000
Other, net .................... 70 (296) 1,099
-----------------------------------------
$ (5,100) $ (5,500) $ 5,500
=========================================
</TABLE>
The Company's federal income tax returns for the years ending 1995 and 1996
are currently under review by the Internal Revenue Service (IRS). During
1996, the IRS completed its audits for the tax years 1990 and 1991 and the
Company and the IRS agreed to a partial settlement of various tax issues
for a payment of $6.5 million including interest which was charged against
previously recorded reserves. Part of the settlement related to the
acquisition from the Company's stockholders of certain Illinois coal
reserves for $55.2 million. The acquisition was valued for accounting
purposes at the stockholders' net book value of $22.8 million with the
$32.4 million difference between the net book value and fair market value
less $12.3 million of deferred tax benefits being recorded as a reduction
to stockholders' equity. As part of the settlement with the IRS, the
Company agreed to adjust the fair market value of the coal properties to
$33.8 million for tax purposes resulting in a decrease to the deferred tax
asset of $8.1 million from $12.3 million to $4.2 million. The decrease in
the deferred tax asset was charged directly to stockholders' equity in
1996.
During 1997, the Company settled its protest of certain adjustments
proposed by the IRS for federal income tax returns for the years 1987
through 1989. A deposit of $8.0 million was made in April 1997 in
anticipation of the settlement and a final payment of approximately $4.0
million was made in 1998.
During 1998, the Company settled its protest of certain unagreed
issues with the IRS for the federal income tax returns for years 1990 and
1991. A final payment of $0.5 million was paid in June 1998 and charged
against previously recorded reserves. The IRS audit of the federal income
tax returns for years 1992 through 1994 was completed during 1998 and
agreed to at the examination level. A payment of $15.5 million was made in
December 1998 in settlement of all issues. A significant amount of the
issues were timing in nature and the tax paid related to these temporary
differences is accounted for as a deferred tax asset and the remaining tax
and interest paid was charged against previously recorded reserves. A
portion of the payment related to items that were settled in the 1987
through 1991 audits previously discussed. Permanent differences included a
reduction in percentage depletion and a decrease in cost depletion related
to the settlement for the adjustment in fair market value of the Illinois
coal reserves.
Management believes that the Company has adequately provided for any
income taxes and interest which may ultimately be paid with respect to all
open tax years.
Significant components of the Company's deferred tax assets and
liabilities that result from carry forwards and
50
<PAGE>
temporary differences between the financial statement basis and tax basis of
assets and liabilities are summarized as follows:
<TABLE>
<CAPTION>
December 31
---------------------
1998 1997
- ----------------------------------------------------------
<S> <C> <C>
Deferred tax assets:
Postretirement benefits other
than pension ................... $136,004 $129,818
Alternative minimum tax credit
carryforward ................... 70,897 80,441
Workers' compensation ............. 29,345 30,503
Reclamation and mine closure ...... 22,567 23,905
Net operating loss
carryforwards .................. 10,232 8,214
Other ............................. 17,983 28,498
-------------------
Total deferred tax assets ......... 287,028 301,379
-------------------
Deferred tax liabilities:
Coal lands and mineral rights ..... 78,869 86,471
Plant and equipment ............... 78,359 79,962
Deferred mine development ......... 941 3,643
Coal supply agreements ............ 17,390 38,406
Other ............................. 19,566 40,368
-------------------
Total deferred tax liabilities .... 195,125 248,850
-------------------
Net deferred tax asset ............ 91,903 52,529
Less current asset ................ 8,694 8,506
-------------------
Long-term deferred tax asset ...... $ 83,209 $ 44,023
===================
</TABLE>
If not used, the carryforwards for net operating losses of $26.2 million
will expire in the years 2008 through 2019. The alternative minimum tax
credit carryforward has no statutory expiration date.
The Company is required to record a valuation allowance when it is
more likely than not that some portion or all of the deferred tax assets
will not be realized. It is management's belief that the Company's net
deferred income tax asset will more likely than not be realized by
generating sufficient taxable income in the future.
6. DEBT AND FINANCING ARRANGEMENTS
Debt consists of the following:
<TABLE>
<CAPTION>
December 31
----------------------
1998 1997
- -------------------------------------------------------------------
<S> <C> <C>
Indebtedness to banks under lines
of credit (weighted average rate
at December 31,1998-5.40%;
1997-7.05%) ......................... $ 12,884 $ 36,302
Indebtedness to banks under
revolving credit agreement,
expiring May 31, 2003
(weighted average rate at
December 31, 1998-6.27%) ............ 390,000 --
Variable rate fully amortizing
term loan payable quarterly
through May 31, 2003
(weighted average rate at
December 31, 1998-6.16%) ............ 285,000 --
Variable rate non-amortizing term
loan due May 31, 2003
(weighted average rate at
December 31, 1998-6.87%) ............ 675,000 --
Indebtedness to banks under
the 1997 revolving credit
agreement ........................... -- 190,000
7.79% senior unsecured notes ........... -- 42,860
Other .................................. 7,203 8,763
-----------------------
1,370,087 277,925
Less current portion ................... 61,000 29,500
-----------------------
Long-term debt ......................... $1,309,087 $ 248,425
=======================
</TABLE>
51
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands of dollars except share and per share data)
On July 1, 1997, concurrent with the Ashland Coal merger, the Company
entered into a $500 million revolving credit agreement which was repaid in
its entirety and the facility terminated effective June 1, 1998, using
proceeds from a new Company credit facility entered into effective June 1,
1998.
In connection with the Arch Western transaction, the Company entered
into two new five-year credit facilities: a $675 million non-amortizing
term loan to Arch Western and a $900 million credit facility to Arch Coal,
including a $300 million fully amortizing term loan and a $600 million
revolver. Borrowings under the new Arch Coal credit facilities were used to
finance the acquisition of ARCO's Colorado and Utah coal operations, to pay
related fees and expenses, to refinance existing corporate debt and for
general corporate purposes. The Company recognized an extraordinary charge
of $1.5 million (net of a tax benefit of $.9 million) related to the
refinancing of the July 1, 1997 credit facility and the prepayment of its
7.79% senior unsecured notes. Borrowings under the Arch Western credit
facility were used to fund a portion of a $700 million cash distribution by
Arch Western to ARCO, which distribution occurred simultaneously with
ARCO's contribution of its Wyoming coal operations and certain other assets
to Arch Western. The $675 million term loan is secured by Arch Western's
membership interests in its subsidiaries. The Arch Western credit facility
is not guaranteed by the Company. The rate of interest on the borrowings
under the agreements is, at the Company's option, the PNC Bank base rate or
a rate based on LIBOR.
The Company periodically establishes uncommitted lines of credit with
banks. These agreements generally provide for short-term borrowings at
market rates. At December 31, 1998, there were $45 million of such
agreements in effect, of which $12.9 million were outstanding at December
31, 1998.
Except for amounts expected to be repaid in 1999, amounts borrowed
under the revolving credit agreement and the bank lines of credit are
classified as long-term as the Company has the intent and the ability to
maintain these borrowings on a long-term basis. Aggregate maturities of
debt at December 31, 1998 are $61.0 million in 1999, $60.6 million in 2000,
$60.5 million in 2001, $60.5 million in 2002 and $1,127.5 million in 2003.
Terms of the Company's credit facilities and leases contain financial
and other restrictive covenants that limit the ability of the Company to,
among other things, pay dividends, effect acquisitions or dispositions and
borrow additional funds, and require the Company to, among other things,
maintain various financial ratios and comply with various other financial
covenants. Failure by the Company to comply with such covenants could
result in an event of default which, if not cured or waived, could have a
material adverse effect on the Company.
The Company enters into interest-rate swap agreements to modify the
interest characteristics of outstanding Arch Coal debt. At December 31,
1998, the Company had interest-rate swap agreements having a total notional
value of $815 million. These swap agreements are used to convert
variable-rate debt to fixed-rate debt. Under these swap agreements, the
Company pays a weighted-average fixed rate of 5.54% (before the credit
spread over LIBOR) and is receiving a weighted-average variable rate based
upon 3 day and 90-day LIBOR. At December 31, 1998, the remaining terms of
the swap agreements ranged from 44 to 68 months.
7. FAIR VALUES OF FINANCIAL INSTRUMENTS
The following methods and assumptions were used by the Company in
estimating its fair value disclosures for financial instruments:
Cash and cash equivalents: The carrying amounts approximate fair
value.
Debt: The carrying amounts of the Company's borrowings under its
revolving credit agreement, lines of credit and variable rate term loans
approximate their fair value. The fair values of the Company's senior notes
and other long-term debt are estimated using discounted cash flow analyses,
52
<PAGE>
based on the Company's current incremental borrowing rates for similar
types of borrowing arrangements at the end of each year presented.
Interest rate swaps: The fair values of interest rate swaps are based
on quoted market prices, which reflect the present value of the difference
between estimated future amounts to be paid and received.
The carrying amounts and fair values of the Company's financial
instruments at December 31, 1998 and 1997 are as follows:
<TABLE>
<CAPTION>
1998 1997
---------------------------------------------
Carrying Fair Carrying Fair
Amount Value Amount Value
- --------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Cash and cash equivalents ...... $ 27,414 $ 27,414 $ 9,177 $ 9,177
Lines of credit ................ 12,884 12,884 36,302 36,302
Revolving credit agreements .... 390,000 390,000 190,000 190,000
Variable rate term loans ....... 960,000 960,000 -- --
Senior notes ................... -- -- 42,860 44,690
Other debt ..................... 7,203 7,203 8,763 8,763
Interest rate swaps ............ -- (14,151) -- (93)
</TABLE>
8. ACCRUED WORKERS' COMPENSATION
The Company is liable under the federal Mine Safety and Health Act of 1977,
as amended, to provide for pneumoconiosis (black lung) benefits to eligible
employees, former employees, and dependents with respect to claims filed by
such persons on or after July 1, 1973. The Company is also liable under
various states' statutes for black lung benefits. The Company currently
provides for federal and state claims principally through a self-insurance
program. Charges are being made to operations as determined by independent
actuaries, at the present value of the actuarially computed present and
future liabilities for such benefits over the employees' applicable years
of service. In addition, the Company is liable for workers' compensation
benefits for traumatic injuries which are accrued as injuries are incurred.
Workers' compensation costs (credits) include the following components:
<TABLE>
<CAPTION>
1998 1997 1996
- ---------------------------------------------------------------------
<S> <C> <C> <C>
Self-insured black lung benefits:
Service cost ...................... $ 1,022 $ 678 $ 639
Interest cost ..................... 3,173 2,353 1,735
Net amortization
and deferral ................... 111 (10,084) (9,766)
--------------------------------
4,306 (7,053) (7,392)
Other workers' compensation
benefits ....................... 19,396 12,182 13,350
--------------------------------
$ 23,702 $ 5,129 $ 5,958
================================
</TABLE>
The actuarial assumptions used in the determination of black lung benefits
included a discount rate of 7.0% as of December 31, 1998 (7.25% and 7.5% as
of December 31, 1997 and 1996, respectively) and a black lung benefit cost
escalation rate of 4% in 1998, 1997 and 1996. In consultation with
independent actuaries, the Company changed the discount rate, black lung
benefit cost escalation rate, rates of disability and other assumptions
used in the actuarial determination of black lung liabilities as of January
1, 1993, to better reflect actual experience. The effect of these changes
was a significant increase in the unrecognized net gain. This gain was
amortized through 1997 and totaled $10.8 million (before tax) and $6.6
million (after tax) in each of the years 1997 and 1996.
Summarized below is information about the amounts recognized in the
consolidated balance sheets for workers' compensation benefits:
53
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands of dollars except share and per share data)
<TABLE>
<CAPTION>
December 31,
----------------------
1998 1997
- ------------------------------------------------------------------------------
<S> <C> <C>
Actuarial present value for self-insured black lung:
Benefits contractually
recoverable from others ......................... $ 4,649 $ 5,053
Benefits for
Company employees ............................... 51,137 42,677
----------------------
Accumulated black
lung benefit obligation ......................... 55,786 47,730
Unrecognized net loss .............................. (1,722) (3,004)
----------------------
54,064 44,726
Traumatic and other
workers' compensation ........................... 67,138 65,682
----------------------
Accrued workers'
compensation .................................... 121,202 110,408
Less amount included
in accrued expenses ............................. 15,869 12,649
----------------------
$ 105,333 $ 97,759
======================
</TABLE>
Receivables related to benefits contractually recoverable from others of
$4,649 in 1998 and $5,053 in 1997 are recorded in other long-term assets.
9. ACCRUED RECLAMATION AND MINE CLOSING COSTS
The federal Surface Mining Control and Reclamation Act of 1977 and similar
state statutes require that mine property be restored in accordance with
specified standards and an approved reclamation plan. The Company accrues
for the costs of final mine closure reclamation over the estimated useful
mining life of the property. These costs relate to reclaiming the pit and
support acreage at surface mines and sealing portals at deep mines. Other
costs of final mine closure common to both types of mining are related to
reclaiming refuse and slurry ponds. The Company also accrues for
significant reclamation that is completed during the mining process prior
to final mine closure. The establishment of the final mine closure
reclamation liability and the other ongoing reclamation liability is based
upon permit requirements and requires various estimates and assumptions,
principally associated with costs and productivities. The Company accrued
$12.5 million, $10.8 million and $6.1 million in 1998, 1997 and 1996,
respectively, for current and final mine closure reclamation excluding
reclamation recosting adjustments identified below. Cash payments for final
mine closure reclamation and current disturbances approximated $15.0
million, $8.5 million and $9.8 million for 1998, 1997 and 1996,
respectively. Periodically, the Company reviews its entire environmental
liability and makes necessary adjustments, including permit changes as
granted by state authorities and revisions to costs and productivities, to
reflect current experience. These recosting adjustments are recorded in
cost of coal sales. Adjustments included an increase in the liability of
$4.9 million in 1998, and decreases in the liability were $4.4 million and
$4.5 million in 1997 and 1996, respectively. The Company's management
believes it is making adequate provisions for all expected reclamation and
other costs associated with mine closures.
10. EMPLOYEE BENEFIT PLANS
Defined Benefit Pension and Other Postretirement Benefit Plans.
The Company has non-contributory defined benefit pension plans
covering certain of its salaried and non-union hourly employees. Benefits
are generally based on the employee's years of service and compensation.
The Company funds the plans in an amount not less than the minimum
statutory funding requirements nor more than the maximum amount that can be
deducted for federal income tax purposes.
The Company also currently provides certain postretirement health and
life insurance coverage for eligible employees. Generally, covered
employees who terminate employment after meeting the eligibility
requirements for pension benefits are also eligible for postretirement
coverage for themselves and their dependents. The salaried employee
postretirement medical and dental plans are contributory,
54
<PAGE>
with retiree contributions adjusted periodically, and contain other
cost-sharing features such as deductibles and coinsurance. The
postretirement medical plan for retirees who were members of the UMWA is
not contributory. The Company's current funding policy is to fund the cost
of all postretirement health and life insurance benefits as they are paid.
Summaries of the changes in the benefit obligations, plan assets (primarily
listed stocks and debt securities) and funded status of the plans are as
follows:
<TABLE>
<CAPTION>
Pension benefits Other postretirement benefits
---------------------------------------------------
1998 1997 1998 1997
- --------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
CHANGE IN BENEFIT OBLIGATIONS
Benefit obligations at January 1 ................. $ 84,085 $ 56,710 $ 333,908 $ 220,332
Service cost ..................................... 5,841 2,788 3,715 3,717
Interest cost .................................... 8,137 4,970 23,101 19,546
Benefits paid .................................... (8,562) (2,769) (13,224) (10,442)
Plan amendments .................................. (3,809) -- (15,924) --
Acquisition of ARCO Coal operations in
1998 and the Ashland Coal merger in 1997 ...... 39,674 20,015 13,625 88,841
Other-primarily actuarial (gain) loss ............ 14,067 2,371 (9,378) 11,914
-----------------------------------------------
Benefit obligations at December 31 ............... $ 139,433 $ 84,085 $ 335,823 $ 333,908
===============================================
CHANGE IN PLAN ASSETS
Value of plan assets at January 1 ................ $ 64,577 $ 45,929 $ -- $ --
Actual return on plan assets ..................... 21,771 7,339 -- --
Employer contributions ........................... 8,346 499 13,224 10,442
Acquisition of ARCO Coal operations in
1998 and the Ashland Coal merger in 1997 ...... 41,142 13,579 -- --
Benefits paid .................................... (8,562) (2,769) (13,224) (10,442)
-----------------------------------------------
Value of plan assets at December 31 .............. $ 127,274 $ 64,577 $ -- $ --
===============================================
FUNDED STATUS OF THE PLANS
Accumulated obligations less plan assets ......... $ 12,159 $ 19,508 $ 335,823 $ 333,908
Unrecognized actuarial gain (loss) ............... 6,920 3,451 6,918 (2,179)
Unrecognized net transition asset ................ 887 1,085 -- --
Unrecognized prior service gain (cost) ........... 2,667 (879) 16,367 5,776
-----------------------------------------------
Net liability recognized ......................... $ 22,633 $ 23,165 $ 359,108 $ 337,505
===============================================
BALANCE SHEET LIABILITIES (ASSETS)
Prepaid benefit costs ............................ $ (1,092) $ -- $ -- $ --
Accrued benefit liabilities ...................... 23,725 23,165 359,108 337,505
-----------------------------------------------
Net liability recognized ......................... $ 22,633 $ 23,165 $ 359,108 $ 337,505
===============================================
</TABLE>
The Company's primary defined benefit pension plan was amended January 1998
to a cash balance plan, which resulted in a $3.8 million gain. Changes in
demographic information resulted in a $14.1 million actuarial loss for
1998. In addition, a January 1997 amendment to the postretirement benefit
plan resulted in a $15.9 million gain. The gain resulted from the
implementation of a defined dollar benefit cap which limits the Company's
disbursements under the plan. The $9.4 million actuarial gain resulted from
favorable claims experience compared to previous projections.
55
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands of dollars except share and per share data)
<TABLE>
<CAPTION>
Pension benefits Other postretirement benefits
---------------------------------------------------------------
1998 1997 1998 1997
- ---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Weighted Average Assumptions as of December 31
Discount rate............................................. 7.00% 7.25% 7.00% 7.25%
Rate of compensation increase............................. 4.75% 5.00% N/A N/A
Expected return on plan assets............................ 9.00% 9.00% N/A N/A
Health care cost trend on covered charges................. N/A N/A 4.5% 6.0% in 1998;
.......................................................... 5.0% thereafter
</TABLE>
The following table details the components of pension and other
postretirement benefit costs.
<TABLE>
<CAPTION>
Pension benefits Other postretirement benefits
-------------------------------------------------------------------------
1998 1997 1996 1998 1997 1996
- -------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Service cost............................ $5,841 $ 2,788 $2,295 $ 3,715 $ 3,717 $ 2,246
Interest cost........................... 8,137 4,970 4,051 23,101 19,546 15,648
Expected return on plan assets.......... (7,521) (4,391) (3,520) -- -- --
Other amortization and deferral......... 790 (503) 642 (2,884) (2,573) (1,527)
------------------------------------------------------------------------
$7,247 $ 2,864 $3,468 $23,932 $20,690 $16,367
========================================================================
</TABLE>
The health care cost trend rate assumption has a significant effect on the
amounts reported. For example, increasing the assumed health care cost
trend rate by one percentage point each year would increase the accumulated
postretirement obligation as of December 31, 1998 by $48.0 million, or
14.3%, and the net periodic postretirement benefit cost for 1998 by $4.2
million, or 20.0%.
Multiemployer Pension and Benefit Plans
Under the labor contract with the United Mine Workers of America ("UMWA"),
the Company made payments of $1.3 million, $2.0 million and $1.9 million in
1998, 1997 and 1996, respectively, into a multiemployer defined benefit
pension plan trust established for the benefit of union employees. Payments
are based on hours worked and are expensed as paid. Under the Multiemployer
Pension Plan Amendments Act of 1980, a contributor to a multiemployer
pension plan may be liable, under certain circumstances, for its
proportionate share of the plan's unfunded vested benefits (withdrawal
liability). The Company has estimated its share of such amount to be $53.4
million at December 31, 1998. The Company is not aware of any circumstances
which would require it to reflect its share of unfunded vested pension
benefits in its financial statements.
The Coal Industry Retiree Health Benefit Act of 1992 ("Benefit Act")
provides for the funding of medical and death benefits for certain retired
members of the UMWA through premiums to be paid by assigned operators
(former employers), transfers of monies in 1993 and 1994 from an overfunded
pension trust established for the benefit of retired UMWA members, and
transfers from the Abandoned Mine Lands Fund (funded by a federal tax on
coal production) commencing in 1995. The Company treats its obligation
under the Benefit Act as a participation in a multiemployer plan and
recognizes expense as premiums are paid. The Company recognized $3.7
million in 1998, $3.9 million in 1997 and $2.8 million in 1996 in expense
relative to premiums paid pursuant to the Benefit Act.
56
<PAGE>
Other Plans
The Company sponsors savings plans which were established to assist
eligible employees in providing for their future retirement needs. The
Company's contributions to the plans were $6.8 million in 1998, $4.6
million in 1997 and $3.4 million in 1996.
11. CAPITAL STOCK
On April 4, 1997, the Company changed its capital stock whereby the number
of authorized shares was increased to 100,000,000 common shares, the par
value was changed to $.01 per share, and a common stock split of
338.0857-for-one was effected. All share and per share information reflect
the stock split.
On September 29, 1998, Arch Coal's Board of Directors authorized the
Company to repurchase up to 2 million shares of Company common stock. The
timing of the purchases and the number of shares to be purchased are
dependent on market conditions. As of December 31, 1998, the Company has
acquired 330,200 shares under the repurchase program at the average price
of $17.08 per share.
12. STOCK INCENTIVE PLAN
On April 22, 1998, the stockholders ratified the adoption of the 1997 Stock
Incentive Plan (the "Company Incentive Plan") reserving 6,000,000 shares of
Arch Coal common stock for awards to officers and other selected key
management employees of the Company. The Company Incentive Plan provides
the Board of Directors with the flexibility to grant stock options, stock
appreciation rights (SARs), restricted stock, restricted stock units,
performance stock, performance units, merit awards, phantom stock awards
and rights to acquire stock through purchase under a stock purchase program
("Awards"). Stock options outstanding under the Ashland Coal stock
incentive plans at the date of the merger were substituted for fully vested
stock options in the Company Incentive Plan (and are exercisable on the
same terms and conditions including per share exercise prices as were
applicable to such options when granted.) Stock options generally become
exercisable in full or in part one year from the date of grant and are
granted at a price equal to 100% of the fair market value of the stock on
the date of grant. SARs entitle employees to receive a payment equal to the
appreciation in market value of the stated number of common shares from the
SARs exercise price to the market value of the shares on the date of its
exercise. Unexercised options and SARs' lapse 10 years after the date of
grant. Restricted stock awards entitle employees to purchase shares at a
nominal cost. Such awards entitle employees to vote shares acquired and to
receive any dividends thereon, but such shares cannot be sold or
transferred and are subject to forfeiture if employees terminate their
employment prior to the prescribed period, which can be from one to five
years. Merit awards are grants of stock without restriction and at a
nominal cost. Performance share or unit awards can be earned by the
recipient if the Company meets certain pre-established performance
measures. Until earned, the performance awards are nontransferable, and
when earned, performance awards are payable in cash, stock, or restricted
stock as determined by the Board of Directors. Phantom stock awards are
based on the appreciation of hypothetical underlying shares or the earnings
performance of such shares and may be paid in cash or in shares. As of
December 31, 1998, performance shares and stock options were the only type
of Awards granted. As of December 31, 1998, 361,550 phantom performance
57
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands of dollar except share and per share data)
shares had been granted and will be earned by participants based on Company
performance for the years 1998 through 2001. Information regarding stock
options under the Company Incentive Plan is as follows for the year ended
December 31, 1998 and 1997:
<TABLE>
<CAPTION>
1998 1997
-------------------------------------------------
Weighted Weighted
Common Average Common Average
Shares Price Shares Price
- ----------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Options outstanding at January 1 ................. 926 $ 25.23 -- $ --
Issued in exchange for Ashland
Coal stock options ............................ -- -- 675 23.69
Granted .......................................... 360 22.88 300 27.88
Exercised ........................................ (48) 14.50 (49) 21.25
Canceled ......................................... (110) 25.88 -- --
----- -----
Options outstanding at December 31 ............... 1,128 24.86 926 25.23
===== =====
Options exercisable at December 31 ............... 600 $ 25.04 626 $ 23.88
Options available for grant at December 31 ....... 4,413 4,684
</TABLE>
The Company applies APB 25, Accounting for Stock Issued to Employees, and
related Interpretations in accounting for the Company Incentive Plan.
Accordingly, no compensation expense has been recognized for the fixed
stock option portion of the Company Incentive Plan. Had compensation
expense for the fixed stock option portion of the Company Incentive Plan
been determined based on the fair value at the grant dates for awards under
this plan consistent with the method of FAS 123, Accounting for Stock-Based
Compensation, the Company's net income and earnings per common share would
have been reduced to the pro forma amounts in the table below. The fair
value of options granted in 1998 and 1997 was determined to be $2.3 million
and $2.5 million, respectively, using the Black-Scholes option pricing
model and the weighted average assumptions noted below. For purposes of
these pro forma disclosures, the estimated fair value of the options is
recognized as compensation expense over the options' vesting period. The
stock options granted in 1998 and 1997 vest ratably over three years.
<TABLE>
<CAPTION>
1998 1997
- ---------------------------------------------------------------------------------------
<S> <C> <C>
Pro Forma
Net income (in millions) ............................... $ 29.3 $ 30.1
Basic and diluted earnings per share ................... $ .74 $ .98
---------- ---------
Weighted average fair value per share of options granted .... $ 7.22 $ 8.36
---------- ---------
Assumptions (weighted average)
Risk-free interest rate ................................ 6.0% 6.3%
Expected dividend yield ................................ 2.0% 2.0%
Expected volatility .................................... 31.8% 29.0%
Expected life (in years) ............................... 5.0 5.0
</TABLE>
58
<PAGE>
The pro forma effect on net income for 1998 and 1997 is not representative
of the pro forma effect on net income in future years because it does not
take into consideration pro forma compensation expense related to grants
issued prior to 1996.
Exercise prices for options outstanding as of December 31, 1998, range
from $17.25 to $34.375, and the weighted average remaining contractual life
at that date was 7.2 years. The table below shows pertinent information on
options outstanding at December 31, 1998, priced below $25 per share and
priced at $25 per share or more:
<TABLE>
<CAPTION>
Option Exercise Price
------------------------
Below $25 $25 or More
- ----------------------------------------------------------------------------------------------
<S> <C> <C>
Options outstanding (in thousands) .................................. 607 521
Weighted-average exercise price ..................................... $ 22.20 $ 27.96
Weighted-average remaining contractual life (in years) .............. 7.4 6.9
Options currently exercisable (in thousands) ........................ 264 336
Weighted-average exercise price of options currently exercisable .... $ 21.33 $ 28.01
</TABLE>
13. MERGER RELATED EXPENSES AND CHANGES IN ESTIMATES
During 1997, in connection with the Ashland Coal merger, the Company
recorded a one-time charge of $39.1 million (before tax) or $23.8 million
(after tax) comprised of termination benefits and relocation costs of $8.1
million and costs of $31.0 million associated with the idling of duplicate
facilities. The $8.1 million costs arising from the termination benefits
and relocation costs have been paid. The $31.0 million costs associated
with the idling of duplicate facilities reduced the book value of the
duplicate facilities. A portion of this charge related to Big Sandy
Terminal. As a result of a change in management strategy related to the Big
Sandy Terminal, the assets were sold in 1998 for a pre-tax gain of $7.5
million.
During 1996, the Company reduced the estimated useful lives of certain
long-lived assets (primarily related to life-of-mine assets including
preparation plants and beltlines) for depreciation and amortization
purposes. These changes in estimates were primarily due to increased
productivities and reductions in recoverable reserves. As a result, an
additional $11.3 million (after-tax impact of $6.9 million or $.33 per
share) of depreciation and amortization expense was recorded in cost of
coal sales. The assets included a preparation plant that had an original
life of 16 years that was adjusted to 7.5 years, a preparation plant and
beltline related to a surface mine that carried an original life of 20
years that was adjusted to 17 years and deferred mine development for a
surface mine with an original life of 5 years adjusted to 4 years.
14. CONCENTRATION OF CREDIT RISK AND MAJOR CUSTOMERS
The Company places its cash equivalents in investment-grade short-term
investments and limits the amount of credit exposure to any one commercial
issuer.
The Company markets its coal principally to electric utilities in the
United States. As of December 31, 1998 and 1997, accounts receivable from
electric utilities located in the United States totaled $152.1 million and
$102.8 million, respectively. Generally, credit is extended based on an
evaluation of the customer's financial condition, and collateral is not
generally required. Credit losses are provided for in the financial
statements and historically have been minimal.
59
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands of dollars except share and per share data)
The Company is committed under long-term contracts to supply coal that
meets certain quality requirements at specified prices. These prices are
generally adjusted based on indices. Quantities sold under some of these
contracts may vary from year to year within certain limits at the option of
the customer. Sales (including spot sales) to major customers were as
follows:
<TABLE>
<CAPTION>
1998 1997 1996
------------------------------
<S> <C> <C> <C>
AEP ................. $195,682 $129,981 $ 86,756
Southern Company .... 170,452 187,800 147,567
</TABLE>
15. EARNINGS PER SHARE
The following table sets forth the computation of basic and diluted
earnings per common share:
<TABLE>
<CAPTION>
1998 1997 1996
-----------------------------
<S> <C> <C> <C>
Numerator:
Income before extraordinary item ............................. $ 31,501 $30,281 $33,020
Extraordinary item ........................................... (1,488) -- --
-----------------------------
Net income ................................................... $ 30,013 $30,281 $33,020
=============================
Denominator:
Weighted average shares-denominator for basic ................ 39,626 30,374 20,948
Dilutive effect of employee stock options .................... 25 34 --
-----------------------------
Adjusted weighted average shares-denominator for diluted 39,651 30,408 20,948
=============================
Basic and diluted earnings per common share before
extraordinary item ........................................... $ .79 $ 1.00 $ 1.58
=============================
Basic and diluted earnings per common share ....................... $ .76 $ 1.00 $ 1.58
=============================
</TABLE>
16. SALE AND LEASEBACK
On January 29, 1998, the Company sold mining equipment for approximately
$74.2 million and leased back the equipment under an operating lease with a
term of three years. This included the sale and leaseback of equipment
purchased under an existing operating lease that expired on the same day.
The proceeds of the sale were used to purchase the equipment under the
expired lease for $28.3 million and to pay down debt. At the end of the
lease term, the Company has the option to renew the lease for two
additional one-year periods or purchase the equipment for approximately
$51.1 million. Alternatively, the equipment may be sold to a third party.
In the event of such a sale, the Company will be required to make a payment
to the lessor in the event, and to the extent, that the proceeds are below
$40.0 million. The gain on the sale and leaseback of $10.7 million was
deferred and is being amortized over the base term of the lease as a
reduction of rental expense.
17. RELATED PARTY TRANSACTIONS
In the ordinary course of business, the Company receives certain services
and purchases fuel, oil and other products on a competitive basis from
subsidiaries of Ashland Inc., which totaled $7.2 million in 1998, $4.7
million in 1997 and $3.8 million in 1996. At December 31, 1998, Ashland
Inc. owns approximately 55% of the Company's outstanding shares of common
stock. Management believes that charges between the Company and Ashland
Inc. for services and purchases were concluded on terms equivalent to those
prevailing among unaffiliated parties.
As described in Note 1, the Company has a 65% ownership interest in
Canyon Fuel which is accounted for on the equity method. The Company
receives administration and production fees from Canyon Fuel for managing
the Canyon Fuel operations. The fees recognized as other income for the
Company and as expense by Canyon Fuel for the year ended December 31, 1998
were $4.1 million.
60
<PAGE>
18. COMMITMENTS AND CONTINGENCIES
The Company leases equipment, land and various other properties under
noncancelable long-term leases, expiring at various dates. Rental expense
related to these operating leases amounted to $31.4 million in 1998, $14.9
million in 1997 and $8.5 million in 1996. The Company has also entered into
various noncancelable royalty lease agreements and federal lease bonus
payments under which future minimum payments are due. On October 1, 1998,
the Company was the successful bidder in a federal auction of certain
mining rights in the 3,546-acre Thundercloud tract in the Powder River
Basin of Wyoming. The Company's lease bonus bid amounted to $158 million
for the tract, of which $31.6 million was paid on October 1, 1998 (the
remaining lease bonus payments are reflected below under the caption
"Royalties"). The tract contains approximately 412 million tons of
demonstrated coal reserves and is contiguous with the Company's Black
Thunder mine. Geological surveys performed by outside consultants indicate
that there are sufficient reserves relative to these properties to permit
recovery of the Company's investment.
Minimum payments due in future years under these agreements in effect
at December 31, 1998 are as follows:
<TABLE>
<CAPTION>
Leases Royalties
- ----------------------------------------------------------
<S> <C> <C>
1999 ..................... $ 31,975 $ 62,375
2000 ..................... 28,092 62,151
2001 ..................... 22,311 61,809
2002 ..................... 16,726 61,589
2003 ..................... 8,284 30,282
Thereafter ............... 10,564 225,824
--------------------------
$117,952 $504,030
==========================
</TABLE>
The Company is a party to numerous claims and lawsuits with respect to
various matters. The Company provides for costs related to contingencies
when a loss is probable and the amount is reasonably determinable. As of
December 31, 1998, the Company estimates that its probable aggregate loss
as a result of such claims is $3.8 million (included in other noncurrent
liabilities) and believes that probable insurance recoveries of $.9 million
(included in other assets) related to these claims will be realized. The
Company estimates that its reasonably possible aggregate losses from all
currently pending litigation could be as much as $.4 million (before tax)
in excess of the probable loss previously recognized. However, the Company
believes it is probable that substantially all of such losses, if any
occur, will be insured. After conferring with counsel, it is the opinion of
management that the ultimate resolution of these claims, to the extent not
previously provided for, will not have a material adverse effect on the
consolidated financial condition, results of operations or liquidity of the
Company.
A customer of the Company has informed the Company that one of the
customer's power plants will no longer provide baseload capacity to a
public utility and instead will be used to provide peak demand only. As a
result, the plant will require substantially less coal under the customer's
existing above-market contract with the Company. The Company has filed a
civil action in Federal District Court in the Southern District of West
Virginia alleging breach of contract and other causes of action against the
customer in respect of the customer's failure to comply with the terms of
this contract. On July 17, 1998 the court granted the customer's motion to
stay the lawsuit pending arbitration. As of December 31, 1998, the carrying
amount of acquisition costs allocated to this coal supply contract amounts
to approximately $13.7 million. The Company currently expects that it will
recover the carrying amount of this asset, however, the ultimate outcome of
this matter is uncertain.
61
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands of dollars except share and per share data)
The Company holds a 17.5% general partnership interest in Dominion
Terminal Associates ("DTA"), which operates a ground storage-to-vessel coal
transloading facility in Newport News, Virginia. DTA leases the facility
from Peninsula Ports Authority of Virginia ("PPAV") for amounts sufficient
to meet debt-service requirements. Financing is provided through $132.8
million of tax-exempt bonds issued by PPAV which mature July 1, 2016. Under
the terms of a throughput and handling agreement with DTA, each partner is
charged its share of cash operating and debt-service costs in exchange for
the right to use its share of the facility's loading capacity and is
required to make periodic cash advances to DTA to fund such costs. On a
cumulative basis, costs exceeded cash advances by $9.2 million at December
31, 1998 (included in other noncurrent liabilities). Future payments for
fixed operating costs and debt service are estimated to approximate $3.3
million annually through 2015 and $26.0 million in 2016.
62
<PAGE>
19. CASH FLOW
The changes in operating assets and liabilities as shown in the
consolidated statements of cash flows are comprised of the following:
<TABLE>
<CAPTION>
1998 1997 1996
--------------------------------
<S> <C> <C> <C>
Decrease (increase) in operating assets:
Receivables ..................................................... $(35,464) $(12,179) $10,857
Inventories ..................................................... 6,723 16,323 4,024
Increase (decrease) in operating liabilities:
Accounts payable and accrued expenses ........................... 30,229 5,403 (7,464)
Income taxes .................................................... (35,057) (27,448) (1,145)
Accrued postretirement benefits other than pension .............. 6,813 7,437 4,566
Accrued reclamation and mine closure ............................ 1,936 (9,370) (10,492)
Accrued workers' compensation ................................... 149 (9,008) (897)
--------------------------------
Changes in operating assets and liabilities .......................... $(24,671) $(28,842) $ (551)
================================
</TABLE>
20. ACCOUNTING DEVELOPMENT
In June 1998, the Financial Accounting Standards Board issued FAS 133,
Accounting for Derivative Instruments and Hedging Activities, which is
required to be adopted in years beginning after June 15, 1999. FAS 133
permits early adoption as of the beginning of any fiscal quarter after its
issuance. FAS 133 will require the Company to recognize all derivatives on
the balance sheet at fair value. Derivatives that are not hedges must be
adjusted to fair value through income. If the derivative is a hedge,
depending on the nature of the hedge, changes in the fair value of the
derivative will either be offset against the change in fair value of the
hedged assets, liabilities, or firm commitments through earnings or
recognized in other comprehensive income until the hedged item is
recognized in earnings. The ineffective portion of a derivative's change in
fair value will be immediately recognized in earnings. The Company has not
yet determined what effect FAS 133 will have on the earnings and financial
position of the Company.
63
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands of dollars except share and per share data)
21. QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
Quarterly financial data for 1998 and 1997 is summarized below:
<TABLE>
<CAPTION>
March 31 June 30 Sept. 30 Dec. 31
----------------------------------------------------
<S> <C> <C> <C> <C>
1998:
Coal sales, equity income and other revenues ............. $312,564(1) $353,238 $ 424,123(2) $415,710
Income from operations ................................... 22,359 27,450 23,909 14,129(3)
Income before extraordinary item ......................... 15,821 14,999 544 137
Net income ............................................... 15,821 13,511 544 137
Basic and diluted earnings per
common share before extraordinary item(5) ........... 0.40 0.38 0.01 0.00
Basic and diluted earnings per common share(5) ........... 0.40 0.34 0.01 0.00
1997:
Coal sales and other revenues ............................ $198,461 $196,425 $ 329,475 $342,514
Income (loss) from operations ............................ 16,314 16,296 (20,468)(4) 29,740
Net income(loss) ......................................... 10,420 11,732 (13,001) 21,130
Basic and diluted earnings (loss) per common share(5) .... 0.50 0.56 (0.33) 0.53
</TABLE>
(1) During the first quarter of 1998, the Company recorded gains on the
sale of surplus land totaling $7.9 million.
(2) During the third quarter of 1998, the Company sold idle assets and
reserves in Eastern Kentucky for a gain of $18.5 million.
(3) During the fourth quarter of 1998, the Company sold its idle Big Sandy
Terminal for a gain of $7.5 million. This was partially offset by a
net unfavorable adjustment of $4.9 million associated with the
Company's routine, periodic review of reclamation accruals.
(4) During the third quarter of 1997, the Company recorded a $39.1 million
charge in connection with the Ashland Coal merger comprised of
termination benefits, relocation costs and costs associated with the
idling of duplicate facilities.
(5) The sum of the quarterly earnings per common share amounts may not
equal earnings per common share for the full year because per share
amounts are computed independently for each quarter and for the year
based on the weighted average number of common shares outstanding
during each period.
64
<PAGE>
SCHEDULE II
ARCH COAL, INC. AND SUBSIDIARIES
SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS
(IN THOUSANDS)
<TABLE>
<CAPTION>
ADDITIONS
BALANCE AT CHARGED TO BALANCE AT
BEGINNING COSTS AND END OF
DESCRIPTION OF YEAR EXPENSES DEDUCTIONS(1) OTHER(2) YEAR
----------- ---------- ---------- ------------- -------- ----------
<S> <C> <C> <C> <C> <C>
Year Ended December 31, 1998
Reserves Deducted from Asset
Accounts
Property, Plant, and
Equipment................. $ -- $ -- $ -- $ -- $ --
Other Assets -- Other Notes
and Accounts
Receivable........... 471 306 195 -- 582
Current Assets -- Supplies
Inventory................. 17,681 2,292 5,999 9,927 23,901
Year Ended December 31, 1997
Reserves Deducted from Asset
Accounts
Property, Plant, and
Equipment................. $ 100 $ -- $ 100 $ -- $ --
Other Assets -- Other Notes
and Accounts
Receivable........... 410 61 -- -- 471
Current Assets -- Supplies
Inventory................. 11,313 1,218 282 5,432 17,681
Year Ended December 31, 1996
Reserves Deducted from Asset
Accounts
Property, Plant, and
Equipment................. $ 1,111 $ -- $1,011 $ -- $ 100
Other Assets -- Other Notes
and Accounts
Receivable........... 408 150 148 -- 410
Current Assets -- Supplies
Inventory................. 11,976 500 1,163 -- 11,313
</TABLE>
- - ---------------
(1) Reserves utilized, unless otherwise indicated.
(2) Balances acquired in the Arch Western transaction and Ashland Coal merger.
23
<PAGE>
EXHIBIT INDEX
Exhibit No. Description
------------ -----------------------------------------------------
10.2 Ashland Inc. Deferred Compensation and Stock
Incentive Plan for Non-Employee Directors.
10.4 Ninth Amended and Restated Ashland Inc. Supplemental
Early Retirement Plan for Certain Key Executive
Employees.
10.11 Ashland Inc. Nonqualified Excess Benefit Pension
Plan.
10.18 Ashland Inc. 1997 Stock Incentive Plan.
13 Portions of Ashland's Annual Report to Shareholders,
incorporated by reference herein, for the fiscal year
ended September 30, 1998.
21 List of subsidiaries.
23.1 Consent of Ernst & Young LLP.
23.2 Consent of PricewaterhouseCoopers LLP.
23.3 Consent of Ernst & Young LLP.
24 Power of Attorney, including resolutions of the Board
of Directors.
27.1 Financial Data Schedule for the fiscal year ended
September 30, 1998.
27.2 Restated Financial Data Schedule for the fiscal year
ended September 30, 1997.
27.3 Restated Financial Data Schedule for the fiscal year
ended September 30, 1996.
Exhibit 23.2
CONSENT OF INDEPENDENT ACCOUNTANTS
We hereby consent to the incorporation by reference in the
Registration Statement (Form S-8 No. 33-52125) pertaining to the Ashland
Inc. Deferred Compensation and Stock Incentive Plan for Non-Employee
Directors, in the Registration Statement (Form S-8 No. 2-95022) pertaining
to the Ashland Inc. Amended Stock Incentive Plan for Key Employees, in the
Registration Statement (Form S-8 No. 33-7501) pertaining to the Ashland
Inc. Employee Savings Plan, in the Registration Statement (Form S-8 No.
33-26101) pertaining to the Ashland Inc. Long-Term Incentive Plan, in the
Registration Statement (Form S-8 No. 33-55922) pertaining to the Ashland
Inc. 1993 Stock Incentive Plan, in the Registration Statement (Form S-8 No.
33-49907) pertaining to the Ashland Inc. Leveraged Employee Stock Ownership
Plan, in the Registration Statement (Form S-8 No. 33-62901) pertaining to
the Ashland Inc. Deferred Compensation Plan, in the Registration Statement
(Form S-8 No. 333-33617) pertaining to the Ashland Inc. 1997 Stock
Incentive Plan, in the Registration Statement (Form S-3 No. 333-70651) as
amended by Amendment No. 3, pertaining to the U.S. $220,000,000 Ashland
Inc. Medium-Term Notes, Series H, and the related Prospectus, of our report
dated February 9, 1999, except as to Note R, which is as of March 1, 1999,
relating to the financial statements of Marathon Ashland Petroleum LLC
included in this Annual Report (on Form 10-K/A Amendment No. 1) for the
year ended September 30, 1998.
PricewaterhouseCoopers LLP
March 16, 1999
Exhibit 23.3
CONSENT OF INDEPENDENT AUDITORS
We consent to the incorporation by reference in the Registration
Statement (Form S-8 No. 33-52125) pertaining to the Ashland Inc. Deferred
Compensation and Stock Incentive Plan for Non-Employee Directors, in the
Registration Statement (Form S-8 No. 2-95022) pertaining to the Ashland
Inc. Amended Stock Incentive Plan for Key Employees, in the Registration
Statement (Form S-8 No. 33-7501) pertaining to the Ashland Inc. Employee
Savings Plan, in the Registration Statement (Form S-8 No. 33-26101)
pertaining to the Ashland Inc. Long-Term Incentive Plan, in the
Registration Statement (Form S-8 No. 33-55922) pertaining to the Ashland
Inc. 1993 Stock Incentive Plan, in the Registration Statement (Form S-8 No.
33-49907) pertaining to the Ashland Inc. Leveraged Employee Stock Ownership
Plan, in the Registration Statement (Form S-8 No. 33-62901) pertaining to
the Ashland Inc. Deferred Compensation Plan, in the Registration Statement
(Form S-8 No. 333-33617) pertaining to the Ashland Inc. 1997 Stock
Incentive Plan, in the Registration Statement (Form S-3 No. 333-70651) as
amended by Amendment No. 3, pertaining to the U.S. $220,000,000 Ashland
Inc. Medium-Term Notes, Series H of our report dated January 22, 1999, with
respect to the consolidated financial statements of Arch Coal, Inc. as of
and for the years ended December 31, 1998 and 1997 included in this Annual
Report (on Form 10-K/A Amendment No. 1) of Ashland Inc. for the year ended
September 30, 1998.
Our audits of the consolidated financial statements of Arch Coal, Inc.
as of December 31, 1998 and 1997 and for the years then ended also included
the Arch Coal, Inc. financial statement schedule included in this Annual
Report (on Form 10-K/A Amendment No. 1) of Ashland Inc. for the year ended
September 30, 1998. This schedule is the responsibility of Arch Coal,
Inc.'s management. Our responsibility is to express an opinion based on our
audits. In our opinion, the financial statement schedule for 1998 and 1997,
when considered in relation to the Arch Coal, Inc. basic financial
statements taken as a whole, presents fairly in all material respects the
information set forth therein.
Ernst & Young LLP
March 16, 1999
