Archer Annual Report 2004

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FY2004 Annual Report · Archer

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Arch Coal, Inc.
One CityPlace Drive
Suite 300
St. Louis, Missouri 63141

314-994-2700

www.archcoal.com

ARCH COAL, INC. 2004 ANNUAL REPORT AND 2005 PROXY

12 WAYS WE ARE GROWING RESPONSIBLY

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Financial Summary

Year Ended December 31 (in millions, except per share data)

Tons sold

Revenues

Income from operations

Net income available to common shareholders

Fully diluted earnings per common share (EPS)

2003

Change

2004

123.1

100.6

$1,907.2

$1,435.5

$178.0

$106.5

$1.78

$40.4

$10.1

$0.19

22%

33%

341%

955%

837%

29%

Dividends declared per common share

$0.2975

$0.2300

Arch Coal is the nation’s second largest coal producer. Our core business
Arch Coal is the nation’s second largest coal producer. Our core business

is providing U.S. power generators with clean-burning, low-sulfur coal
is providing U.S. power generators with clean-burning, low-sulfur coal

for electric generation. Through our national network of mines, we supply
for electric generation. Through our national network of mines, we supply

the fuel for approximately 7% of the nation’s electricity. We are also a
the fuel for approximately 7% of the nation’s electricity. We are also a

recognized leader in mine safety and land reclamation. Arch Coal main-
recognized leader in mine safety and land reclamation. Arch Coal main-

tains its headquarters in St. Louis and our stock is traded on the New York
tains its headquarters in St. Louis and our stock is traded on the New York

Stock Exchange under the ticker symbol ACI. For more information, visit
Stock Exchange under the ticker symbol ACI. For more information, visit

us at www.archcoal.com.
us at www.archcoal.com.

Board of Directors

J A M E S R . B O Y D (a)(b)(c)
Chairman of the Board, Arch Coal, Inc.;
Retired Senior Vice President and Group Operating Officer,
Ashland Inc.

F R A N K M . B U R K E (a)*(d)
Chairman, CEO and Managing Partner,
Burke Mayborn Company, Ltd.

PAT R I C I A F R Y G O D L E Y (c)(d)
Partner, Van Ness Feldman, P.C.

D O U G L A S H . H U N T (c)(d)*
Director of Acquisitions, Petro-Hunt, LLC

S T E V E N F. L E E R (c)
President and Chief Executive Officer, Arch Coal, Inc.

T H O M A S A . L O C K H A R T (c)(d)
State Representative, Wyoming House;
Retired Vice President, PacifiCorp

A . M I C H A E L P E R R Y (a)(b)*
Retired Chairman of the Board,
Bank One, West Virginia, N.A.

R O B E R T G . P O T T E R (b)(d)
Retired Chairman and Chief Executive Officer, Solutia Inc.

T H E O D O R E D . S A N D S (c)*(d)
President, HAAS Capital, LLC;
Retired Managing Director, Investment Banking,
For the Global Metals/Mining Group, Merrill Lynch & Co.

(a) Audit Committee
(b) Nominating and Corporate Governance Committee
(c) Finance Committee
(d) Personnel and Compensation Committee

*Committee Chair

Senior Officers

S T E V E N F. L E E R
President and Chief Executive Officer

B R A D L E Y M . A L L B R I T T E N
Vice President, Marketing

J O H N W. E AV E S
Executive Vice President and Chief Operating Officer

S H E I L A B . F E L D M A N
Vice President, Human Resources

C . H E N R Y B E S T E N
Senior Vice President, Strategic Development

R O B E R T G . J O N E S
Vice President—Law, General Counsel and Secretary

R O B E R T J . M E S S E Y
Senior Vice President and Chief Financial Officer

D AV I D B . P E U G H
Vice President, Business Development

Other Officers

L A R R Y R . B R O W N
Vice President and Chief Information Officer

J A M E S E . F L O R C Z A K
Treasurer

B E N N E T T K . H AT F I E L D
Vice President, Eastern Operations

J O H N W. L O R S O N
Controller

D E S I G N : www.KolbrenerUSA.com

R O B E R T W. S H A N K S
Vice President, Western Operations,
and President, Arch Western Resources, LLC

D E C K S . S L O N E
Vice President, Investor Relations and Public Affairs

C . D AV I D S T E E L E
Vice President, Tax

J O H N Z I E G L E R , J R .
Director, Internal Audit

12 WAYS WE ARE GROWING RESPONSIBLY

GROWING THROUGH SELECTIVE ACQUISITIONS

FOCUSING ON STRATEGIC BASINS

EMPHASIZING THE CLEANEST-BURNING COALS

BUILDING WORLD-CLASS OPERATIONS

SEIZING OPPORTUNITIES

INVESTING IN OUR PEOPLE

STRENGTHENING OUR POSITION

EMPLOYING LEADING-EDGE TECHNOLOGIES

TAPPING OUR EXTENSIVE RESERVE BASE

10.

MAINTAINING A STRONG BALANCE SHEET

11.

MEETING OUR CUSTOMERS’ CHANGING NEEDS

12.

ACTING AS CAREFUL STEWARDS OF THE LAND

Dear Fellow Shareholders,

As the theme of this report suggests, Arch Coal
grew in every conceivable way during 2004.
We boosted production via strategic acquisitions. We expanded our

coal holdings through reserve additions. We initiated the development

of new mines in key basins. We achieved growth in operating margins,

income from operations and earnings per share.

Moreover, your company grew in all the right ways. We stuck to what we do best—mining and marketing

coal. We built on our leadership positions in highly strategic basins. We maintained our focus on the clean-

est-burning, lowest-sulfur coals. We grew strategically, opportunistically and—above all—responsibly.

Arch pursued such growth only after much preparation. Since completing several major acquisitions

in 1998, we had pursued a disciplined strategy of shoring up our balance sheet and enhancing our

financial flexibility. Thus, when opportunity arose—as it did repeatedly in 2004—we were ready.

Our timing was impeccable. After climbing throughout 2004, coal prices in many basins ended the

year at near historic highs—and the outlook for U.S. and world coal markets is exceptionally strong.

With each passing year, it becomes increasingly clear that we will build the economy of the future on

coal-fired electricity. I’m pleased to report that—after the excellent progress of 2004—your company

is better positioned than ever to thrive in such an exciting environment.

GETTING STRONGER ON ALL FRONTS

By the time 2004 came to a close, we had committed—or announced plans to commit—$1.2 billion of

capital on growth initiatives. We expanded our reserve base by 30%, boosted pro-forma sales volume

by approximately 40% via consolidating acquisitions, and laid the foundation for future organic growth.

We also created a wealth of acquisition-related operating synergies that we expect to take to the

bottom line in 2005 and thereafter. We are confident that the initiatives launched during 2004 will

deliver attractive returns and tremendous value for our shareholders in the years ahead.

POWDER RIVER BASIN. In August, Arch augmented its already strong position in the PRB via two

major transactions. First, we acquired North Rochelle, the seventh largest U.S. coal mine, and inte-

grated it into our world-class Black Thunder operation. Then, a month later, we added 719 million tons

of high-quality, super-compliance coal contiguous to Black Thunder with our winning bid for the Little

Thunder federal coal lease. These initiatives greatly strengthen our competitive position in the largest

and fastest-growing U.S. coal supply region. With its exceptional geology and ultra-low-sulfur coal, the

PRB is poised to capture the lion’s share of new demand growth over the next decade. In 2004, more than

20 U.S. power plants tried PRB coal for the first time—and many more are likely to follow suit in 2005.

“We are confident that the initiatives
launched during 2004 will deliver attractive
returns and tremendous value for our
shareholders in the years ahead.”

WESTERN BITUMINOUS REGION. In July, we solidi-

fied our status as the No. 1 producer in the Western

Bituminous Region through the acquisition of the remain-

ing 35% of our Utah subsidiary. Then, in early 2005, we

announced plans to develop a new mine—with targeted

production of three million tons annually—on what we

believe to be one of the region’s best untapped longwall

reserves. Coal from the Western Bituminous Region, once

a niche regional supply source, is increasingly prized as a

high-Btu, low-sulfur substitute for supply-constrained

Eastern coal. As a result, demand for such coal has

boomed and spot pricing has doubled over the course

of the past year.

CENTRAL APPALACHIA. In 2004, Arch announced

plans to develop a five-million-ton-per-year longwall

mine in southern West Virginia—the biggest expansion

project in the region in recent years. The new mine

complex, Mountain Laurel, is being established on one

of the few large, undeveloped reserve blocks remaining in

Steven F. Leer, President and CEO

Eastern low-sulfur coal fields. When the mine ramps up to

full production in 2007, we expect it to be the centerpiece of our Central Appalachian operations and one

of the lowest-cost mines in the region. Nowhere are market dynamics stronger than in Central Appalachia,

the principal source of low-sulfur coal east of the Mississippi River. Coal production in the region has

fallen precipitously in recent years as producers grapple with reserve degradation, regulatory challenges

and a labor shortage. As a result, demand is outpacing supply—and prices have soared in response.

MAINTAINING OUR SOUND FINANCIAL FOOTING

Even after our dramatic growth, we ended the year with one of the industry’s strongest balance sheets.

We had built a solid foundation for expansion before the year began and continued to lay that ground-

work into the first half of 2004. We paid down debt, divested non-strategic assets and built a large cash

position. We supplemented those efforts in October 2004 with the sale of 7.2 million shares of stock that

helped us maintain a balanced capital structure. We also completed a $250 million bond offering to

replace our non-public debt.

At year end, our ratio of debt to total capitalization stood at 48%—a very manageable level for us,

and 36 percentage points lower than it was just four years ago. Moreover, we locked in an effective and

highly competitive interest rate of 6.75% on virtually all of our debt through 2013. We are confident that

we have the financial flexibility to fund our current organic growth plans and to capitalize on any new

opportunities that arise.

FOCUSING ON IMPROVING RETURNS

But expanding our size and scope was just one of the many achievements of 2004. Of equal importance,

we made good progress across the whole range of financial metrics. Revenues increased 33%, income

from operations climbed 341%, and EPS rose nine-fold to $1.78. We view these improved results as

a first step in what we expect to be a sustained period of upward momentum in our financial results.

We expect revenues and margins to increase significantly as the vast majority of our planned produc-

tion resets to market-based pricing over the course of the next three years.

Arch is taking a patient approach in today’s market environment. We have yet to price 60 to 70 million

tons of our planned production in 2006, and 110 to 120 million tons of our planned production in 2007.

CAPITALIZING ON A STRONG INDUSTRY OUTLOOK

We expect to have ample opportunity to layer in attractive new commitments in future periods.

Coal has tremendous advantages as a fuel source for electric generation—including its abundance,

reliability and attractive economics. Those advantages have become even more pronounced in recent

Creating

growth. U.S. nuclear plants are operating at near capacity levels. Natural gas production in North America

years as other key fuel sources for electric generation have encountered daunting barriers to future

In response, power generators are taking steps to facilitate greater coal use. With the tripling

appears to be approaching a plateau. The construction of new hydroelectric dams is unlikely.

in the price of natural gas in recent years, utilities already have a powerful economic incentive to

maximize output at their existing coal-fired plants. In addition, plans are under way to add as much as

65,000 megawatts of new and ultra-clean coal-fired capacity over the course of the next few years—

additions that would increase the installed base by 20%.

Near-term market fundamentals are equally attractive. In 2004, coal consumption outstripped produc-

tion for the second year in a row and stockpiles at U.S. power plants ended the year roughly 15% below

the five-year average. Furthermore, a resurgence in global steel markets has greatly boosted requirements

for metallurgical coal. Coal producers are struggling to keep pace with this robust demand equation.

PURSUING EXCELLENCE IN SAFETY AND ENVIRONMENTAL STEWARDSHIP

While Arch accomplished great things in 2004, I am most proud of our achievements in safety and

environmental stewardship. We have an unwavering commitment to excellence in these areas that

pervades everything we do.

That commitment was very much on display in 2004. We had a record safety performance, with

1.4 lost-time incidents per 200,000 employee-hours worked. That’s a nearly 30% improvement over 2003,

and more than two times better than the industry average. While we are pleased with these results,

we are not satisfied. We remain focused on our ultimate goal: an entirely injury-free workplace.

In recent years, Arch has won dozens of national and state awards for reclamation excellence—

and 2004 was no exception. In September, we were honored by the U.S. Department of the Interior with

the Director’s Award—the nation’s highest tribute for land reclamation. We also claimed the state of

West Virginia’s top reclamation honor for the fourth year in a row. These accolades are indicative of

our ongoing efforts to mine the land in the most environmentally responsible manner—and to restore it

to a natural and productive state once mining is complete.

OFFERING A UNIQUE VALUE PROPOSITION

At the writing of this letter, Arch’s stock price had increased by 43% since the beginning of 2004.

Last year was the fifth year in a row that our stock outperformed the S&P 500. We believe there

is potential for even greater value creation in the years ahead. In many respects, we have built the

ideal company for the current market environment. Arch is positioned to capitalize on each of the core

market opportunities in the U.S. coal sector.

the epicenter of coal industry growth.

exceeds supply and pricing has been most robust.

2 SUPPLY PRESSURES: We have high-quality assets in Central Appalachia, where demand

3 LOW-SULFUR PREMIUMS: We are a producer of low-sulfur coal exclusively, and thus are

1 DEMAND GROWTH: We are a leading producer in the Powder River Basin, which is likely to be

Value

4 METALLURGICAL DEMAND: Nearly one quarter of our Central Appalachian production has the
flexibility to move into metallurgical markets, where tremendous premiums are being earned.

positioned to capitalize on the quadrupling in the price of sulfur dioxide emission allowances
since the beginning of 2003.

Taken together, these stories add up to a compelling investment proposition.

CREATING SHAREHOLDER VALUE

We believe the U.S. coal industry is at the outset of a long and sustained run. Coal is back in favor with

U.S. power generators, a new generation of coal plants is moving forward, and revolutionary new com-

bustion technologies are drawing closer to reality. With our innovative workforce, world-class mines

and highly strategic reserve base, Arch Coal is uniquely positioned to excel in such an environment.

Looking ahead, we will focus on what I consider to be the three essential components for success

in the U.S. coal industry: safe operations, environmental stewardship and strong financial performance.

If we can excel in all three areas, I am confident that we will deliver tremendous value for you—our

shareholders. The next few years should be exciting ones for your company. We will continue to strive

every day to earn your support, your investment and your trust.

Sincerely,

Steven F. Leer

President and CEO

February 25, 2005

GROWING THROUGH SELECTIVE ACQUISITIONS

During 2004, we completed acquisitions that boosted our reserve base by 30% and our sales

volume by 40% on a pro forma basis. In doing so, we built upon leading positions in strategic coal basins where

we have proven expertise, unique synergy opportunities and strong customer relationships.

Reserves
(in billions of tons, at year end)

Sales Volume
(in millions of tons, at year end)

3.7

2.9

2003

2004

142.9

100.6

2003

2004

2003

2004
pro forma

2. FOCUSING ON STRATEGIC BASINS

During 2004, Arch solidified its
During 2004, Arch solidified its
leading position in the Western
leading position in the Western
Bituminous Region by acquiring
Bituminous Region by acquiring
the remaining 35% stake in its
the remaining 35% stake in its
Utah subsidiary.
Utah subsidiary.

Today, Arch produces roughly 20 million
Today, Arch produces roughly 20 million

tons in this increasingly strategic basin.
tons in this increasingly strategic basin.

Due to a growing deficit of high-Btu,
Due to a growing deficit of high-Btu,

low-sulfur coal from Eastern coal fields,
low-sulfur coal from Eastern coal fields,

demand for similar coals from Colorado
demand for similar coals from Colorado

and Utah is growing rapidly.
and Utah is growing rapidly.

EMPHASIZING THE CLEANEST-BURNING COALS

At Arch Coal, we produce only the cleanest-burning coals America has to offer.

That strategic focus is proving to be highly advantageous. In the past two years, the

premium that lower-sulfur coals receive in the marketplace has climbed markedly in response to

a quadrupling in the price of sulfur dioxide emission allowances. Equally significant is the fact

that the use of low-sulfur coals has helped U.S. power generators reduce targeted emissions by

50% over the past three decades, despite a tripling in coal use over that same time frame.

BUILDING WORLD-CLASS

OPERATIONS

With the acquisition of the North

Rochelle mine and its integra-

tion into Black Thunder during

2004, we created one of the

largest and most productive

coal mines in the world.

Not only does the combination of

the two mines create impressive

operating synergies, but it also

greatly enhances Arch’s ability

to serve its customer base.

The expanded Black Thunder

produces approximately three

tons of coal per second and

loads 25 miles of rail cars each

and every day.

SEIZING OPPORTUNITIES

Arch is a market-driven

company adept at responding

to changes in the marketplace.

In recent months, world steel

markets have boomed, driving up

demand for metallurgical quality

coal. In response, Arch doubled

its met sales in 2004, and expects

an additional 50% increase in

2005. Arch has the flexibility to

divert even more tons into the

met market in the days ahead,

or to shift those tons back into

the power generation market

should such a strategy prove

more advantageous.

INVESTING IN OUR PEOPLE

Arch’s employees are among the

most skilled and dedicated in

the industry. Their commitment

to excellence enables Arch to

operate some of the industry’s

most efficient mines. On average,

our mines produce 25% more

coal per employee shift than

our regional competitors.

Our employees also have made

Arch one of the nation’s safest

coal operators, with a safety

record more than two times

superior to the industry average.

STRENGTHENING OUR POSITION IN THE FASTEST-GROWING U.S. SUPPLY REGION

Arch further augmented its leading position in the Powder River Basin in 2004.

With the addition of the North Rochelle mine and the Little Thunder federal coal lease,

Arch expanded its PRB reserves by more than 900 million tons and its productive capacity

by more than 25 million tons. Demand for PRB coal has doubled in the past 12 years, and

we expect this rapid growth to continue.

EMPLOYING LEADING-EDGE TECHNOLOGIES

Arch excels at running large, modern mines employing highly

advanced mining technologies. That focus enables us to run some

of the industry’s lowest-cost operations. Arch is a leader in the use of

GPS-enhanced truck dispatch systems, nuclear coal analyzers, highly

efficient longwall mining equipment, and some of the largest land-

based machines in the world.

TAPPING OUR EXTENSIVE RESERVE BASE

West Virginia

Mountain Laurel

Arch has an extensive and

highly strategic reserve

base that creates attractive

opportunities for growth.

During 2004, Arch secured the

permits needed to start work on

one of the best remaining low-

sulfur coal reserves in the East.

The five-million-ton-per-year

Mountain Laurel longwall mine

should ramp up to full production

in mid-2007. We expect the mine

to be one of the lowest-cost

operations in the supply-

constrained Eastern coal fields.

10.

MAINTAINING A STRONG BALANCE SHEET

Even after our aggressive growth

initiatives in 2004, we boast one of the

industry’s strongest balance sheets.

Debt as a Percentage
of Capitalization (at year end)

83.9%

57.6%

58.3%

50.7%

48.4%

‘00

‘01

‘02

‘03

‘04

Powder River Basin

Western Bituminous Region

Central Appalachia

MEETING OUR CUSTOMERS’ CHANGING NEEDS

11.

Through our geographically diverse portfolio of mines, we are uniquely

equipped to supply our power generation customers with the widest

range of low-sulfur coal products. Arch is also recognized as one of the

industry’s most innovative, reliable and ethical coal suppliers.

ACTING AS CAREFUL STEWARDS OF THE LAND

Year after year, Arch helps pioneer advances in the

science of land reclamation. During 2004, Arch was honored by the U.S.

Department of the Interior with the Director’s Award, the nation’s most prestigious

award for land reclamation. Since 2000, Arch has planted 1.2 million trees and

created more than 200 acres of new wetlands on its reclaimed Eastern mine sites.

12.

2004 FACTS & F I G U R E S

Electricity demand (U.S. electricity generation in billions of kilowatt-hours)

The U.S. becomes more electrified every year.

(Source: EEI)

472 3,850

1954

2004

U.S. energy resources

95% COAL

3% NATURAL GAS

2% CRUDE OIL

Coal is America’s most
abundant domestic fuel source.

(Source: EIA)

Fuel shares for electric generation

50% COAL
7% HYDROELECTRIC

20% NUCLEAR

18% NATURAL GAS

3% RENEWABLES

2% CRUDE OIL

Coal is the dominant fuel source for electric
generation in the United States.

(Source: EIA)

New plant announcements (in gigawatts)

300

365*

U.S. power generators have announced plans
to boost coal-fired capacity by more than
20% in coming years. (Source: Platts)

Current Capacity

Expanded Capacity

* Assumes all 65 gigawatts of new capacity will be completed

Productivity

Tons per employee-shift (rolling 12-month average at 9/30/04)

395

Arch is one of the nation’s most productive
coal mining companies.

(Source: MSHA/Platts)

367

100

Arch Coal

Industry Average

Arch Coal

Industry Average

Arch Coal

Industry Average

Powder River Basin

Central Appalachia

Western Bituminous

Competing fuel prices (average U.S. generating costs from Jan-Oct 2004 in dollars per megawatt-hour)

Coal is the logical source for additional electric power
due to its compelling economics. (Source: Platts)

$14.09 COAL

$47.78 CRUDE OIL

$51.97 NATURAL GAS

Vast low-sulfur reserves

The vast majority of Arch’s 3.7 billion tons of reserves meet
the most stringent standards of the Clean Air Act without the
application of expensive scrubbing technology.

75% COMPLIANCE

16% LOW SULFUR

9% HIGH SULFUR

Compliance: < 1.2 lbs. of SO2/mm Btu

Low sulfur: 1.21-1.59 lbs. of SO2/mm Btu

High sulfur: > 1.6 lbs. of SO2/mm Btu

Safety 2004 Lost-time incident rates (per 200,000 employee-hours)

4.0*

Industry

1.4
Arch Coal

Arch’s safety record ranks
among the best in the industry.

*Source: MSHA Mine Injury & Worktime Statistics for Q1–Q3 2004