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The following is an excerpt from a 8-K SEC Filing, filed by PATRIOT COAL CORP on 6/16/2009.
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PATRIOT COAL CORP - 8-K - 20090616 - NOTES_TO_FINANCIAL_STATEMENT
PATRIOT COAL CORPORATION
 
DECEMBER 31, 2008
 
(1)   Basis of Presentation
 
Description of Business
 
Effective October 31, 2007, Patriot Coal Corporation (Patriot) was spun-off from Peabody Energy Corporation (Peabody) and became a separate, public company traded on the New York Stock Exchange (symbol PCX). The spin-off from Peabody, including coal assets and operations in Appalachia and the Illinois Basin, was accomplished through a dividend of all outstanding shares of Patriot.
 
Patriot is engaged in the mining of thermal coal, also known as steam coal, for sale primarily to electric utilities and metallurgical coal, for sale to steel mills and independent coke producers. Patriot’s mining operations and coal reserves are located in the eastern and midwestern United States, primarily in West Virginia and Kentucky.
 
On April 2, 2008, Patriot entered into an agreement to acquire Magnum Coal Company (Magnum). Magnum was one of the largest coal producers in Appalachia, operating 11 mines and 7 preparation plants with production from surface and underground mines and controlling more than 600 million tons of proven and probable coal reserves. On July 23, 2008, Patriot consummated the acquisition of Magnum. See Note 4 for additional information on the acquisition. In conjunction with the acquisition, Patriot issued debt in order to repay Magnum’s existing senior secured indebtedness. See Note 13 for additional information.
 
Basis of Presentation
 
The consolidated financial statements include the accounts of Patriot and its wholly-owned affiliates. All significant transactions, profits and balances have been eliminated between Patriot and its subsidiaries. Patriot operates in two domestic coal segments; Appalachia and the Illinois Basin (see Note 21).
 
The statements of operations and cash flows and related discussions for the years ended December 31, 2007 and 2006 relate to Patriot’s historical results and may not necessarily reflect what its results of operations and cash flows will be in the future or would have been as a stand-alone company. Upon the completion of the spin-off, Patriot’s capital structure changed significantly. At the spin-off date, Patriot entered into various operational agreements with Peabody, including certain on-going agreements that enhance both the financial position and cash flows of Patriot. Such agreements include the assumption by Peabody of certain retiree healthcare liabilities and the repricing of a major coal supply agreement to be more reflective of the then current market pricing for similar quality coal.
 
Effective August 11, 2008, Patriot implemented a 2-for-1 stock split effected in the form of a 100% stock dividend. All share and per share amounts in these consolidated financial statements and related notes reflect this stock split, including share information related to the Convertible Senior Notes and the Magnum acquisition.
 
As required, Patriot adopted the following authoritative guidance effective January 1, 2009: Statement of Financial Accounting Standards (SFAS) No. 160, “Noncontrolling Interests in Consolidated Financial Statements, an amendment to ARB 51” (SFAS No. 160); Financial Accounting Standards Board (FASB) Staff Position (FSP) APB 14-1, “Accounting for Convertible Debt Instruments That May Be Settled in Cash upon Conversion (Including Partial Cash Settlement)” (FSP APB 14-1); and FSP Emerging Issues Task Force 03-6-1, “Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities” (FSP EITF 03-6-1). The consolidated financial statements reflect the retrospective application of these accounting standards. See Notes 3, 4, 7, 13, 21 and 24 for further description of these changes and their related impact on the financial statements.
 
(2)   Summary of Significant Accounting Policies
 
Sales
 
Patriot’s revenue from coal sales is realized and earned when risk of loss passes to the customer. Coal sales are made to customers under the terms of supply agreements, most of which are long-term (greater than one year). Under the typical terms of these coal supply agreements, title and risk of loss transfer to the customer at the mine, where coal is loaded onto the rail, barge, truck or other transportation source that delivers coal to its destination. Shipping and transportation costs are generally borne by the customer. In relation to export sales, Patriot holds inventories at port facilities where title and risk of loss do not transfer until the coal is loaded into an ocean-going vessel. The Company incurs certain “add-on” taxes and fees on coal sales. Coal sales are reported including taxes and fees charged by various federal and state governmental bodies.


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PATRIOT COAL CORPORATION
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
Other Revenues
 
Other revenues include royalties related to coal lease agreements and farm income. Royalty income generally results from the lease or sublease of mineral rights to third parties, with payments based upon a percentage of the selling price or an amount per ton of coal produced. Certain agreements require minimum annual lease payments regardless of the extent to which minerals are produced from the leasehold, although revenue is only recognized on these payments as the mineral is mined. The terms of these agreements generally range from specified periods of 5 to 15 years, or can be for an unspecified period until all reserves are depleted.
 
Cash and Cash Equivalents
 
Cash and cash equivalents are stated at cost, which approximates fair value. Cash equivalents consist of highly liquid investments with original maturities of three months or less.
 
Inventories
 
Materials and supplies and coal inventory are valued at the lower of average cost or market. Saleable coal represents coal stockpiles that will be sold in current condition. Raw coal represents coal stockpiles that may be sold in current condition or may be further processed prior to shipment to a customer. Coal inventory costs include labor, supplies, equipment, operating overhead and other related costs.
 
Property, Plant, Equipment and Mine Development
 
Property, plant, equipment and mine development are recorded at cost. Interest costs applicable to major asset additions are capitalized during the construction period, including $0.1 million, $0.5 million and $0.3 million for the years ended December 31, 2008, 2007 and 2006, respectively.
 
Expenditures which extend the useful lives of existing plant and equipment assets are capitalized. Maintenance and repairs are charged to operating costs as incurred. Costs incurred to develop coal mines or to expand the capacity of operating mines are capitalized. Costs incurred to maintain current production capacity at a mine and exploration expenditures are charged to operating costs as incurred, including costs related to drilling and study costs incurred to convert or upgrade mineral resources to reserves. Costs to acquire computer hardware and the development and/or purchase of software for internal use are capitalized and depreciated over the estimated useful lives.
 
Coal reserves are recorded at cost, or at fair value in the case of acquired businesses. Coal reserves are included in “Land and coal interests” on the consolidated balance sheets. As of December 31, 2008 and 2007, the fair value of coal reserves totaled $2.5 billion and $545.5 million, respectively. The Company is still in the process of determining the fair value of the coal reserves related to Magnum, which is preliminarily valued at $1.9 billion at December 31, 2008. For further discussion related to the acquisition see Note 4, Business Combinations. Excluding Magnum, these coal reserve amounts included $287.8 and $287.6 million at December 31, 2008 and 2007, respectively, attributable to properties where the Company was not currently engaged in mining operations or leasing to third parties and, therefore, the coal reserves were not currently being depleted. Included in the book value of coal reserves are mineral rights for leased coal interests including advance royalties. The net book value of these mineral rights, excluding Magnum, was $373.9 million and $380.1 million at December 31, 2008 and 2007, respectively. The remaining net book value of the coal reserves relates to coal reserves held by fee ownership.
 
Depletion of coal reserves and amortization of advance royalties are computed using the units-of-production method utilizing only proven and probable reserves (as adjusted for recoverability factors) in the depletion base. Mine development costs are principally amortized ratably over the estimated lives of the mines.


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PATRIOT COAL CORPORATION
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
Depreciation of plant and equipment (excluding life of mine assets) is computed ratably over the estimated useful lives as follows:
 
     
    Years
 
Building and improvements
  10 to 29
Machinery and equipment
  1 to 20
Leasehold improvements
  Shorter of life of asset, mine
 
In addition, certain plant and equipment assets associated with mining are depreciated ratably over the estimated life of the mine. Remaining lives vary from less than one year up to 29 years. The charge against earnings for depreciation of property, plant, equipment and mine development was $87.8 million, $60.3 million and $65.1 million for the years ended December 31, 2008, 2007 and 2006, respectively.
 
Purchased Contract Rights
 
In connection with the Magnum acquisition, the Company acquired certain below market coal purchase contracts. These below market purchase contracts were recorded at their preliminarily-determined fair value, resulting in a gross asset of $42.9 million and accumulated amortization of $33.4 million as of December 31, 2008. The purchase contracts are amortized into earnings as the coal is sold to the end customer, expected to be within a year from the acquisition date and included in “Operating costs and expenses” in the consolidated statements of operations. The Company also has gross purchased contract rights associated with the KE Ventures, LLC acquisition of $6.2 million, with accumulated amortization of $4.0 million as of December 31, 2008. The current portion of these acquired contract rights is reported in “Below market purchase contracts acquired” and the long-term portion is recorded in “Investments and other assets” in the consolidated balance sheets.
 
Joint Ventures
 
The Company applies the equity method to investments in joint ventures when it has the ability to exercise significant influence over the operating and financial policies of the joint venture. The Company reviews the documents governing each joint venture to assess if it has a controlling financial interest in the joint venture to determine if the equity method is appropriate or if the joint venture should be consolidated. Investments accounted for under the equity method are initially recorded at cost, and any difference between the cost of the Company’s investment and the underlying equity in the net assets of the joint venture at the investment date is amortized over the lives of the related assets that gave rise to the difference. The Company’s pro rata share of earnings from joint ventures and basis difference amortization was expense of $0.9 million for the year ended December 31, 2008 and income of $0.1 million and $0.1 million for the years ended December 31, 2007 and 2006, respectively, which is reported in “Operating costs and expenses” in the consolidated statements of operations. The book values of the Company’s equity method investments as of December 31, 2008, and 2007 were $21.2 million and $0.7 million, respectively, and are reported in “Investments and other assets” in the consolidated balance sheets.
 
Sales Contract Liability
 
In connection with the Magnum acquisition, the Company recorded liabilities related to below market sales contracts. The below market supply contracts were recorded at their preliminarily-determined fair value when allocating the purchase price, which is accreted into earnings as the coal is shipped over a weighted average period of approximately three years. Net sales contract accretion related to the below market coal supply contracts acquired is included as a reduction of “Operating costs and expenses” in the consolidated statements of operations. The net liability at December 31, 2008 relating to these below market sales contracts was $641.1 million, including accumulated accretion of $313.3 million. The current portion of the liability is recorded in “Below market sales contracts acquired” in the consolidated balance sheets and the long-term portion of the liability is recorded in “Below market sales contracts acquired, noncurrent” in the consolidated balance sheets.


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PATRIOT COAL CORPORATION
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
Asset Retirement Obligations
 
Statement of Financial Accounting Standards (SFAS) No. 143, “Accounting for Asset Retirement Obligations” (SFAS No. 143) addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. The Company’s asset retirement obligations (ARO) primarily consist of spending estimates related to reclaiming surface land and support facilities at both surface and underground mines in accordance with federal and state reclamation laws as defined by each mining permit.
 
ARO liabilities for final reclamation and mine closure are estimated based upon detailed engineering calculations of the amount and timing of the future cash spending for a third-party to perform the required work. Spending estimates are escalated for inflation and then discounted at the credit-adjusted, risk-free rate. Patriot records an ARO asset associated with the discounted liability for final reclamation and mine closure. The obligation and corresponding asset are recognized in the period in which the liability is incurred. The ARO asset is amortized on the units-of-production method over its expected life and the ARO liability is accreted to the projected spending date. As changes in estimates occur (such as mine plan revisions, changes in estimated costs or changes in timing of the performance of reclamation activities), the revisions to the obligation and asset are recognized at the appropriate credit-adjusted, risk-free rate. The Company also recognizes an obligation for contemporaneous reclamation liabilities incurred as a result of surface mining. Contemporaneous reclamation consists primarily of grading, topsoil replacement and revegetation of backfilled pit areas.
 
Environmental Liabilities
 
Included in “Other noncurrent liabilities” are accruals for other environmental matters that are recorded in operating expenses when it is probable that a liability has been incurred and the amount of the liability can be reasonably estimated. Accrued liabilities are exclusive of claims against third parties and are not discounted. In general, costs related to environmental remediation are charged to expense.
 
Income Taxes
 
Income taxes are accounted for using a balance sheet approach in accordance with SFAS No. 109, “Accounting for Income Taxes” (SFAS No. 109). Deferred income taxes are accounted for by applying statutory tax rates in effect at the date of the balance sheet to differences between the book and tax basis of assets and liabilities. A valuation allowance is established if it is “more likely than not” that the related tax benefits will not be realized. In determining the appropriate valuation allowance, projected realization of tax benefits is considered based on expected levels of future taxable income, available tax planning strategies and the overall deferred tax position.
 
SFAS No. 109 specifies that the amount of current and deferred tax expense for an income tax return group shall be allocated among the members of that group when those members issue separate financial statements. For purposes of the consolidated financial statements prepared for the twelve months ended December 31, 2007 and for the other periods prior to the spin-off, the Company’s income tax expense has been recorded as if it filed a consolidated tax return separate from Peabody, notwithstanding that a majority of the operations were historically included in the U.S. consolidated income tax return filed by Peabody. The Company’s valuation allowance for these periods was also determined on the separate tax return basis. Additionally, the Company’s tax attributes (i.e. net operating losses and AMT credits) for these periods have been determined based on U.S. consolidated tax rules describing the apportionment of these items upon departure (i.e. spin-off) from the Peabody consolidated group.
 
Peabody was managing its tax position for the benefit of its entire portfolio of businesses. Peabody’s tax strategies were not necessarily reflective of the tax strategies that the Company would have followed or will follow as a stand-alone company, nor were they necessarily strategies that optimized the Company’s stand-alone position.


33


 

 
PATRIOT COAL CORPORATION
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
Postretirement Healthcare Benefits
 
Postretirement benefits other than pensions are accounted for in accordance with SFAS No. 106, “Employers’ Accounting for Postretirement Benefits Other Than Pensions” (SFAS No. 106), which requires the costs of benefits to be provided to be accrued over the employees’ period of active service. These costs are determined on an actuarial basis. The consolidated balance sheets as of December 31, 2008 and 2007 fully reflect the funded status of postretirement benefits.
 
Multi-Employer Benefit Plans
 
The Company has an obligation to contribute to two plans established by the Coal Industry Retiree Health Benefits Act of 1992 (the Coal Act) — the “Combined Fund” and the “1992 Benefit Plan.” A third fund, the 1993 Benefit Fund (the 1993 Benefit Plan), was established through collective bargaining, but is now a statutory plan under legislation passed in 2006. A portion of these obligations are accounted for in accordance with Emerging Issues Task Force (EITF) No. 92-13, “Accounting for Estimated Payments in Connection with the Coal Industry Retiree Health Benefit Act of 1992,” as determined on an actuarial basis. The remainder of these obligations qualify as multi-employer plans under SFAS No. 106, and expense is recognized as contributions are made.
 
Pension Plans
 
Prior to the spin-off, Patriot participated in a non-contributory defined benefit pension plan (the Peabody Pension Plan) accounted for in accordance with SFAS No. 87, “Employers’ Accounting for Pensions” (SFAS No. 87), which requires that the cost to provide the benefits be accrued over the employees’ period of active service. The Peabody Pension Plan was sponsored by one of Peabody’s subsidiaries and covered certain salaried employees and eligible hourly employees of Peabody. In connection with the spin-off, Patriot employees no longer participate in a defined benefit pension plan, and Patriot did not retain any of the assets or liabilities for the Peabody Pension Plan. Accordingly the assets and liabilities of the Peabody Pension Plan are not allocated to Patriot and are not presented in the accompanying balance sheets. However, annual contributions to the Peabody Pension Plan were made as determined by consulting actuaries based upon the Employee Retirement Income Security Act of 1974 minimum funding standard. Patriot recorded expense of $1.1 million and $3.7 million for the years ended December 31, 2007 and 2006, respectively, as a result of its participation in the Peabody Pension Plan, reflecting Patriot’s proportional share of Peabody’s expense based on the number of plan participants.
 
Patriot also participates in two multi-employer pension plans, the United Mine Workers of America 1950 Pension Plan (the 1950 Plan) and the United Mine Workers of America 1974 Pension Plan (the 1974 Plan). These plans qualify as multi-employer plans under SFAS No. 87, and expense is recognized as contributions are made. The plan assets of the 1950 Plan and the 1974 Plan are managed by the UMWA. See Note 16 for additional information.
 
Postemployment Benefits
 
Postemployment benefits are provided to qualifying employees, former employees and dependents, and Patriot accounts for these items on the accrual basis in accordance with SFAS No. 112 “Employers’ Accounting for Postemployment Benefits.” Postemployment benefits include workers’ compensation occupational disease, which is accounted for on the actuarial basis over the employees’ periods of active service; workers’ compensation traumatic injury claims, which are accounted for based on estimated loss rates applied to payroll and claim reserves determined by independent actuaries and claims administrators; disability income benefits, which are accrued when a claim occurs; and continuation of medical benefits, which are recognized when the obligation occurs. The Company’s consolidated balance sheets as of December 31, 2008 and 2007 fully reflect the funded status of postemployment benefits.


34


 

 
PATRIOT COAL CORPORATION
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
Use of Estimates in the Preparation of the Consolidated Financial Statements
 
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 reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
 
In particular, Patriot has significant long-term liabilities relating to retiree healthcare and work-related injuries and illnesses. Each of these liabilities is actuarially determined and uses various actuarial assumptions, including the discount rate and future cost trends, to estimate the costs and obligations for these items. In addition, the Company has significant asset retirement obligations that involve estimations of costs to remediate mining lands and the timing of cash outlays for such costs. If these assumptions do not materialize as expected, actual cash expenditures and costs incurred could differ materially from current estimates. Moreover, regulatory changes could increase the obligation to satisfy these or additional obligations.
 
Finally, in evaluating the valuation allowance related to deferred tax assets, various factors are taken into account, including the expected level of future taxable income and available tax planning strategies. If actual results differ from the assumptions made in the evaluation of the valuation allowance, a change in valuation allowance may be recorded through income tax expense in the period such determination is made.
 
Share-Based Compensation
 
The Company has an equity incentive plan for employees and eligible non-employee directors that allows for the issuance of share-based compensation in the form of restricted stock, incentive stock options, nonqualified stock options, stock appreciation rights, performance awards, restricted stock units and deferred stock units. The Company recognizes share-based compensation expense in accordance with SFAS No. 123(R), “Share-Based Payment”. The Company recognized compensation cost for awards with only service conditions that have a graded vesting schedule on a straight line basis over the requisite service period for each separately vesting portion of the award.
 
Derivatives
 
The Company has utilized derivative financial instruments to manage exposure to certain commodity prices. SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities” (SFAS 133), and related interpretive guidance require the recognition of derivative financial instruments at fair value on the consolidated balance sheet. For derivatives that are not designated as hedges, the periodic change in fair value is recorded directly to earnings. For derivative instruments that are eligible and qualify as cash flow hedges, the periodic change in fair value is recorded to “Accumulated other comprehensive income (loss)” until the contract settles or the relationship ceases to qualify for hedge accounting. In addition, if a portion of the change in fair value for a cash flow hedge is deemed ineffective during a reporting period, as defined in SFAS No. 133, the ineffective portion of the change in fair value is recorded directly to earnings. In 2008, the Company entered heating oil swap contracts to manage its exposure to diesel fuel prices. The changes in diesel fuel and heating oil prices are highly correlated thus allowing the swap contracts to be designated as cash flow hedges.
 
Impairment of Long-Lived Assets
 
Impairment losses on long-lived assets used in operations are recorded when events and circumstances indicate that the assets might be impaired and the undiscounted cash flows estimated to be generated by those assets under various assumptions are less than the carrying amounts of those assets. Impairment losses are measured by comparing the estimated fair value of the impaired asset to its carrying amount. No impairment losses were recorded during the periods covered by the consolidated financial statements.


35


 

 
PATRIOT COAL CORPORATION
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
Business Combinations
 
The Company accounts for its business acquisitions using the purchase method of accounting consistent with the requirements of SFAS No. 141, “Business Combinations”. Under this method of accounting, the purchase price is allocated to the fair value of the net assets acquired. Determining the fair value of assets acquired and liabilities assumed requires management’s judgment, and the utilization of independent valuation experts, and often involves the use of significant estimates and assumptions, including, but not limited to, assumptions with respect to future cash flows, discount rates and asset lives.
 
Deferred Financing Costs
 
The Company capitalizes costs incurred in connection with borrowings or establishment of credit facilities and issuance of debt securities. These costs are amortized as an adjustment to interest expense over the life of the borrowing or term of the credit facility using the interest method.
 
Reclassifications
 
Certain amounts in prior periods have been reclassified to conform to the 2008 presentation.
 
(3)   New Accounting Pronouncements
 
Newly Adopted Accounting Pronouncements
 
FASB Staff Position APB 14-1
 
In May 2008, the FASB issued FSP APB 14-1, “Accounting for Convertible Debt Instruments That May Be Settled in Cash upon Conversion (Including Partial Cash Settlement).” FSP APB 14-1 changes the accounting for the Company’s convertible notes, specifying that issuers of convertible debt instruments that may settle in cash upon conversion must bifurcate the proceeds from the debt issuance between debt and equity components in a manner that reflects the entity’s nonconvertible debt borrowing rate when interest cost is recognized in subsequent periods. The equity component reflects the value of the conversion feature of the notes. The Company adopted the provisions of FSP APB 14-1 effective January 1, 2009, and has retrospectively applied the provisions to its 3.25% Convertible Senior Notes issued in May 2008. See Note 13 for additional disclosures regarding the impact of adoption.
      FASB Staff Position EITF 03-6-1
In June 2008, the FASB issued FSP EITF 03-6-1, “Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities.” FSP EITF 03-6-1 addresses that instruments granted in share-based payment awards that entitle their holders to receive nonforfeitable dividends or dividend equivalents before vesting should be considered participating securities and need to be included in the earnings allocation in computing earnings per share under the “two-class method.” The two-class method of computing earnings per share is an earnings allocation formula that determines earnings per share for each class of common stock and participating security according to dividends declared (or accumulated) and participation rights in undistributed earnings. The Company adopted the provisions of FSP EITF 03-6-1 effective January 1, 2009, and has applied the provisions retrospectively to all applicable periods presented. See Note 7 for additional disclosures regarding the impact of adoption.


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PATRIOT COAL CORPORATION
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
      FASB Statement No. 157
 
In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements.” SFAS No. 157 defines fair value, establishes a framework for measuring fair value under generally accepted accounting principles, and expands disclosures about fair value measures. SFAS No. 157 clarifies that fair value is a market-based measurement that should be determined based on the assumptions that market participants would use in pricing an asset or liability . SFAS No. 157 establishes a three-level fair value hierarchy for fair value to be measured based on the observability of the inputs utilized in the valuation. The levels are: Level 1 — inputs from quoted prices in an active market, Level 2 — inputs other than a quoted price market that are directly or indirectly observable through market corroborated inputs and Level 3 — inputs that are unobservable and require assumptions about pricing by market participants. SFAS No. 157 is effective for fiscal years beginning after November 15, 2007. The Company elected to implement SFAS No. 157 with the one-year deferral permitted by FASB issued Staff Position No. 157-2 (FSP SFAS 157-2) for nonfinancial assets and nonfinancial liabilities, except for those items that are recognized or disclosed at fair value in the financial statements on a recurring basis. The deferral applies to nonfinancial assets and liabilities measured at fair value in a business combination. The Company utilized SFAS No. 157 for an exchange transaction described in Note 6.
 
In October 2008, the FASB issued Staff Position No. 157-3, “Determining the Fair Value of a Financial Asset When the Market for That Asset Is Not Active” (FSP SFAS 157-3), which clarified the application of SFAS No. 157 in an inactive market and demonstrated how the fair value of a financial asset is determined when the market for that financial asset is inactive. FSP SFAS 157-3 was effective upon issuance, including prior periods for which financial statements had not been issued. The adoption of FSP SFAS 157-3 did not have a material effect on the Company’s results of operations or financial condition since it did not have any financial assets in inactive markets.
      FASB Statement No. 159
 
In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities.” SFAS No. 159 permits entities to choose to measure many financial instruments and certain other items at fair value that are not currently required to be measured at fair value. Entities electing the fair value option are required to recognize changes in fair value in earnings and to expense upfront costs and fees associated with each item for which the fair value option is elected. SFAS No. 159 is effective for fiscal years beginning after November 15, 2007. The Company adopted SFAS No. 159 on January 1, 2008, with no impact to the financial statements upon adoption since the Company did not elect fair value treatment for any items not currently required to be measured at fair value.
      FASB Statement No. 160
 
In December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements, an amendment of ARB No. 51.” SFAS No. 160 establishes accounting and reporting standards for noncontrolling interests in partially-owned consolidated subsidiaries and the loss of control of subsidiaries. SFAS No. 160 requires that a noncontrolling interest (previously referred to as minority interest) in a consolidated subsidiary be displayed in the consolidated balance sheet as a separate component of equity and the amount of net income attributable to the noncontrolling interest be included in consolidated net income on the face of the consolidated statement of operations. In addition, this statement requires that a parent recognize a gain or loss in net income when a subsidiary is deconsolidated. The Company adopted the provisions of SFAS No. 160 effective January 1, 2009, and has retroactively applied the provisions to all applicable periods presented.


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PATRIOT COAL CORPORATION
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
Pending Adoption of Recent Accounting Pronouncements
      FASB Statement No. 141(R)
 
In December 2007, the FASB issued SFAS No. 141(R), Business Combinations , which replaces SFAS No. 141 and retains the fundamental requirements in SFAS No. 141, including that the purchase method be used for all business combinations and for an acquirer to be identified for each business combination. This standard defines the acquirer as the entity that obtains control of one or more businesses in the business combination and establishes the acquisition date as the date that the acquirer achieves control instead of the date that the consideration is transferred. SFAS No. 141(R) requires an acquirer in a business combination to recognize the assets acquired, liabilities assumed, and any noncontrolling interest in the acquiree at the acquisition date, measured at their fair values as of that date, with limited exceptions. It also requires the recognition of assets acquired and liabilities assumed arising from certain contractual contingencies as of the acquisition date, measured at their acquisition-date fair values. SFAS No. 141(R) will be effective for the Company for any business combination with an acquisition date on or after January 1, 2009.
      FASB Statement No. 161
 
In March 2008, the FASB issued SFAS No. 161, “Disclosures about Derivative Instruments and Hedging Activities — an amendment of FASB Statement No. 133” (SFAS No. 161). SFAS No. 161 expands the disclosure requirement for derivative instruments and hedging activities. This statement specifically requires entities to provide enhanced disclosures about its use of derivative instruments, the accounting for derivatives and related hedge items, and the related affect on an entity’s financial condition, results of operations and cash flows. SFAS No. 161 is effective for fiscal years and interim periods beginning after November 15, 2008 (January 1, 2009 for the Company). While the Company is currently evaluating the impact SFAS No. 161 will have on its disclosures, the adoption of SFAS No. 161 will not affect the Company’s results of operations or financial condition.
      EITF 08-6
 
In November 2008, the Emerging Issues Task Force issued EITF 08-6, “Accounting for Equity Method Investments” (EITF 08-6), because of questions raised regarding the application of the equity method after FASB Statement 160 and FASB Statement 141(R) were issued. This EITF issue addresses other-than-temporary impairment, the accounting for gains or losses on issuance of shares by the investee and the loss of significant influence such that the accounting method must change. EITF 08-06 is effective on a prospective basis for transactions in an investee’s shares occurring or impairments recognized in fiscal years, beginning after December 15, 2008. The Company does not expect EITF 08-6 to have a significant impact on the accounting for its equity investments.
 
(4)   Business Combinations
 
Magnum Coal Company
 
On July 23, 2008, Patriot consummated the acquisition of Magnum. Magnum stockholders received 23,803,312 shares of newly-issued Patriot common stock and cash in lieu of fractional shares. The fair value of $25.29 per share of Patriot common stock issued to the Magnum shareholders was based on the average of Patriot stock price for the five business days surrounding and including the merger announcement date, April 2, 2008. The total purchase price was $739.0 million, including the assumption of $148.6 million of long-term debt, $11.8 million of which related to capital lease obligations. In conjunction with the acquisition, Patriot issued debt in order to repay Magnum’s existing senior secured indebtedness as discussed in Note 13. Magnum was one of the largest coal producers in Appalachia, operating 11 mines and 7 preparation plants with production from surface and underground mines and controlling more than 600 million tons of proven and probable coal reserves.
 
The results of operations of Magnum are included in the Appalachia Mining Operations segment from the date of acquisition. The acquisition was accounted for using the purchase method of accounting. Under this method of accounting, the purchase price is allocated to the fair value of the net assets acquired. The excess purchase price over the fair value of the assets acquired, if any, is allocated to goodwill.


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PATRIOT COAL CORPORATION
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
The following table summarizes the preliminary estimated fair values of the assets acquired and the liabilities assumed at the date of acquisition:
 
         
    (In thousands)  
 
Cash
  $ 21,015  
Accounts receivable, net
    88,636  
Inventories
    53,609  
Other current assets
    43,008  
Property, plant, equipment and mine development, net
    2,261,199  
Other non-current assets
    11,719  
         
Total assets acquired
    2,479,186  
         
Accounts payable and accrued expenses
    240,483  
Below market sales contracts acquired, current
    497,882  
Long-term debt
    144,606  
Below market sales contracts acquired, noncurrent
    459,802  
Accrued postretirement benefit costs
    445,675  
Other non-current liabilities
    88,871  
         
Total liabilities assumed
    1,877,319  
         
Net assets acquired
  $ 601,867  
         
 
As of December 31, 2008, the accounting for the acquisition is preliminary. The Company is conducting reserve studies on the acquired properties, the outcome of which will determine the fair value to be allocated to reserve assets. Additionally, the Company is in the process of preparing estimates, as well as obtaining third party estimates of fair value of coal reserves, property, plant and equipment, intangible assets and environmental liabilities.
 
In connection with the Magnum acquisition, the Company recorded liabilities and assets related to below market coal sales and purchase contracts. The below market supply contracts were recorded at their preliminarily-determined fair value when allocating the purchase price, resulting in a liability of $957.7 million, which is being accreted into earnings as the coal is shipped over a weighted average period of approximately three years. The below market purchase contracts were recorded at their preliminarily-determined fair value, resulting in an asset of $42.9 million, which is being amortized into earnings as the coal is acquired, expected to be within a year from the acquisition date. Net sales contract accretion related to the below market coal supply and purchase contracts acquired is included as a reduction of “Operating costs and expenses” in the consolidated statements of operations.
 
Based on the preliminary estimated fair values set forth above as compared to the carryover tax basis in assets and liabilities, $67.0 million of net deferred tax liability would be recorded on Magnum’s opening balance sheet. As part of the business combination, these Magnum deferred tax liabilities have impacted management’s view as to the realization of Patriot deferred tax assets, against which a full valuation allowance had previously been recorded. In such situations, SFAS 109 requires that any reduction in the acquiring company’s valuation allowance be accounted for as part of the business combination. As such, preliminary deferred tax liabilities have been offset against a release of $67.0 million of valuation allowance within purchase accounting. Any final determination of the net deferred tax liability (or net deferred tax asset) associated with the business combination will not be complete until the value of all Magnum assets and liabilities is finalized.
 
Upon the acquisition of Magnum, the Company performed a comprehensive strategic review of all mining complexes and their relative cost structure in order to optimize performance. As a result of this review, the Company announced plans to idle operations of both the acquired Jupiter and Remington mining complexes. The Jupiter


39


 

 
PATRIOT COAL CORPORATION
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
mining complex ceased operations in December 2008 and the Remington mining complex is scheduled to cease operations in March 2009. The fair value of the assets and liabilities acquired for these two mining complexes will reflect their status as idled in final purchase accounting.
 
The following unaudited pro forma financial information presents the combined results of operations of the Company and Magnum, on a pro forma basis, as though the companies had been combined as of January 1, 2007 and January 1, 2008, respectively.
 
                 
    Year Ended December 31,  
    2008     2007  
    (Dollars in thousands,
except per share data)
 
 
Revenues:
               
As reported
  $ 1,654,622     $ 1,073,362  
Pro forma
    2,207,353       2,194,432  
Net income (loss):
               
As reported
  $ 146,850     $ (106,868 )
Pro forma
    285,671       299,725  
Basic earnings per share:
               
As reported
  $ 2.23     $ (2.00 )
Pro forma
    4.46       5.60  
Diluted earnings per share:
               
As reported
  $ 2.21     $ (2.00 )
Pro forma
    4.42       5.60  
 
Patriot’s historical financial information has been adjusted in the pro forma amounts above to present the results as if the spin-off from Peabody occurred on January 1, 2007 instead of October 31, 2007. The combined pro forma financial information has been further adjusted to exclude non-recurring transaction-related expenses and include purchase accounting adjustments for preliminarily-determined fair values impacting coal inventories, net sales contract accretion, depletion of coal reserves and depreciation of property, plant and equipment. This unaudited pro forma financial information does not necessarily reflect the results of operations that would have occurred had the Company and Magnum constituted a single entity during those periods.
 
KE Ventures, LLC
 
As of December 31, 2005, the Company owned a 49% interest in KE Ventures, LLC and accounted for the interest under the equity method of accounting. In March 2006, Patriot increased its ownership interest in the joint venture to an effective 73.9% and accordingly, fully consolidated KE Ventures, LLC effective January 1, 2006. The purchase price for the additional 24.9% interest was $44.5 million plus assumed debt. The purchase price was allocated over the various assets and liabilities in proportion to the additional ownership percentage with an additional $52.8 million allocated to coal reserves and plant and equipment included in “Property, plant, equipment and mine development” and customer contracts included in “Investments and other assets.”
 
In September 2007, Patriot acquired an additional 7.6% interest in KE Ventures, LLC for $13.6 million, increasing effective ownership to 81.5%. The noncontrolling holders of KE Ventures, LLC held an option which could require Patriot to purchase the remaining 18.5% of KE Ventures, LLC upon a change in control. This option became fully exercisable upon the spin-off from Peabody. The noncontrolling owners of KE Ventures, LLC exercised this option in 2007, and the Company acquired the remaining noncontrolling interest in KE Ventures, LLC on November 30, 2007 for $33.0 million. The additional purchase price of $46.6 million was allocated to the proportional percentage of assets and liabilities acquired in 2007. The purchase price was primarily allocated to coal reserves as it was the most significant asset acquired.


40


 

 
PATRIOT COAL CORPORATION
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
Because the option requiring Patriot to purchase KE Ventures, LLC was considered a mandatorily redeemable instrument outside of the Company’s control, amounts paid to the noncontrolling interest holders in excess of carrying value of the noncontrolling interest in KE Ventures, LLC was reflected as an increase in net loss attributable to common stockholders of $15.7 million in 2007. This treatment is consistent with the guidance in SEC ASR 268 “Redeemable Preferred Stock” and EITF Topic D-98 “Classification and Measurement of Redeemable Securities.” This obligation was fully redeemed as of December 31, 2007.
 
(5)   Risk Management and Financial Instruments
 
Patriot is exposed to various types of risk in the normal course of business, including fluctuations in commodity prices and interest rates. These risks are actively monitored to ensure compliance with the Company’s risk management policies. The Company manages its commodity price risk related to the sale of coal through the use of long-term, fixed-price contracts, rather than financial instruments.
 
Credit Risk
 
Patriot’s concentration of credit risk is substantially with utility customers and Peabody. In 2008, Patriot sold more than 40% of its production through a marketing affiliate of Peabody at prices paid by third-party customers (see Note 18 for additional discussion of related party transactions). Allowance for doubtful accounts was $540,000 and $251,000 at December 31, 2008 and 2007, respectively and reflects specific amounts for which risk of collection has been identified based on the current economic environment and circumstances of which the Company is aware. The Company also has $142.3 million in notes receivable as of December 31, 2008 outstanding from counterparties from the sale of coal reserves and surface lands discussed in Note 6. The current portion of these receivables was $11.1 million as of December 31, 2008 and is included in “Accounts receivable and other” on the consolidated balance sheets. Each of these notes contain a cross-collaterization provision secured primarily by the underlying coal reserves and surface lands.
 
The Company’s policy is to independently evaluate each customer’s creditworthiness prior to entering into transactions and to constantly monitor the credit extended. In the event that a transaction occurs with a counterparty that does not meet the Company’s credit standards, the Company may protect its position by requiring the counterparty to provide appropriate credit enhancement. When appropriate, steps have been taken to reduce credit exposure to customers or counterparties whose credit has deteriorated and who may pose a higher risk, as determined by the credit management function, of failure to perform under their contractual obligations. These steps might include obtaining letters of credit or cash collateral, requiring prepayments for shipments or the creation of customer trust accounts held for the Company’s benefit to serve as collateral in the event of failure to pay.
 
Commodity Price Risk
 
With the Magnum acquisition, the Company’s commodity risk profile changed as its annual usage of diesel fuel increased significantly. To manage this risk, the Company entered into heating oil swap contracts with financial institutions in the fourth quarter of 2008. These derivative contracts have been designated as cash flow hedges of anticipated diesel fuel purchases such that the changes in fair value of these derivatives are recorded through other comprehensive income. As of December 31, 2008, the notional amount outstanding for these swap contracts included 9.5 million gallons of heating oil, which expire throughout 2009, and 9.0 million gallons of heating oil expiring throughout 2010. At December 31, 2008, the fair value of these derivatives was a liability of $9.7 million. The Company did not recognize any gains or losses in earnings in the year ended December 31, 2008, for hedge ineffectiveness or realized gains or losses on these contracts.
 
Employees
 
As of December 31, 2008, Patriot had approximately 4,300 employees. Approximately 47% of the employees at Company operations were represented by an organized labor union and they generated approximately 41% of the


41


 

 
PATRIOT COAL CORPORATION
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
2008 sales volume. Relations with our employees and, where applicable, organized labor, are important to the Company’s success. Union labor is represented by the United Mine Workers of America (UMWA) under labor agreements which expire December 31, 2011.
 
Fair Value of Financial Instruments
 
The Company’s heating oil swap contracts discussed above were the only financial instruments that were measured and recorded at fair value on a recurring basis at December 31, 2008. The unrealized loss of $9.7 million was recorded as a liability at December 31, 2008. The Company utilized NYMEX quoted market prices for the fair value measurement of these contracts, which reflects a Level 2 input as defined in SFAS No. 157 and discussed in Note 3.
 
Cash and cash equivalents, accounts receivable, accounts payable and accrued expenses have carrying values which approximate fair value due to the short maturity or the financial nature of these instruments. The fair value of notes receivable approximates the carrying value as of December 31, 2008 and 2007. At December 31, 2008, the estimated fair market value of the Company’s Convertible Senior Notes due 2013 was $100 million compared to a face value of $200 million. These notes were valued using a Level 2 input as defined in SFAS No. 157.
 
(6)   Net Gain on Disposal or Exchange of Assets and Other Commercial Transactions
 
In June 2008, Patriot entered into an agreement to swap certain leasehold coal mineral rights with another coal producer. Additionally, Patriot sold approximately 2.7 million tons of adjacent leasehold coal mineral rights in Appalachia for $1.0 million. Patriot recognized gains totaling $6.3 million on these transactions. The swap transaction was recorded at fair value in accordance with SFAS No. 153 “Exchanges of Nonmonetary Assets” and SFAS No. 157. The Company utilized Level 3 inputs as defined by SFAS No. 157 in a discounted cash flows model to calculate the fair value of the coal reserve swap due to the lack of an active, quoted market and due to the inability to use other transaction comparisons because of the unique nature of each coal seam.
 
Also in the second quarter of 2008, Patriot recorded a $4.9 million gain related to a structured settlement on a property transaction and received a $4.5 million settlement for past due coal royalties, which had previously been fully reserved due to the uncertainty of collection. Both transactions were recorded as “Other revenues” in the consolidated statements of operations. Additionally, in the second quarter of 2008, Patriot entered into two joint ventures for which it has contributed cash totaling $16.4 million and committed certain coal reserve rights. Patriot holds a 49% interest in each joint venture and accounts for the interests under the equity method of accounting. Patriot’s maximum exposure to loss is the value contributed plus additional future committed capital contributions, which, for one of the joint ventures, is capped at $4.1 million. The investment in these joint ventures was recorded in “Investments and other assets” in the consolidated balance sheets. One of the joint ventures commenced coal mining operations in the third quarter of 2008 and the other is expected to commence coal mining operations in 2009.
 
During 2007, Patriot sold approximately 88 million tons of non-strategic coal reserves and over 18,000 acres of surface land located in Kentucky for cash of $26.5 million and notes receivable of $69.4 million. Patriot recognized gains totaling $78.5 million on these transactions.
 
During 2006, Patriot sold coal reserves and surface land located in Kentucky and West Virginia for proceeds of $84.9 million including cash of $31.8 million and notes receivable of $53.1 million which resulted in a gain of $66.6 million. The gain from these transactions is included in “Net gain on disposal or exchange of assets” in the consolidated statements of operations.


42


 

 
PATRIOT COAL CORPORATION
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
(7)   Earnings per Share
 
Basic earnings per share is computed by dividing net income by the number of weighted average common shares outstanding during the reporting period. Diluted earnings per share is calculated to give effect to all potentially dilutive common shares that were outstanding during the reporting period. Earnings (loss) per share is not presented for periods prior to October 31, 2007, because Patriot was wholly-owned by Peabody and its affiliates prior to the spin-off.
 
For the year ended December 31, 2008 the effect of dilutive securities includes the dilutive impact of stock options and restricted stock units. For the year ended December 31, 2008, the Company had additional potential dilutive securities outstanding representing 0.3 million common shares related to share-based compensation awards as described in Note 23 and 3.0 million common shares related to the convertible notes issuance described in Note 13 that were not included in the computation of dilutive securities because they were anti-dilutive for that period. For the year ended December 31, 2007, 34,638 shares related to share-based compensation awards were excluded from the diluted earnings per share calculation for the Company’s common stock because they were anti-dilutive due to the net loss for that period.
For the years ended December 31, 2008 and 2007, 377,221 and 369,598 restricted stock shares, respectively, were included in the calculation of basic earnings per share as unvested participating securities as required by FSP EITF 03-6-1 as discussed in Note 3 above.
 
(8)   Inventories
 
Inventories consisted of the following:
 
                 
    December 31,  
    2008     2007  
    (Dollars in thousands)  
 
Saleable coal
  $ 15,107     $ 13,519  
Materials and supplies
    52,023       13,385  
Raw coal
    13,823       4,133  
                 
Total
  $ 80,953     $ 31,037  
                 
 
Saleable coal represents coal stockpiles that will be sold in current condition. Raw coal represents coal stockpiles that may be sold in current condition or may be further processed prior to shipment to a customer. Coal inventory costs include labor, supplies, equipment, operating overhead and other related costs. Materials, supplies and coal inventory are valued at the lower of average cost or market. The increase in inventories from December 31, 2007 to December 31, 2008 is primarily attributable to the Magnum acquisition.


43


 

 
PATRIOT COAL CORPORATION
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
(9)   Accumulated Other Comprehensive Loss
 
The following table sets forth the components of comprehensive loss:
 
                                 
    Net
                   
    Actuarial Loss
                   
    Associated with
                   
    Postretirement
    Prior Service
          Total
 
    Plans and
    Cost Associated
          Accumulated
 
    Workers’
    With
    Diesel
    Other
 
    Compensation
    Postretirement
    Fuel
    Comprehensive
 
    Obligations     Plans     Hedge     Loss  
    (Dollars in thousands)  
 
December 31, 2005
  $     $     $     $  
SFAS No. 158 adoption impact of postretirement plans and workers’ compensation obligations
    (318,614 )     (3,507 )           (322,121 )
                                 
December 31, 2006
    (318,614 )     (3,507 )           (322,121 )
Unrealized gains (losses)
    56,624       (7,656 )           48,968  
Reclassification from other comprehensive income to earnings
    35,085       (1,306 )           33,779  
Retention by Peabody of certain liabilities at spin-off
    165,334                   165,334  
                                 
December 31, 2007
    (61,571 )     (12,469 )           (74,040 )
Unrealized losses
    (39,263 )           (9,695 )     (48,958 )
Reclassification from other comprehensive income to earnings
    11,397       (680 )           10,717  
                                 
December 31, 2008
  $ (89,437 )   $ (13,149 )   $ (9,695 )   $ (112,281 )
                                 
 
Comprehensive loss differs from net income (loss) attributable to Patriot by the amount of unrealized gain or loss resulting from valuation changes of the Company’s diesel fuel hedge and adjustments related to the change in funded status of various benefit plans during the periods. For the year ended December 31, 2006, comprehensive loss was impacted by the adjustment required by SFAS No. 158 to initially record the funded status of the Company’s pension and other post-retirement benefit plans.
 
(10)   Leases
 
Patriot leases equipment and facilities, directly or through Peabody, under various non-cancelable operating lease agreements. Certain lease agreements require the maintenance of specified ratios and contain restrictive covenants that limit indebtedness, subsidiary dividends, investments, asset sales and other actions by both Peabody and Patriot. Rental expense under operating leases was $39.5 million, $30.9 million and $28.4 million for the years ended December 31, 2008, 2007 and 2006, respectively.
 
A substantial amount of the coal mined by Patriot is produced from mineral reserves leased from third-party land owners. Patriot leases these coal reserves under agreements that require royalties to be paid as the coal is mined. Certain of these lease agreements also require minimum annual royalties to be paid regardless of the amount of coal mined during the year. Total royalty expense was $71.6 million, $43.2 million and $51.0 million for the years ended December 31, 2008, 2007 and 2006, respectively.


44


 

 
PATRIOT COAL CORPORATION
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
Future minimum lease and royalty payments as of December 31, 2008, are as follows:
 
                         
    Capital
    Operating
    Coal
 
    Leases     Leases     Reserves  
    (Dollars in thousands)  
 
2009
  $ 4,775     $ 41,853     $ 25,056  
2010
    5,668       34,789       22,994  
2011
    593       25,947       20,672  
2012
          17,882       18,827  
2013
          10,056       18,091  
2014 and thereafter
          2,755       86,692  
                         
Total minimum lease and royalty payments
  $ 11,036     $ 133,282     $ 192,332  
                         
Less interest
    (818 )                
                         
Present value of minimum capital lease payments
  $ 10,218                  
                         
 
During 2002, Peabody entered into a transaction with Penn Virginia Resource Partners, L.P. (PVR) whereby two Peabody subsidiaries sold 120 million tons of coal reserves in exchange for $72.5 million in cash and 2.76 million units, or 15%, of the PVR master limited partnership. Patriot participated in the transaction, selling approximately 40 million tons of coal reserves with a net book value of $14.3 million in exchange for $40.0 million. Patriot leased back the coal from PVR and pays royalties as the coal is mined. A $25.7 million gain was deferred at the inception of this transaction, and $3.2 million of the gain was recognized in each of the years 2008, 2007 and 2006. The remaining deferred gain of $6.4 million at December 31, 2008 is intended to provide for potential exposure to loss resulting from continuing involvement in the properties and will be amortized to “Operating costs and expenses” in the consolidated statements of operations over the minimum remaining term of the lease, which ends December 31, 2010.
 
As of December 31, 2008, certain of the Company’s lease obligations were secured by $13.4 million outstanding letters of credit under Patriot’s Credit Facility.
 
(11)   Trade Accounts Payable and Accrued Expenses
 
Trade accounts payable and accrued expenses consisted of the following:
 
                 
    December 31,  
    2008     2007  
    (Dollars in thousands)  
 
Trade accounts payable
  $ 201,046     $ 66,811  
Accrued healthcare, including post-retirement
    66,509       30,120  
Workers’ compensation obligations
    28,225       23,778  
Accrued payroll and related benefits
    40,719       21,565  
Accrued taxes other than income
    27,646       13,339  
Other accrued benefits
    11,029       9,487  
Accrued royalties
    9,532       5,281  
Accrued lease payments
    4,330       1,692  
Diesel fuel hedge
    5,915        
Other accrued expenses
    18,839       11,519  
                 
Total trade accounts payable and accrued expenses
  $ 413,790     $ 183,592  
                 


45


 

 
PATRIOT COAL CORPORATION
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
(12)   Income Taxes
 
Income (loss) before income taxes was income of $146.9 million, loss of $102.1 million, and income of $6.0 million for the years ended December 31, 2008, 2007 and 2006, respectively, and consisted entirely of domestic results.
 
The income tax rate differed from the U.S. federal statutory rate as follows:
 
                         
    Year Ended December 31,  
    2008     2007     2006  
    (Dollars in thousands)  
 
Federal statutory rate
  $ 51,398     $ (35,751 )   $ 2,110  
Depletion
    (16,597 )     (11,281 )     (15,006 )
State income taxes, net of U.S. federal tax benefit
    5,918       (6,911 )     (2,183 )
Noncontrolling interest
          (1,652 )     (3,909 )
Changes in valuation allowance
    (44,540 )     55,183       26,864  
Changes in tax reserves
    960       107       172  
Other, net
    2,861       305       302  
                         
Total
  $     $     $ 8,350  
                         
 
The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and liabilities consisted of the following:
 
                 
    December 31,  
    2008     2007  
    (Dollars in thousands)  
 
Deferred tax assets:
               
Postretirement benefit obligations
  $ 425,087     $ 233,881  
Tax credits and loss carryforwards
    133,860       20,346  
Accrued workers’ compensation liabilities
    92,199       91,925  
Accrued reclamation and mine closing liabilities
    98,084       53,483  
Obligation to industry fund
    12,672       12,672  
Sales contract liabilities
    274,704        
Other
    43,986       20,387  
                 
Total gross deferred tax assets
    1,080,592       432,694  
                 
Deferred tax liabilities:
               
Property, plant, equipment and mine development, leased coal interests and advance royalties, principally due to differences in depreciation, depletion and asset writedowns
    878,144       162,092  
                 
Total gross deferred tax liabilities
    878,144       162,092  
                 
Valuation allowance
    (202,448 )     (270,602 )
                 
Net deferred tax liability
  $     $  
                 
Deferred taxes consisted of the following:
               
Current deferred income taxes
  $     $  
Noncurrent deferred income taxes
           
                 
Net deferred tax liability
  $     $  
                 


46


 

 
PATRIOT COAL CORPORATION
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
In June 2006, the FASB issued Interpretation No. 48, “Accounting for Uncertainty in Income Taxes — an interpretation of FASB Statement No. 109” (FIN No. 48). This interpretation prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN No. 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition.
 
Patriot adopted the provisions of FIN No. 48 on January 1, 2007, with no impact to retained earnings. At adoption and at December 31, 2008, the unrecognized tax benefits in our consolidated financial statements were immaterial, and if recognized, would not currently affect the Company’s effective tax rate as any recognition would be offset by valuation allowance. The Company does not expect any significant increases or decreases to our unrecognized tax benefits within 12 months of this reporting date.
 
Due to the immaterial nature of its unrecognized tax benefits and the existence of net operating loss carryforwards, the Company has not currently accrued interest on any of its unrecognized tax benefits. The Company has considered the application of penalties on its unrecognized tax benefits and has determined, based on several factors, including the existence of net operating loss carryforwards, that no accrual of penalties related to its unrecognized tax benefits is required. If the accrual of interest or penalties becomes appropriate, the Company will record an accrual as part of its income tax provision.
 
The Company’s deferred tax assets include net operating losses (NOL) carryforwards and alternative minimum tax (AMT) credits of $133.9 million and $20.3 million as of December 31, 2008 and 2007, respectively. The NOL carryforwards and AMT credits represent amounts apportioned to the Company in accordance with the Internal Revenue Code and Treasury Regulations at the time of the Company’s spin-off from Peabody on October 31, 2007, Magnum NOL carryforwards from periods prior to the merger, as well as taxable losses from the Company’s operations for the last two months of 2007 and for the calendar year ended December 31, 2008. The NOL carryforwards begin to expire in 2019, and the AMT credits have no expiration date.
 
Overall, the Company’s net deferred tax assets are offset by a valuation allowance of $202.4 million and $270.6 million as of December 31, 2008 and 2007, respectively. The valuation allowance decreased by $68.2 million for the year ended December 31, 2008 primarily as a result of the Magnum acquisition. The Company evaluated and assessed the expected near-term utilization of net operating loss carryforwards, book and taxable income trends, available tax strategies and the overall deferred tax position to determine the valuation allowance required as of December 31, 2008 and 2007.
 
The Federal and state income tax returns for the Magnum companies for the tax years 2005-2008 remain subject to examination by the relevant taxing authorities. The Company and the remainder of its subsidiaries were included in the consolidated Peabody income tax returns prior to November 1, 2007, with Peabody retaining all liability related to these returns. Therefore, for the Company and the remainder of its subsidiaries, Patriot only has examination exposure related to the Federal and state income tax returns for the two month tax year ended December 31, 2007.
 
The Company made no Federal income tax payments and made only immaterial state and local tax payments for the years ended December 31, 2008 and 2007.


47


 

 
PATRIOT COAL CORPORATION
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
(13)   Long-Term Debt
 
Patriot’s total indebtedness consisted of the following:
                 
    December 31,  
    2008     2007  
    (Dollars in thousands)  
3.25 % Convertible Senior Notes due 2013 less debt discount of $40,363
  $ 159,637     $  
Short-term borrowings
    23,000        
Promissory notes
    11,438       12,365  
Capital Leases
    10,218        
 
           
Total
  $ 204,293     $ 12,365  
 
           
      Private Convertible Notes Issuance
 
On May 28, 2008, Patriot completed a private offering of $200 million in aggregate principal amount of 3.25% Convertible Senior Notes due 2013 (the notes), including $25 million related to the underwriters’ overallotment option. The net proceeds of the offering were $193.5 million after deducting the initial purchasers’ commissions and fees and expenses of the offering and were used to repay Magnum’s credit facility at the date of acquisition. The Company has retrospectively applied the provisions of FSP APB 14-1, which was adopted on January 1, 2009, to these notes.
 
The Company utilized an interest rate of 8.85% to reflect the nonconvertible market rate of the Company’s offering upon issuance, which resulted in a $44.7 million discount to the convertible note balance and an increase to “Additional paid-in capital” to reflect the value of the conversion feature. The nonconvertible market interest rate was based on an analysis of similar securities trading in the market at the pricing date of the issuance, taking into account company specific data such as credit spreads and implied volatility. In addition, the Company allocated the financing costs related to the issuance of the convertible instruments between the debt and equity components. The Company will amortize the debt discount over the contractual life of the convertible notes, resulting in additional interest expense above the contractual coupon amount.
 
At December 31, 2008, based on the required application of FSP APB 14-1, the principal amount of the convertible notes of $200.0 million, net of the debt discount of $40.4 million, results in a long-term convertible note balance of $159.6 million. The additional interest expense resulting from the application of FSP APB 14-1 above the stated coupon rate of 3.25% for the year ended December 31, 2008 was $4.1 million, net of a $0.2 million decrease to amortization of deferred financing costs ($0.06 per share — basic and diluted).
 
Interest on the notes is payable semi-annually in arrears on May 31 and November 30 of each year, beginning November 30, 2008. The notes mature on May 31, 2013, unless converted, repurchased or redeemed in accordance with their terms prior to such date. The notes are senior unsecured obligations and rank equally with all of the Company’s existing and future senior debt and are senior to any subordinated debt. Patriot used the proceeds of the offering to repay Magnum’s existing senior secured indebtedness and acquisition related fees and expenses. All remaining amounts were used for other general corporate purposes.
 
The notes are convertible into cash and, if applicable, shares of Patriot’s common stock during the period from issuance to February 15, 2013, subject to certain conditions of conversion as described below. The conversion rate for the notes is 14.7778 shares of Patriot’s common stock per $1,000 principal amount of notes, which is equivalent to a conversion price of approximately $67.67 per share of common stock. The conversion rate and the conversion price are subject to adjustment for certain dilutive events, such as a future stock split or a distribution of a stock dividend.


48


 

 
PATRIOT COAL CORPORATION
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
The notes require Patriot to settle all conversions by paying cash for the lesser of the principal amount or the conversion value of the notes, and by settling any excess of the conversion value over the principal amount in cash or shares, at the Company’s option.
 
Holders of the notes may convert their notes prior to the close of business on the business day immediately preceding February 15, 2013, only under the following circumstances: (1) during the five trading day period after any ten consecutive trading day period (the measurement period) in which the trading price per note for each trading day of that measurement period was less than 97% of the product of the last reported sale price of Patriot’s common stock and the conversion rate on each such trading day; (2) during any calendar quarter after the calendar quarter ending September 30, 2008, and only during such calendar quarter, if the last reported sale price of Patriot’s common stock for 20 or more trading days in a period of 30 consecutive trading days ending on the last trading day of the immediately preceding calendar quarter exceeds 130% of the conversion price in effect on each such trading day; (3) if such holder’s notes have been called for redemption or (4) upon the occurrence of corporate events specified in the indenture. The notes will be convertible, regardless of the foregoing circumstances, at any time from, and including, February 15, 2013 until the close of business on the business day immediately preceding the maturity date.
 
The number of shares of Patriot’s common stock that it may deliver upon conversion will depend on the price of its common stock during an observation period as described in the indenture. Specifically, the number of shares deliverable upon conversion will increase as the common stock price increases above the conversion price of $67.67 per share during the observation period. The maximum number of shares that Patriot may deliver is 2,955,560. However, if certain fundamental changes occur in Patriot’s business that are deemed “make-whole fundamental changes” in the indenture, the number of shares deliverable on conversion may increase, up to a maximum amount of 4,137,788 shares. These maximum amounts are subject to adjustment for certain dilutive events, such as a stock split or a distribution of a stock dividend.
 
Holders of the notes may require Patriot to repurchase all or a portion of their notes upon a fundamental change in Patriot’s business, as defined in the indenture. The holders would receive cash for 100% of the principal amount of the notes, plus any accrued and unpaid interest.
 
Patriot may redeem (i) some or all of the notes at any time on or after May 31, 2011, but only if the last reported sale price of Patriot’s common stock for 20 or more trading days in a period of 30 consecutive trading days ending on the trading day prior to the date Patriot provides the relevant notice of redemption exceeds 130% of the conversion price in effect on each such trading day, or (ii) all of the notes if at any time less than $20 million in aggregate principal amount of notes remain outstanding. In both cases, notes will be redeemed for cash at a redemption price equal to 100% of the principal amount of the notes to be redeemed, plus any accrued and unpaid interest up to, but excluding, the relevant redemption date.
 
Under the indenture for the notes, if Patriot fails to timely file any document or report required to be filed with the Securities and Exchange Commission pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, (other than reports on Form 8-K), Patriot is required to pay additional interest on the notes of 0.50% of the principal balance of the notes. Per the guidance set forth in SFAS No. 133 “Accounting for Derivative Instruments and Hedging Activities” (SFAS No. 133), this additional interest feature is considered an embedded derivative. Management has determined the fair value of this embedded derivative is de minimis as the probability of reports not being filed timely is remote and the Company has no history of late submissions.
 
The notes and any shares of common stock issuable upon conversion have not been registered under the Securities Act of 1933, as amended (the Securities Act), or any state securities laws. The notes were only offered to qualified institutional buyers pursuant to Rule 144A promulgated under the Securities Act.


49


 

 
PATRIOT COAL CORPORATION
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
      Credit Facility
 
Effective October 31, 2007, the Company entered into a $500 million, four-year revolving credit facility, which includes a $50 million swingline sub-facility and a letter of credit sub-facility. This facility is available for the Company’s working capital requirements, capital expenditures and other corporate purposes. As of December 31, 2008, the balance of outstanding letters of credit issued against the credit facility totaled $351 million, and $23 million short-term borrowings were outstanding under the sub-facility. As of December 31, 2007, the balance of outstanding letters of credit issued against the credit facility totaled $254 million. Availability under the credit facility was $126 million and $247 million as of December 31, 2008 and 2007, respectively. The weighted-average effective interest rate of the sub-facility was 3.99% as of December 31, 2008.
 
The obligations under the Company’s credit facility are secured by a first lien on substantially all of our assets, including but not limited to certain of our mines and coal reserves and related fixtures and accounts receivable. The credit facility contains certain customary covenants, including financial covenants limiting the Company’s total indebtedness (maximum leverage ratio of 2.75) and requiring minimum EBITDA coverage of interest expense (minimum interest coverage ratio of 4.0), as well as certain limitations on, among other things, additional debt, liens, investments, acquisitions and capital expenditures, future dividends and asset sales. The credit facility calls for quarterly reporting of compliance with financial covenants. The financial covenants are calculated based on pro forma results as if we acquired Magnum on January 1, 2008 and EBITDA as defined by the credit agreement. The terms of the credit facility also contain certain customary events of default, which will give the lender the right to accelerate payments of outstanding debt in certain circumstances. Customary events of default include breach of covenants, failure to maintain required ratios, failure to make principal payments or to make interest or fee payments within a grace period, and default, beyond any applicable grace period, on any of the Company’s other indebtedness exceeding a certain amount.
 
In connection with the merger agreement with Magnum, Patriot entered into an amendment dated as of April 2, 2008 to the credit facility. The amendment among other things, (i) permitted the merger with Magnum and the transactions contemplated by the merger agreement, (ii) increased the rate of interest applicable to loans and letters of credit fees under the credit facility and (iii) modified certain covenants and related definitions to allow for changes in permitted indebtedness, permitted liens, permitted capital expenditures and other changes in respect of Patriot and its subsidiaries in connection with the acquisition. The increase in the interest rate and the covenant modifications were effective with the closing of the acquisition. In connection with Patriot’s issuance of the convertible notes discussed above, Patriot entered into an amendment to the credit facility dated as of May 19, 2008, allowing the issuance of the convertible notes and modifying certain covenants for the period prior to the closing of the Magnum acquisition. On September 25, 2008, Patriot entered into an amendment to the credit facility allowing, among other things, permitted securitization programs without adjusting the capacity of the credit facility. At December 31, 2008 we were in compliance with the covenants of our amended credit facility.
      Promissory Notes
 
In conjunction with an exchange transaction involving the acquisition of Illinois Basin coal reserves in 2005, the Company entered into Promissory Notes. The Promissory Notes and related interest are payable in annual installments of $1.7 million beginning January 2008. The Promissory Notes mature in January 2017. At December 31, 2008, the short-term portion of the Promissory Notes was $1.0 million.
      Capital Lease Obligations and Other
 
Capital lease obligations include obligations assumed in the Magnum acquisition, primarily for mining equipment (see Note 10 for additional information on the Company’s capital lease obligations). As of December 31, 2008, “Property, plant, equipment and mine development” on the consolidated balance sheets includes approximately $7.6 million related to assets subject to capital leases and $13.5 million related to a capital lease for the Blue Creek mining complex preparation plant that is under construction.


50


 

 
PATRIOT COAL CORPORATION
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
      Bridge Loan Facility
 
In connection with the Magnum acquisition agreement, Patriot obtained a subordinated bridge loan financing commitment, allowing it to draw up to $150 million under the related bridge loan facility at the effective date of the acquisition to repay a portion of the outstanding debt of Magnum. Patriot terminated the financing commitment on May 30, 2008, as a result of the Convertible Senior Notes issuance. Patriot recognized $1.5 million in commitment fees in connection with the financing commitment, which were included in “Interest expense” in the consolidated statements of operations.
 
The aggregate amounts of long-term debt maturities subsequent to December 31, 2008, including capital lease obligations, were as follows:
         
    (Dollars in  
Year of Maturity   thousands)  
2009
  $ 5,071  
2010
    6,596  
2011
    1,695  
2012
    1,182  
2013
    201,255  
2014 and thereafter
  5,857  
 
     
Total cash payments on debt
  221,656  
Debt discount on convertible notes
  (40,363 )
 
     
Total long-term debt
$ 181,293  
 
     
 
Interest paid on long-term debt was $5.2 million for the year ended December 31, 2008. Prior to the spin-off, all cash payments for interest were made by the Company’s former parent, Peabody. The following table summarizes the amount of interest cost recognized related to both the contractual interest and the accretion of the discount of the liability component of the convertible notes:
                         
    Year Ended December 31,  
    2008     2007     2006  
    (Dollars in thousands)
Cash interest
  $ 16,744     $ 8,123     $ 11,419  
Discount amortization
    4,293              
Amortization of debt issuance costs
    2,611       214        
 
                 
Total interest expense
  $ 23,648     $ 8,337     $ 11,419  
 
                 
 
(14)   Asset Retirement Obligations
 
Reconciliations of Patriot’s liability for asset retirement obligations were as follows:
 
                 
    December 31,  
    2008     2007  
    (Dollars in thousands)  
 
Balance at beginning of year
  $ 134,364     $ 139,703  
Liabilities incurred
    203       224  
Liabilities settled or disposed
    (6,540 )     (17,228 )
Accretion expense
    19,116       13,291  
Revisions to estimate
    1,057       7,089  
Liabilities conveyed to Peabody (upon spin-off)
          (8,715 )
Liabilities acquired through acquisition
    75,980        
                 
Balance at end of year
  $ 224,180     $ 134,364  
                 
 
As of December 31, 2008, asset retirement obligations of $224.2 million consisted of $171.8 million related to locations with active mining operations and $52.4 million related to locations that are closed or inactive. As of December 31, 2007, asset retirement obligations of $134.4 million consisted of $102.7 million related to locations with active mining operations and $31.7 million related to locations that are closed or inactive. The credit-adjusted, risk-free interest rates were 9.00% and 6.60% at January 1, 2008 and 2007, respectively.
 
For the year ended December 31, 2007, the Company recorded a $1.3 million reduction in its asset retirement obligations and expense associated with the disposal of non-strategic properties and the assumption of the related reclamation liabilities by the purchaser. For the year ended December 31, 2008, no similar reduction was recorded.


51


 

 
PATRIOT COAL CORPORATION
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
As of December 31, 2008 and 2007, Patriot had $135.5 million and $84.1 million, respectively, in surety bonds outstanding to secure the Company’s reclamation obligations or activities. As of December 31, 2007, Peabody had $19.9 million of self bonding outstanding that related to Patriot’s reclamation obligations or activities. In 2008, these self bonds were replaced with Patriot surety bonds.
 
As of December 31, 2008, Arch Coal, Inc. (Arch) held surety bonds of $91.9 million related to reclamation for properties acquired by Patriot in the Magnum acquisition. As a result of the acquisition, Patriot is required to post letters of credit in Arch’s favor at an increasing percentage of the accrued reclamation liabilities beginning August 2009 through February 2011.
 
(15)   Workers’ Compensation Obligations
 
Certain of Patriot’s operations are subject to the Federal Coal Mine Health and Safety Act of 1969, and the related workers’ compensation laws in the states in which the Company operates. These laws require Patriot’s operations to pay benefits for occupational disease resulting from coal workers’ pneumoconiosis (occupational disease). Provisions for occupational disease costs are based on determinations by independent actuaries or claims administrators.
 
Patriot provides income replacement and medical treatment for work related traumatic injury claims as required by applicable state law. Provisions for estimated claims incurred are recorded based on estimated loss rates applied to payroll and claim reserves determined by independent actuaries or claims administrators. Certain of the Company’s operations are required to contribute to state workers’ compensation funds for second injury and other costs incurred by the state fund based on a payroll-based assessment by the applicable state. Provisions are recorded based on the payroll-based assessment criteria.
 
The workers’ compensation provision consists of the following components:
 
                         
    Year Ended December 31,  
    2008     2007     2006  
    (Dollars in thousands)  
 
Service cost
  $ 3,382     $ 2,971     $ 2,807  
Interest cost
    9,876       9,124       9,568  
Net amortization of actuarial gains
    (4,009 )     (1,607 )     (1,369 )
                         
Total occupational disease
    9,249       10,488       11,006  
Traumatic injury claims
    13,261       13,160       10,984  
State assessment taxes
    2,546       4,373       10,388  
                         
Total provision
  $ 25,056     $ 28,021     $ 32,378  
                         
 
The decline in traumatic workers’ compensation costs was primarily driven by the impact of changes in workers’ compensation law in West Virginia. Administrative fees have been reduced as a result of successfully self-administering, at a lower cost, claims that were previously administered by the state. In addition, the law changes have reduced the frequency and magnitude of claims.
 
The weighted-average assumptions used to determine the workers’ compensation provision were as follows:
 
                         
    Year Ended December 31,  
    2008     2007     2006  
 
Discount rate:
                       
Occupational disease
    6.40 %     6.00 %     5.90 %
Traumatic injury
    5.80 %     6.00 %     5.90 %
Inflation rate
    3.50 %     3.50 %     3.50 %
 
Workers’ compensation obligations consist of amounts accrued for loss sensitive insurance premiums, uninsured claims, and related taxes and assessments under black lung and traumatic injury workers’ compensation programs.


52


 

 
PATRIOT COAL CORPORATION
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
The workers’ compensation obligations consisted of the following:
 
                 
    December 31,  
    2008     2007  
    (Dollars in thousands)  
 
Occupational disease costs
  $ 154,527     $ 155,829  
Traumatic injury claims
    61,878       60,679  
                 
Total obligations
    216,405       216,508  
Less current portion (included in Accrued expenses)
    (28,225 )     (23,778 )
                 
Noncurrent obligations (included in Workers’ compensation obligations)
  $ 188,180     $ 192,730  
                 
 
As a result of the adoption of SFAS No. 158 on December 31, 2006, the accrued workers’ compensation liability recorded on the consolidated balance sheets at December 31, 2008 and 2007 reflects the accumulated benefit obligation less any portion that is currently funded. The accumulated actuarial gain that had not yet been reflected in net periodic postretirement benefit costs was included in “Accumulated other comprehensive loss.”
 
As of December 31, 2008 and 2007, Patriot had $189.5 million and $183.8 million, respectively, in surety bonds and letters of credit outstanding to secure workers’ compensation obligations.
 
The reconciliation of changes in the occupational disease liability benefit obligation was as follows:
 
                 
    December 31,  
    2008     2007  
    (Dollars in thousands)  
 
Change in benefit obligation:
               
Beginning of year obligation
  $ 155,829     $ 173,924  
Service cost
    3,382       2,971  
Interest cost
    9,876       9,124  
Acquisitions/divestitures
    3,176        
Net change in actuarial gain
    (6,876 )     (21,653 )
Benefit and administrative payments
    (10,860 )     (8,537 )
                 
Net obligation at end of year
    154,527       155,829  
Change in plan assets:
               
Fair value of plan assets at beginning of period
           
Employer contributions
    10,860       8,537  
Benefits paid
    (10,860 )     (8,537 )
                 
Fair value of plan assets at end of period
           
                 
Obligation at end of period
  $ 154,527     $ 155,829  
                 
 
The liability for occupational disease claims represents the actuarially-determined present value of known claims and an estimate of future claims that will be awarded to current and former employees. The liability for occupational disease claims was based on a discount rate of 6.0% and 6.4% at December 31, 2008 and 2007, respectively. Traumatic injury workers’ compensation obligations are estimated from both case reserves and actuarial determinations of historical trends, discounted at 6.1% and 5.8% as of December 31, 2008 and 2007, respectively.


53


 

 
PATRIOT COAL CORPORATION
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
Federal Black Lung Excise Tax Refund Claims
 
In addition to the obligations discussed above, certain subsidiaries of Patriot are required to pay black lung excise taxes to the Federal Black Lung Trust Fund (the Trust Fund). The Trust Fund pays occupational disease benefits to entitled former miners who worked prior to July 1, 1973. Excise taxes are based on the selling price of coal, up to a maximum of $1.10 per ton for underground mines and $0.55 per ton for surface mines. The Company has a receivable for excise tax refunds of $5.8 million as of December 31, 2008, related to new legislation that allows for excise taxes paid in prior years on export coal and related interest to be refundable to the Company, which is included in “Accounts receivable and other” in the consolidated balance sheets. The refund is reflected in the consolidated statements of operations as a reduction to “Operating costs and expenses” of $2.4 million and an increase to “Interest income” of $3.4 million.
 
(16)   Pension and Savings Plans
 
Multi-Employer Pension Plans
 
Certain subsidiaries participate in multi-employer pension plans (the 1950 Plan and the 1974 Plan), which provide defined benefits to substantially all hourly coal production workers represented by the UMWA. Benefits under the UMWA plans are computed based on service with the subsidiaries or other signatory employers. The 1950 Plan and the 1974 Plan qualify under SFAS No. 106 as multi-employer benefit plans, which allows Patriot to recognize expense as contributions are made. The expense related to these funds was $13.5 million and $6.9 million for the years ended December 31, 2008 and 2007, respectively. There were no contributions to the multi-employer pension plans during the year ended December 31, 2006. In December 2006, the 2007 National Bituminous Coal Wage Agreement was signed, which required funding of the 1974 Plan through 2011 under a phased funding schedule. The funding is based on an hourly rate for certain UMWA workers. Under the labor contract, the per-hour funding rate increased to $2.00 in 2007 and increases each year thereafter until reaching $5.50 in 2011. The Company expects to pay approximately $19.7 million related to these funds in 2009.
 
Defined Contribution Plans
 
Patriot sponsors employee retirement accounts under a 401(k) plan for eligible salaried and non-union hourly employees of the Company (the 401(k) Plan). Patriot matches voluntary contributions to the 401(k) Plan up to specified levels. Prior to the spin-off, Peabody also sponsored a similar 401(k) plan in which eligible Patriot employees could participate. A performance contribution feature under both Patriot’s plan and Peabody’s plan allows for additional contributions based upon meeting specified performance targets. The Company recognized expense for these plans of $6.1 million, $3.4 million and $5.6 million for the years ended December 31, 2008, 2007 and 2006, respectively.
 
In addition, Magnum had three defined contribution plans prior to the acquisition. The first two were the Magnum Coal Company 401(k) Plan and the Day Plan, LLC. These plans matched voluntary employee contributions up to specified levels, similar to Patriot’s 401(k) Plan. Additionally, certain employees were covered by the Magnum Coal Company Defined Contribution Retirement Plan based on age and compensation. Magnum funded the plan in an amount not less than the minimum statutory funding requirements or more than the maximum amount allowed to be deducted for federal income tax purposes. Magnum’s expense under these plans was $2.4 million for the year ended December 31, 2008. These plans were merged into Patriot’s 401(k) Plan effective January 1, 2009.
 
(17)   Postretirement Healthcare Benefits
 
The Company currently provides healthcare and life insurance benefits to qualifying salaried and hourly retirees and their dependents from defined benefit plans established by Peabody and continued by Patriot after the spin-off. Plan coverage for health and life insurance benefits is provided to certain hourly retirees in accordance with the applicable labor agreement.


54


 

 
PATRIOT COAL CORPORATION
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
Net periodic postretirement benefit costs included the following components:
 
                         
    Year Ended December 31,  
    2008     2007     2006  
    (Dollars in thousands)  
 
Service cost for benefits earned
  $ 1,731     $ 981     $ 599  
Interest cost on accumulated postretirement benefit obligation
    51,472       65,964       62,385  
Amortization of prior service cost
    (680 )     (1,306 )     (2,545 )
Amortization of actuarial losses
    13,516       34,260       26,866  
                         
Net periodic postretirement benefit costs
  $ 66,039     $ 99,899     $ 87,305  
                         
 
The following table sets forth the plans’ combined funded status reconciled with the amounts shown in the consolidated balance sheets:
 
                 
    December 31,  
    2008     2007  
    (Dollars in thousands)  
 
Change in benefit obligation:
               
Accumulated postretirement benefit obligation at beginning of period
  $ 554,748     $ 1,214,032  
Service cost
    1,731       981  
Interest cost
    51,472       65,964  
Participant contributions
    412       840  
Plan amendments
          11,687  
Acquisitions/divestitures
    456,396        
Retention by Peabody of certain liabilities
          (615,837 )
Benefits paid
    (42,491 )     (74,948 )
Change in actuarial (gain) or loss
    42,660       (47,971 )
                 
Accumulated postretirement benefit obligation at end of period
    1,064,928       554,748  
                 
Change in plan assets:
               
Fair value of plan assets at beginning of period
           
Employer contributions
    42,079       74,108  
Participant contributions
    412       840  
Benefits paid and administrative fees (net of Medicare Part D reimbursements)
    (42,491 )     (74,948 )
                 
Fair value of plan assets at end of period
           
                 
Accrued postretirement benefit obligation
    1,064,928       554,748  
Less current portion (included in Accrued expenses)
    (61,674 )     (27,433 )
                 
Noncurrent obligation (included in Accrued postretirement benefit costs)
  $ 1,003,254     $ 527,315  
                 
 
Peabody assumed certain of the Company’s retiree healthcare liabilities at the spin-off, which are valued at $597.6 million as of December 31, 2008 and are not reflected above. These liabilities included certain obligations under the Coal Act for which Peabody and Patriot are jointly and severally liable, obligations under the 2007 National Bituminous Coal Wage Act for which the Company is secondarily liable, and obligations for certain active, vested employees of the Company.


55


 

 
PATRIOT COAL CORPORATION
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
As a result of the adoption of SFAS No. 158 on December 31, 2006, the accrued postretirement benefit liability recorded on the consolidated balance sheets at December 31, 2008 and 2007 reflects the accumulated postretirement benefit obligation less any portion that is currently funded. The accumulated actuarial loss and prior service costs that had not yet been reflected in net periodic postretirement benefit costs were included in “Accumulated other comprehensive loss”.
 
The Company amortizes actuarial gains and losses using a 0% corridor with an amortization period that covers the average remaining service period of active employees (6.47 years, 6.47 years and 8.47 years utilized for 2008, 2007 and 2006, respectively). For the year ending December 31, 2009, an estimated actuarial loss of $18.4 million and an estimated gain from prior service cost of $0.6 million will be amortized from accumulated comprehensive loss into net periodic postretirement costs.
 
The weighted-average assumptions used to determine the benefit obligations as of the end of each year were as follows:
 
         
    Year Ended December 31,
    2008   2007
 
Discount rate
  6.80%   6.80%
Rate of compensation increase
  3.50%   3.50%
Measurement date
  December 31, 2008   December 31, 2007
 
The weighted-average assumptions used to determine net periodic benefit cost were as follows:
 
             
    Year Ended December 31,
    2008   2007   2006
 
Discount rate
  6.80%   6.00%   5.90%
Rate of compensation increase
  3.50%   3.50%   3.50%
Measurement date
  December 31, 2007   December 31, 2006   December 31, 2005
 
The discount rate used for Magnum for the five months of 2008 following acquisition was 7.25%. The discount rate above for 2008 was for the full twelve months.
 
The following presents information about the assumed healthcare cost trend rate:
 
                 
    Year Ended December 31,  
    2008     2007  
 
Healthcare cost trend rate assumed for next year
    9.25 %     7.50 %
Rate to which the cost trend is assumed to decline (the ultimate trend rate)
    4.75 %     4.75 %
Year that the rate reaches that ultimate trend rate
    2014       2013  
 
Assumed healthcare cost trend rates have a significant effect on the amounts reported for healthcare plans. A one percentage-point change in the assumed healthcare cost trend would have the following effects:
 
                 
    +1.0%   -1.0%
    (Dollars in thousands)
 
Effect on total service and interest cost components
  $ 10,058     $ (8,220 )
Effect on year-end postretirement benefit obligation
    127,213       (105,631 )
 
Plan Assets
 
The Company’s postretirement benefit plans are unfunded.


56


 

 
PATRIOT COAL CORPORATION
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
Estimated Future Benefits Payments
 
The following benefit payments (net of retiree contributions), which reflect expected future service, as appropriate, are expected to be paid by Patriot:
 
         
    Postretirement
 
    Benefits  
    (Dollars in thousands)  
 
2009
  $ 61,674  
2010
    67,205  
2011
    75,600  
2012
    79,936  
2013
    84,488  
Years 2014-2018
    454,930  
 
Medicare and Other Plan Changes
 
Effective January 1, 2007, the Company entered into a new labor relations agreement for certain UMWA represented employees in Appalachia. The provisions of the new agreement resulted in an actuarially determined projected increase in healthcare costs of $11.7 million primarily in relation to the elimination of certain deductibles.
 
Multi-Employer Benefit Plans
 
Retirees formerly employed by certain subsidiaries and their predecessors, who were members of the UMWA; last worked before January 1, 1976; and were receiving health benefits on July 20, 1992; receive health benefits provided by the Combined Fund, a fund created by the Coal Act. The Coal Act requires former employers (including certain entities of the Company) and their affiliates to contribute to the Combined Fund according to a formula. The Coal Act also established the 1992 Benefit Plan, which provides medical and death benefits to persons who are not eligible for the Combined Fund, who retired prior to October 1, 1994. A prior national labor agreement established the 1993 Benefit Plan to provide health benefits for retired miners not covered by the Coal Act. The 1993 Benefit Plan provides benefits to qualifying retired former employees, who retired after September 30, 1994, of certain signatory companies which have gone out of business and defaulted in providing their former employees with retiree medical benefits. Beneficiaries continue to be added to this fund as employers go out of business. The Company expects to pay $19.1 million in 2009 related to these funds.
 
The Surface Mining Control and Reclamation Act of 2006 (the 2006 Act), enacted in December 2006, amended the federal laws establishing the Combined Fund, 1992 Benefit Plan and the 1993 Benefit Plan. Among other things, the 2006 Act guarantees full funding of all beneficiaries in the Combined Fund, provides funds on a phased-in basis for the 1992 Benefit Plan, and authorizes the trustees of the 1993 Benefit Plan to determine the contribution rates through 2010 for pre-2007 beneficiaries. The new and additional federal expenditures to the Combined Fund, 1992 Benefit Plan, 1993 Benefit Plan and certain Abandoned Mine Land payments to the states and Indian tribes are collectively limited by an aggregate annual cap of $490 million. To the extent that (i) the annual funding of the programs exceeds this amount (plus the amount of interest from the Abandoned Mine Land trust fund paid with respect to the Combined Fund), and (ii) Congress does not allocate additional funds to cover the shortfall, contributing employers and affiliates, including some of the Company’s entities, would be responsible for the additional costs.
 
The Company has recorded actuarially determined liabilities representing a portion of the amount anticipated to be due to these funds. The noncurrent portion related to these obligations was $42.5 million and $31.1 million as of December 31, 2008 and 2007, respectively, and is reflected in “Obligation to industry fund” in the consolidated balance sheets. The current portion related to these obligations reflected in “Trade accounts payable and accrued expenses” in the consolidated balance sheets was $6.6 million and $5.2 million as of December 31, 2008 and 2007,


57


 

 
PATRIOT COAL CORPORATION
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
respectively. Expense of $2.6 million was recognized related to these obligations for the year ended December 31, 2008, and consisted of interest discount of $2.7 million and amortization of actuarial gain of $0.1 million. Expense of $2.9 million was recognized related to these obligations for the year ended December 31, 2007, and consisted of interest discount of $2.3 million and amortization of actuarial loss of $0.6 million. Expense of $2.5 million was recognized related to these obligations for the year ended December 31, 2006, and consisted of interest discount of $2.4 million and amortization of actuarial loss of $0.1 million. The Company made payments of $6.1 million, $5.5 million and $8.3 million to these obligations for the years ended December 31, 2008, 2007 and 2006, respectively.
 
As a result of the adoption of SFAS No. 158 on December 31, 2006, the obligation to industry fund recorded on the consolidated balance sheets at December 31, 2008 and 2007 reflects the obligation less any portion that is currently funded. The accumulated actuarial gain that has not yet been reflected in expense as of December 31, 2008 and 2007 was $0.8 million and $0.6 million, respectively, and is included in “Accumulated other comprehensive loss.”
 
A portion of these funds qualifies under SFAS No. 106 as multi-employer benefit plans, which allows the Company to recognize expense as contributions are made. The expense related to these funds was $11.8 million, $15.9 million and $6.9 million for the years ended December 31, 2008, 2007 and 2006, respectively.
 
Pursuant to the provisions of the Coal Act and the 1992 Benefit Plan, the Company was required to provide security in an amount equal to three times the annual cost of providing healthcare benefits for all individuals receiving benefits from the 1992 Benefit Plan who are attributable to the Company, plus all individuals receiving benefits from an individual employer plan maintained by the Company who are entitled to receive such benefits. Beginning in 2007, the amount of security the Company was required to provide for the 1992 Benefit Plan was reduced to one times the annual cost to provide the above mentioned healthcare benefits.
 
(18)   Related Party Transactions
 
Prior to the spin-off, Patriot routinely entered into transactions with Peabody and its affiliates. The terms of these transactions were outlined in agreements executed by Peabody and its affiliates.
 
The Company sold 12.1 million tons of coal resulting in revenues of $578.1 million for the year ended December 31, 2008; 21.6 million tons of coal resulting in revenues of $1.03 billion for the year ended December 31, 2007; and 24.3 million tons of coal resulting in revenues of $1.13 billion for the year ended December 31, 2006 to a marketing affiliate of Peabody, which negotiated and maintained coal sales contracts. These sales were made at prices paid by outside third-party customers, with the exception in 2008 of one major coal supply agreement which was re-priced to reflect the then market price as part of the spin-off from Peabody. As of December 31, 2008, “Accounts receivable and other” on the consolidated balances sheets included $34.8 million of outstanding trade receivables from Peabody related to coal sales. As of December 31, 2007, the majority of the “Accounts receivable and other” on the consolidated balance sheets represented outstanding trade receivables from Peabody related to coal sales.
 
Selling and administrative expenses include $37.3 million and $47.9 million for the twelve months ended December 31, 2007 and 2006, respectively, for services provided by Peabody and represent an allocation of Peabody general corporate expenses to all of its mining operations, both foreign and domestic, based on principal activity, headcount, tons sold and revenues as applicable to the specific expense being allocated. The allocated expenses generally reflected service costs for: marketing and sales, legal, finance and treasury, public relations, human resources, environmental engineering and internal audit. Different general accounting allocation bases or methods could have been used and could have resulted in significantly different results. The allocation from Peabody was not necessarily indicative of the selling and administrative expenses that would have been incurred if Patriot had been an independent entity.


58


 

 
PATRIOT COAL CORPORATION
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
Patriot recognized interest expense of $4.1 million and $5.0 million for the twelve months ended December 31, 2007 and 2006, respectively, related to a $62.0 million intercompany demand note payable to Peabody, which was forgiven at spin-off.
 
Patriot entered into certain agreements with Peabody to provide transition services following the spin-off. As of September 30, 2008, Peabody is no longer providing support to Patriot. For the twelve months ended December 31, 2008, transition service expenses were $1.4 million, and are included in “Selling and administrative expenses” in the consolidated statements of operations.
 
In 2007 and 2006, the Company received contributions from Peabody of $43.6 million and $44.5 million, respectively, primarily for the funding of acquisitions.
 
In June 2007, Peabody exchanged numerous oil and gas rights and assets owned throughout its operations, including some owned by Patriot, for coal reserves in West Virginia and Kentucky. Peabody did not allocate gain recognized from this transaction to Patriot but contributed to Patriot approximately 28 million tons of West Virginia coal reserves. These reserves are located in the Pittsburgh coal seam adjacent to Patriot’s Federal No. 2 mining operations and were valued at $45.2 million.
 
ArcLight Energy Partners Fund I L.P. (ArcLight) is a significant stockholder of Patriot due to its former ownership of Magnum. In January 2007, ArcLight purchased from a third party rights to a royalty stream based on coal mined on certain properties, and then leased the rights to one of Magnum’s operations. Royalty payments to ArcLight for the period from July 23, 2008 to December 31, 2008 were approximately $475,000.
 
(19)   Guarantees
 
In the normal course of business, Patriot is a party to guarantees and financial instruments with off-balance-sheet risk, such as bank letters of credit, performance or surety bonds and other guarantees and indemnities, which are not reflected in the accompanying consolidated balance sheets. Such financial instruments are valued based on the amount of exposure under the instrument and the likelihood of required performance. Management does not expect any material losses to result from these guarantees or off-balance-sheet instruments.
 
Letters of Credit and Bonding
 
The Company’s letters of credit and surety bonds in support of the Company’s reclamation, lease, workers’ compensation and other obligations were as follows as of December 31, 2008:
 
                                                 
                Workers’
    Retiree
             
    Reclamation
    Lease
    Compensation
    Health
             
    Obligations     Obligations     Obligations     Obligations     Other(1)     Total  
    (Dollars in thousands)  
 
Surety Bonds
  $ 135,506     $     $     $     $ 19,487     $ 154,993  
Letters of Credit
    92,239       13,399       189,488       49,849       5,841       350,816  
                                                 
    $ 227,745     $ 13,399     $ 189,488     $ 49,849     $ 25,328     $ 505,809  
                                                 
 
 
(1) Other includes letters of credit and surety bonds related to collateral for surety companies and bank guarantees, road maintenance and performance guarantees.
 
Additionally, as of December 31, 2007, Peabody continued to guarantee certain bonds (self bonding) related to Patriot liabilities that had not yet been replaced by Patriot surety bonds. Patriot replaced these Peabody self bonds in 2008.
 
As of December 31, 2008, Arch Coal, Inc. (Arch) held surety bonds of $93.6 million related to properties acquired by Patriot in the Magnum acquisition, of which $91.9 million related to reclamation. As a result of the


59


 

 
PATRIOT COAL CORPORATION
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
acquisition, Patriot is required to post letters of credit in Arch’s favor at an increasing percentage of the accrued reclamation liabilities beginning August 2009 through February 2011.
 
In relation to an exchange transaction involving the acquisition of Illinois Basin coal reserves in 2005, the Company guaranteed bonding for a partnership in which it formerly held an interest. The aggregate amount that the Company guaranteed was $2.8 million and the fair value of the guarantee recognized as a liability was $0.3 million as of December 31, 2008. The Company’s obligation under the guarantee extends to September 2015.
 
Other Guarantees
 
Patriot is the lessee or sublessee under numerous equipment and property leases. It is common in such commercial lease transactions for Patriot, as the lessee, to agree to indemnify the lessor for the value of the property or equipment leased, should the property be damaged or lost during the course of Patriot’s operations. Patriot expects that losses with respect to leased property would be covered by insurance (subject to deductibles). Patriot and certain of its subsidiaries have guaranteed other subsidiaries’ performance under their various lease obligations. Aside from indemnification of the lessor for the value of the property leased, Patriot’s maximum potential obligations under their leases are equal to the respective future minimum lease payments, assuming no amounts could be recovered from third parties.
 
(20)   Commitments and Contingencies
 
Commitments
 
As of December 31, 2008, purchase commitments for capital expenditures were $68.1 million.
 
Other
 
At times Patriot becomes a party to claims, lawsuits, arbitration proceedings and administrative procedures in the ordinary course of business. Management believes that the ultimate resolution of such pending or threatened proceedings is not reasonably likely to have a material effect on Patriot’s financial position, results of operations or cash flows. The Company’s significant legal proceedings are discussed below.
 
Flood Litigation
 
2001 Flood Litigation
 
One of the Company’s subsidiaries, Catenary Coal Company, LLC (Catenary), has been named as defendant, along with various other property owners, coal companies, timbering companies and oil and natural gas companies, in connection with alleged damages arising from flooding that occurred on July 8, 2001 in various watersheds primarily located in southern West Virginia (referred to as the 2001 flood litigation). Pursuant to orders from the West Virginia Supreme Court of Appeals, the cases are being handled as mass litigation, and a panel of three judges was appointed to handle the matters that have been divided between the judges pursuant to the various watersheds.
 
One of the cases, in the Upper Guyandotte River watershed, went to trial against two defendants, both of which were land holding companies, to determine whether the plaintiffs could establish liability. The jury found in favor of the plaintiffs, but the judge in this matter set aside the verdict stating he committed reversible error by allowing certain testimony of the plaintiffs’ experts. The judge went on to address the core foundation necessary to prevail in the flood litigation in his order, which is whether the plaintiffs can scientifically establish that a certain flood event caused and/or contributed to injury and, if so, who caused the injury and what persons were injured by such conduct. An appeal of this order was filed with the West Virginia Supreme Court of Appeals. The West Virginia Supreme Court issued its decision reversing the trial judge’s order and remanded the matter to the Mass Litigation Panel for further disposition.


60


 

 
PATRIOT COAL CORPORATION
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
In the Coal River watershed of the 2001 flood litigation, another judge in the panel provided an opportunity for the plaintiffs to amend their complaints to more specifically identify, among other things, the defendants’ specific injury-causing conduct, and the amount of damages sustained by each plaintiff. The plaintiffs were unable to meet the pleading standard announced by the judge and in January 2007, the judge entered an order that granted defendants’ motions to dismiss with prejudice. An appeal of this order was filed with the West Virginia Supreme Court of Appeals. The West Virginia Supreme Court issued its decision reversing the trial judge’s order and remanded the matter to the Mass Litigation Panel for further disposition.
 
Pursuant to the purchase and sale agreement related to Magnum, Arch Coal, Inc. (Arch) indemnifies the Company against claims arising from certain pending litigation proceedings, including the 2001 flood litigation, which obligation will continue indefinitely. The failure of Arch to satisfy its indemnification obligations under the purchase agreement could have a material adverse effect on the Company.
 
2004 Flood Litigation
 
In 2006, Hobet Mining, LLC (Hobet) and Catenary, two of the Company’s subsidiaries, were named as defendants along with various other property owners, coal companies, timbering companies and oil and natural gas companies, arising from flooding that occurred on May 30, 2004 in various watersheds primarily located in southern West Virginia. This litigation is pending before two different judges in the Circuit Court of Logan County, West Virginia.
 
In the first action, the plaintiffs have asserted that (i) Hobet failed to maintain an approved drainage control system for a pond on land on, near, and/or contiguous to the sites of flooding; and (ii) Hobet participated in the development of plans to grade, blast, and alter the land on, near, and/or contiguous to the sites of the flooding. Hobet has filed a motion to dismiss both claims based upon the assertion that insufficient facts have been stated to support the claims of the plaintiffs.
 
In the second action, on behalf of Catenary and Hobet, motions to dismiss have been filed, asserting that the allegations asserted by the plaintiffs are conclusory in nature and likely deficient as a matter of law. Most of the other defendants also filed motions to dismiss. Both actions were stayed during the pendency of the appeals to the West Virginia Supreme Court of Appeals in the 2001 flood litigation.
 
The outcome of the West Virginia flood litigation is subject to numerous uncertainties. Based on the Company’s evaluation of the issues and their potential impact, the amount of any future loss cannot be reasonably estimated. However, based on current information, the Company believes this matter is likely to be resolved without a material adverse effect on its financial condition, results of operations and cash flows.
 
Clean Water Act Permit Issues
 
The federal Clean Water Act and corresponding state and local laws and regulations affect coal mining operations by restricting the discharge of pollutants, including dredged or fill materials, into waters of the United States. In particular, the Clean Water Act requires effluent limitations and treatment standards for wastewater discharge through the NPDES program. NPDES permits, which the Company must obtain for both active and historical mining operations, govern the discharge of pollutants into water and require regular monitoring and reporting and set forth performance standards. States are empowered to develop and enforce “in stream” water quality standards, which are subject to change and must be approved by the EPA. In stream standards vary from state to state.


61


 

 
PATRIOT COAL CORPORATION
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
Environmental claims and litigation in connection with our various NPDES permits, and related Clean Water Act issues, include the following:
 
EPA Consent Decree
 
In February 2009, the Company announced that it had entered into a consent decree with the EPA and the West Virginia Department of Environmental Protection (WVDEP) to resolve certain claims under the Clean Water Act and the West Virginia Water Pollution Control Act relating to its NPDES permits at several mining operations in West Virginia. The consent decree does not cover issues related to discharge limits for selenium, and it is subject to public comment, which could result in delays, modifications, or even withdrawal of the consent decree. Under the current terms of the consent decree, the Company is obligated to pay a civil penalty of $6.5 million in 2009. The Company also could be subject to stipulated penalties in the future for failure to comply with certain permit requirements as well as certain other terms of the consent decree. Because the Company’s operations are complex and it periodically experiences exceedances of its permit limitations, it is possible that the Company will have to pay stipulated penalties in the future, but the Company does not expect the amounts of any such penalties would be material. The civil penalty of $6.5 million was included in the estimated fair value of acquired environmental liabilities accrued as part of the Magnum acquisition purchase accounting described in Note 4.
 
The consent decree also requires the Company to implement an enhanced company-wide environmental management system, which will include regular compliance audits, electronic tracking and reporting, and annual training for all employees and contractors with environmental responsibilities. In addition, the Company will complete several stream restoration projects in consultation with the EPA and WVDEP. These latter requirements could result in incremental operating costs in addition to the $6.5 million civil penalty. Initial estimates ranging from $3 million to $6 million of incremental costs could increase or decrease as the Company implements the various requirements.
 
In a separate administrative proceeding with the WVDEP, the Company has agreed to pay a civil penalty of $315,000 for past violations of NPDES permits held by certain subsidiaries.
 
Apogee Coal Company, LLC (Apogee)
 
In 2007, Apogee, a subsidiary of the Company, was sued in the U.S. District Court for the Southern District of West Virginia by the Ohio Valley Environmental Coalition, Inc. (OVEC) and another environmental group (pursuant to the citizen suit provisions of the Clean Water Act). The Company refers to this lawsuit as the Federal Apogee Case. This lawsuit alleges that Apogee has violated water discharge limits for selenium set forth in one of its NPDES permits. The lawsuit seeks fines and penalties as well as injunctions prohibiting Apogee from further violating laws and its permit.
 
Currently, there is no reasonably available technology that has been proven effective at addressing selenium exceedances in mining outfalls. As a result, the WVDEP has deferred the obligations to comply with the selenium discharge limits in most permits related to mining outfalls until April 2010. However, on May 28, 2008, the judge in the Federal Apogee Case determined that the attempted deferral of the selenium discharge limits set forth in the relevant Apogee permit failed to meet certain procedural requirements and ordered Apogee to develop and implement a treatment plan or to show cause of its inability to do so. After a July 2008 hearing, the judge ordered Apogee to submit a report specifying an explanation of the treatment alternatives under consideration. After Apogee submitted its report, the judge entered an order requiring complete installation of treatment no later than May 31, 2009, and final compliance with the selenium discharge limits in Apogee’s NPDES permit no later than June 30, 2009.
 
The Company is actively engaged in studying potential solutions to controlling selenium discharges and is installing treatment facilities at various permitted outfalls in an effort to comply with the deadlines established in the Federal Apogee Case. The potential solutions identified to date, some of which have been provided to the court,


62


 

 
PATRIOT COAL CORPORATION
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
have not been proven to be effective and otherwise may not be feasible due to a range of problems concerning technological issues, prohibitive implementation costs and other issues. While the Company is actively continuing to explore options, there can be no assurance as to when a definitive solution will be identified and implemented. As a result, it is possible that the Company will be unable to meet the court order. While these selenium discharge issues generally relate to historical rather than ongoing mining operations, any failure to meet the deadlines or to otherwise comply with selenium limits in the Company’s permits could result in further litigation against the Company, an inability to obtain new permits or to maintain existing permits, the incurrence of significant and material fines and penalties or other costs and could otherwise materially adversely affect the Company’s results of operations, cash flows and financial condition.
 
Penalties related to the Company’s violations of the selenium discharge limits under its NPDES permit will be addressed at a separate hearing before the court in November 2009, and the Company may be subject to further penalties in the event it is unable to comply with the deadlines established by the court’s August 2008 order. Finally, the Company will likely incur significant costs related to the investigations and ultimate installation and maintenance of treatment facilities designed to control selenium discharges. The amount of these civil penalties and other costs may be significant, although the Company is unable to reasonably estimate such costs at this time.
 
The outcome of this litigation is subject to numerous uncertainties. Based on the Company’s evaluation of the issues and their potential impact, the amount of any future loss cannot be reasonably estimated.
 
Hobet
 
In 2007, Hobet was sued for exceedances of effluent limits contained in its NPDES permits in state court in Boone County by the WVDEP. The Company refers to this case as the WVDEP Action. In 2008, OVEC and another environmental group filed a lawsuit against Hobet and WVDEP in the U.S. District Court for the Southern District of West Virginia (pursuant to the citizen suit provisions of the Clean Water Act). The Company refers to this case as the Federal Hobet Case. The Federal Hobet Case involves the same NPDES permits that are the subject of the WVDEP Action in state court. However, the Federal Hobet Case is focused exclusively on selenium exceedances in permitted water discharges, while the WVDEP Action addresses several pollutant discharge limits including selenium.
 
The WVDEP Action was resolved by a settlement and consent order entered in the Boone County circuit court on September 5, 2008. As part of the settlement, the Company agreed to pay approximately $1.5 million in civil penalties, with $500,000 due immediately and the remaining approximately $1 million payable in ten monthly installments. The settlement also requires the Company to complete five supplemental environmental projects estimated to cost approximately $2.6 million, many of which focus on identifying methods for treatment of selenium discharges and studying the effects of selenium on aquatic wildlife. Finally, the Company agreed to make gradual reductions in its selenium discharges from its Hobet Job 21 Surface Mine, achieving full compliance with its NPDES permits by April 2010, and to study potential treatments for wastewater runoff.
 
Following the WVDEP Action settlement, motions to dismiss and for summary judgment have been filed by both sides and are pending in the Federal Hobet Case. To date, the federal court has dismissed all injunctive claims asserted by the plaintiffs as moot because of the WVDEP Action settlement. However, the federal court is still considering a pending motion to dismiss plaintiffs’ claims for civil penalties. The Company expects to pay an additional penalty relating to the period of time not covered by the WVDEP Action settlement, which could exceed $100,000, but which the Company does not anticipate will be material. It is also possible that the federal court would hold that the plaintiffs continue to maintain viable claims for additional civil penalties.
 
As a result of the litigation involving Apogee and Hobet, the process of applying for new permits has become more time-consuming and complex, the review and approval process is taking longer, and in certain cases, new


63


 

 
PATRIOT COAL CORPORATION
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
permits may not be issued. The lack of proven treatment methods for selenium discharges also causes uncertainty as to the magnitude of the Company’s future liability. Based on the Company’s evaluation of the issues and their potential impact, the amount of any future loss cannot be reasonably estimated.
 
Comprehensive Enviromental Response, Compensation and Liability Act (CERCLA)
 
CERCLA and similar state laws create liability for investigation and remediation in response to releases of hazardous substances in the environment and for damages to natural resources. Under CERCLA and many similar state statutes, joint and several liability may be imposed on waste generators, site owners and operators and others regardless of fault. These regulations could require the Company to do some or all of the following: (i) remove or mitigate the effects on the environment at various sites from the disposal or release of certain substances; (ii) perform remediation work at such sites; and (iii) pay damages for loss of use and non-use values.
 
Although waste substances generated by coal mining and processing are generally not regarded as hazardous substances for the purposes of CERCLA and similar legislation and are generally covered by SMCRA, some products used by coal companies in operations, such as chemicals, and the disposal of these products are governed by CERCLA. Thus, coal mines currently or previously owned or operated by the Company, and sites to which the Company has sent waste materials, may be subject to liability under CERCLA and similar state laws. A predecessor of one of the Company’s subsidiaries has been named as a potentially responsible party at a third-party site, but given the large number of entities involved at the site and the Company’s anticipated share of expected cleanup costs, the Company believes that its ultimate liability, if any, will not be material to the Company’s financial condition and results of operations.
 
Other Environmental Litigation
 
Apogee has been sued, along with eight other defendants, including Monsanto Company, Pharmacia Corporation and Akzo Nobel Chemicals, Inc. by certain plaintiffs in state court in Putnam County, West Virginia. The lawsuits were filed in October 2007, but not served on Apogee until February 2008, and each are identical except for the named plaintiff. They each allege personal injury occasioned by exposure to dioxin generated by a plant owned and operated by certain of the other defendants during production of a chemical, 2,4,5-T, from 1949-1969. Apogee is alleged to be liable as the successor to the liabilities of a company that owned and/or controlled a dump site known as the Manila Creek landfill, which allegedly received and incinerated dioxin-contaminated waste from the plant. The lawsuits seek class action certification as well as compensatory and punitive damages for personal injury. Under the terms of the governing lease, Monsanto has assumed the defense of these lawsuits and has agreed to indemnify Apogee for any related damages. The failure of Monsanto to satisfy its indemnification obligations under the lease could have a material adverse effect on the Company.
 
One of the Company’s subsidiaries operated the Eagle No. 2 mine located near Shawneetown, Illinois from 1969 until closure of the mine in July of 1993. In 1999, the State of Illinois brought a proceeding before the Illinois Pollution Control Board against the subsidiary alleging that groundwater contamination due to leaching from a coal waste pile at the mine site violated state standards. The subsidiary has developed a remediation plan with the State of Illinois and is in litigation with the Illinois Attorney General’s office with respect to its claim for a civil penalty of $1.3 million.
 
On December 31, 2008, 45 related lawsuits were filed by 116 plaintiffs against several coal companies, including one of the Company’s subsidiaries in the Circuit Court of Boone County, West Virginia. The plaintiffs in each case allege contamination of their drinking water wells from slurry impoundments in Boone County. The lawsuits seek property damages, personal injury damages and medical monitoring costs. Because of the early stage of the lawsuits, we are unable to predict the likelihood of success of the plaintiffs’ claims, though the Company intends to vigorously defend against all claims.


64


 

 
PATRIOT COAL CORPORATION
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
The outcome of this other environmental litigation is subject to numerous uncertainties. Based on the Company’s evaluation of the issues and their potential impact, the amount of any future loss cannot be reasonably estimated. However, based on current information, the Company believes these matters are likely to be resolved without a material adverse effect on the Company’s financial condition, results of operations and cash flows.
 
(21)   Segment Information
 
Patriot reports its operations through two reportable operating segments, Appalachia and Illinois Basin. The Appalachia and Illinois Basin segments primarily consist of Patriot’s mining operations in West Virginia and Kentucky, respectively. The principal business of the Appalachia segment is the mining, preparation and sale of thermal coal, sold primarily to electric utilities and metallurgical coal, sold to steel and coke producers. The principal business of the Illinois Basin segment is the mining, preparation and sale of thermal coal, sold primarily to electric utilities. For the twelve months ended December 31, 2008, 79% of Patriot’s sales were to electricity generators and 21% to steel and coke producers. For the twelve months ended December 31, 2008 and 2007, Patriot’s revenues attributable to foreign countries, based on where the product was shipped, were $241.3 million and $120.8 million, respectively. Patriot utilizes underground and surface mining methods and produces coal with high and medium Btu content. Patriot’s operations have relatively short shipping distances from the mine to most of its domestic utility customers and certain metallurgical coal customers. “Corporate and Other” includes selling and administrative expenses, net gains on disposal or exchange of assets and costs associated with past mining obligations.
 
Patriot’s chief operating decision makers use Adjusted EBITDA as the primary measure of segment profit and loss. Adjusted EBITDA is defined as net income (loss) attributable to Patriot before deducting net interest expense; income taxes; noncontrolling interest; asset retirement obligation expense; depreciation, depletion and amortization; and net sales contract accretion excluding back-to-back coal purchase and sales contracts. The net contract accretion on the back-to-back coal purchase and sale contracts reflects the net accretion related to certain coal purchase and sales contracts existing prior to July 23, 2008, whereby Magnum purchased coal from third parties to fulfill tonnage commitments on sales contracts. Because Segment Adjusted EBITDA is not calculated identically by all companies, Patriot’s calculation may not be comparable to similarly titled measures of other companies.
 
Operating segment results for the year ended December 31, 2008 were as follows:
 
                                 
                Corporate
       
    Appalachia     Illinois Basin     and Other (1)     Consolidated  
    (Dollars in thousands)  
 
Revenues
  $ 1,370,979     $ 283,643     $     $ 1,654,622  
Adjusted EBITDA
    172,994       13,155       (141,911 )     44,238  
Additions to property, plant, equipment and mine development
    107,358       10,893       3,137       121,388  
Loss from equity affiliates
    (915 )                 (915 )
 
Operating segment results for the year ended December 31, 2007 were as follows:
 
                                 
                Corporate
       
    Appalachia     Illinois Basin     and Other(1)     Consolidated  
    (Dollars in thousands)  
 
Revenues
  $ 821,116     $ 252,246     $     $ 1,073,362  
Adjusted EBITDA
    89,850       11,862       (101,281 )     431  
Additions to property, plant, equipment and mine development
    48,955       6,639             55,594  
Income from equity affiliates
    63                   63  


65


 

 
PATRIOT COAL CORPORATION
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
Operating segment results for the year ended December 31, 2006 were as follows:
 
                                 
                Corporate
       
    Appalachia     Illinois Basin     and Other (1)     Consolidated  
    (Dollars in thousands)        
 
Revenues
  $ 890,198     $ 257,721     $     $ 1,147,919  
Adjusted EBITDA
    204,827       (1,900 )     (76,158 )     126,769  
Additions to property, plant, equipment and mine development
    72,236       7,988             80,224  
Income from equity affiliates
    60                   60  
 
 
(1) Corporate and Other results include the gains on disposal of assets discussed in Note 6.
 
A reconciliation of Adjusted EBITDA to net income (loss) attributable to Patriot follows:
                         
    Year Ended December 31,  
    2008     2007     2006  
    (Dollars in thousands)  
Consolidated Adjusted EBITDA
  $ 44,238     $ 431     $ 126,769  
Depreciation, depletion and amortization
    (125,356 )     (85,640 )     (86,458 )
Sales contract accretion
    249,522              
Asset retirement obligation expense
    (19,260 )     (20,144 )     (24,282 )
Interest expense
    (23,648 )     (8,337 )     (11,419 )
Interest income
    17,232       11,543       1,417  
Income tax provision
                (8,350 )
 
                 
Net income (loss)
    142,728       (102,147 )     (2,323 )
Net income attributable to noncontrolling interest
          (4,721 )     (11,169 )
 
                 
Net income (loss) attributable to Patriot
  $ 142,728     $ (106,868 )   $ (13,492 )
 
                 
 
(22)   Stockholders’ Equity
 
Common Stock
 
On October 31, 2007, the spin-off of Patriot from Peabody was completed and holders of Peabody common stock received a dividend of one share of Patriot common stock for each ten shares of Peabody common stock that they owned. The Company has 100 million authorized shares of $0.01 par value common stock. Each share of common stock will be entitled to one vote in the election of directors and all other matters submitted to stockholder vote. Except as otherwise required by law or provided in any resolution adopted by the Board of Directors with respect to any series of preferred stock, the holders of common stock will possess all voting power. The holders of common stock do not have cumulative voting rights. In general, all matters submitted to a meeting of stockholders, other than as described below, shall be decided by vote of a majority of the shares of Patriot’s common stock. Directors are elected by a plurality of the shares of Patriot’s common stock.
 
Subject to preferences that may be applicable to any series of preferred stock, the owners of Patriot’s common stock may receive dividends when declared by the Board of Directors. Common stockholders will share equally in the distribution of all assets remaining after payment to creditors and preferred stockholders upon liquidation, dissolution or winding up of the Company, whether voluntarily or not. The common stock will have no preemptive or similar rights.
 
Effective August 11, 2008, the Company implemented a two-for-one stock split on all shares of its common stock. All share and per share amounts in these consolidated financial statements and related notes reflect the stock split.


66


 

 
PATRIOT COAL CORPORATION
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
The following table summarizes common share activity from October 31, 2007 to December 31, 2008:
 
         
    Shares
 
    Outstanding  
 
October 31, 2007
    53,141,880  
Stock grants to employees
    375,656  
         
December 31, 2007
    53,517,536  
Stock grants to employees
    5,697  
Employee stock purchases
    56,654  
Shares issued to Magnum shareholders
    23,803,312  
         
December 31, 2008
    77,383,199  
         
 
Preferred Stock
 
In addition to the common stock, the Board of Directors is authorized to issue up to 10 million shares of $0.01 par value preferred stock. The authorized preferred shares include one million shares of Series A Junior Participating Preferred Stock. Patriot’s certificate of incorporation authorizes the Board of Directors, without the approval of the stockholders, to fix the designation, powers, preferences and rights of one or more series of preferred stock, which may be greater than those of the common stock. Patriot believes that the ability of the Board to issue one or more series of preferred stock will provide the Company with flexibility in structuring possible future financings and acquisitions and in meeting other corporate needs that might arise. The issuance of shares of preferred stock, or the issuance of rights to purchase shares of preferred stock, could be used to discourage an unsolicited acquisition proposal. There were no outstanding shares of preferred stock as of December 31, 2008.
 
Preferred Share Purchase Rights Plan and Series A Junior Participating Preferred Stock
 
The Board of Directors of Patriot adopted a stockholders rights plan pursuant to the Rights Agreement with American Stock Transfer & Trust Company (the Rights Agreement). In connection with the Rights Agreement, on October 31, 2007, the Company filed the Certificate of Designations of Series A Junior Participating Preferred Stock (the Certificate of Designations) with the Secretary of State of the State of Delaware. Pursuant to the Certificate of Designations, the Company designated 1,000,000 shares of preferred stock as Series A Junior Participating Preferred Stock having the designations, rights, preferences and limitations set forth in the Rights Agreement. Each preferred share purchase right represents the right to purchase one-half of one-hundredth of a share of Series A Junior Participating Preferred Stock.
 
The rights have certain anti-takeover effects. If the rights become exercisable, the rights will cause substantial dilution to a person or group that attempts to acquire Patriot on terms not approved by the Board of Directors, except pursuant to any offer conditioned on a substantial number of rights being acquired. The rights should not interfere with any merger or other business combination approved by the Board since the rights may be redeemed by the Company at a nominal price prior to the time that a person or group has acquired beneficial ownership of 15% or more of common stock. Thus, the rights are intended to encourage persons who may seek to acquire control of the Company to initiate such an acquisition through negotiations with the Board. However, the effect of the rights may be to discourage a third party from making a partial tender offer or otherwise attempting to obtain a substantial equity position in Patriot’s equity securities or seeking to obtain control of the Company. To the extent any potential acquirers are deterred by the rights, the rights may have the effect of preserving incumbent management in office. There were no outstanding shares of Series A Junior Participating Preferred Stock as of December 31, 2008.
 
The Company has not paid cash dividends and does not anticipate that it will pay cash dividends on its common stock in the near term. The declaration and amount of future dividends, if any, will be determined by the Company’s Board of Directors and will be dependent upon covenant limitations in the Company’s credit facility and other debt


67


 

 
PATRIOT COAL CORPORATION
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
agreements, the Company’s financial condition and future earnings, the Company’s capital, legal and regulatory requirements, and other factors the Board deems relevant.
 
(23)   Stock-Based Compensation
 
The Company has one equity incentive plan for employees and eligible non-employee directors that allows for the issuance of share-based compensation in the form of restricted stock, incentive stock options, nonqualified stock options, stock appreciation rights, performance awards, restricted stock units and deferred stock units. Members of the Company’s Board of Directors are eligible for deferred stock unit grants at the date of their election and annually. This plan has 5.2 million shares of the Company’s common stock available for grant, with 2.5 million shares available for grant as of December 31, 2008. Additionally, the Company has established an employee stock purchase plan that provides for the purchase of up to 2.0 million shares of the Company’s common stock, with 1.9 million shares available for grant as of December 31, 2008.
 
Share-based compensation expense of $7.3 million and $1.3 million was recorded in “Selling and administrative expenses” in the consolidated statements of operations at December 31, 2008 and 2007, respectively, and $0.6 million was recorded in “Operating costs and expenses” for the year ended December 31, 2008. Share-based compensation expense included $1.4 million and $0.3 million related to awards from restricted stock and stock options granted by Peabody to Patriot employees prior to spin-off for the years ended December 31, 2008 and 2007, respectively. As of December 31, 2008, the total unrecognized compensation cost related to nonvested awards granted after the spin-off was $7.5 million, net of taxes, which is expected to be recognized over seven years. As of December 31, 2008, the total unrecognized compensation cost related to nonvested awards granted by Peabody prior to the spin-off was $1.7 million, net of taxes, which is expected to be recognized through 2011.
 
Restricted Stock
 
The Company has restricted stock agreements in place for grants to employees and service providers of the Company and its subsidiaries and affiliates. Generally, these agreements provide that restricted stock issued will fully vest on the third anniversary of the date the restricted stock was granted to the employee or service provider. However, the restricted stock will fully vest sooner if a grantee terminates employment with or stops providing services to the Company because of death or disability, or if a change in control occurs (as such term is defined in the Patriot Coal Corporation 2007 Long-Term Equity Incentive Plan (the Equity Plan)).
 
A summary of restricted stock award activity is as follows:
 
                 
          Weighted
 
    Year Ended
    Average
 
    December 31,
    Grant-Date
 
    2008     Fair Value  
 
Nonvested at January 1, 2008
    375,656     $ 18.75  
Granted
    54,681       54.60  
Forfeited
    (48,984 )     20.01  
                 
Nonvested at December 31, 2008
    381,353       23.73  
                 
 
Extended Long-Term Incentive Restricted Stock Units
 
The Company has extended long-term incentive restricted stock units agreements in place for grants to employees and service providers. These agreements grant restricted stock units that vest over time as well as restricted stock units that vest based upon the Company’s financial performance. In general, the restricted stock units that vest over time will be 50% vested on the fifth anniversary of the initial date of grant, 75% vested on the sixth such anniversary and 100% vested on the seventh such anniversary. However, the restricted stock units that vest over time will fully vest sooner if a grantee terminates employment with or stops providing services to the


68


 

 
PATRIOT COAL CORPORATION
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
Company because of death or disability, or if a change in control occurs (as such term is defined in the Equity Plan). The performance-based restricted stock units vest according to a formula described in the form of Extended Long-Term Incentive Restricted Stock Units Agreement, which is primarily based on the Company’s financial performance as measured by EBITDA, return on equity and leverage ratios. The achievements of the performance-based unit calculations is determined on December 31 following the fifth, sixth and seventh anniversaries of the initial grant date. The Company estimated the number of performance-based units that are expected to vest and utilized this amount in the calculation of the stock-based compensation expense related to these awards. Any changes to this estimate will impact stock-based compensation expense in the period the estimate is changed.
 
In addition, the Company has deferred stock units agreements in place for grants to non-employee directors of Patriot. These agreements provide that the deferred stock units will fully vest on the first anniversary of the date of grant, but only if the non-employee director served as a director for the entire one-year period between the date of grant and the first anniversary of the grant. However, the deferred stock units will fully vest sooner if a non-employee director ceases to be a Patriot director due to death or disability, or if a change in control occurs (as such term is defined in the Equity Plan). Any unvested deferred stock units will be forfeited if a non-employee director terminates service with Patriot for any reason other than death or disability prior to the first anniversary of the grant date. After vesting, the deferred stock units will be settled by issuing shares of Patriot common stock equal to the number of deferred stock units, and the settlement will occur upon the earlier of (i) the non-employee director’s termination of service as a director or (ii) the third anniversary of the grant date or a different date chosen by the non-employee director, provided the date was chosen by the non-employee director prior to January 1 of the year in which the director received the grant.
 
A summary of restricted stock time units and deferred stock units award activity is as follows:
 
                 
          Weighted
 
    Year Ended
    Average
 
    December 31,
    Grant-Date
 
    2008     Fair Value  
 
Nonvested at January 1, 2008
    509,438     $ 18.75  
Granted
    105,835       34.01  
Forfeited
    (71,558 )     19.18  
Vested
    (37,340 )     18.75  
                 
Nonvested at December 31, 2008
    506,375       21.88  
                 
 
As of December 31, 2008, there were 37,340 deferred stock units vested that had an aggregate intrinsic value of $0.7 million.
 
A summary of restricted stock performance units award activity is as follows:
 
                 
          Weighted
 
    Year Ended
    Average
 
    December 31,
    Grant-Date
 
    2008     Fair Value  
 
Nonvested at January 1, 2008
    708,164     $ 18.75  
Granted
    78,524       60.20  
Forfeited
    (107,336 )     19.18  
                 
Nonvested at December 31, 2008
    679,352       23.47  
                 
 
Extended Long-Term Incentive Non-Qualified Stock Option
 
The Company has extended long-term incentive non-qualified stock option agreements in place for grants to employees and service providers of Patriot. Generally, the agreements provide that any option awarded will become


69


 

 
PATRIOT COAL CORPORATION
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
exercisable in three installments. The option shall be 50% exercisable on the fifth anniversary of the date of grant, 75% exercisable on the sixth such anniversary and 100% exercisable on the seventh such anniversary. However, the option will become fully exercisable sooner if a grantee terminates employment with or stops providing services to Patriot because of death or disability, or if a change in control occurs (as such term is defined in the Equity Plan). No option can be exercised more than ten years after the date of grant, but the ability to exercise the option may terminate sooner upon the occurrence of certain events detailed in the form Extended Long-Term Incentive Non-Qualified Stock Option Agreement. Each award will be forfeited if the grantee terminates employment with or stops providing services to Patriot for any reason other than death or disability prior to the time the award becomes vested. As of December 31, 2008, there were no stock options vested or exercisable. There is no intrinsic value for the outstanding options as of December 31, 2008.
 
A summary of non-qualified stock option outstanding activity is as follows:
 
                         
                Weighted
 
          Weighted
    Average
 
    Year Ended
    Average
    Remaining
 
    December 31,
    Exercise
    Contractual
 
    2008     Price     Life  
 
Outstanding at January 1, 2008
    1,109,346     $ 18.75          
Granted
    128,618       60.20          
Forfeited
    (168,234 )     19.20          
                         
Outstanding at December 31, 2008
    1,069,730       23.66       8.835  
                         
 
The Company recognizes share-based compensation expense in accordance with SFAS No. 123(R), “Share-Based Payment”. The Company used the Black-Scholes option pricing model to determine the fair value of stock options. Determining the fair value of share-based awards requires judgment, including estimating the expected term that stock options will be outstanding prior to exercise and the associated volatility. The Company utilized U.S. Treasury yields as of the grant date for its risk-free interest rate assumption, matching the treasury yield terms to the expected life of the option. The Company utilized a seven-year peer historical lookback to develop its expected volatility. Expected option life assumptions were developed by taking the weighted average time to vest plus the weighted average holding period after vesting.
 
         
    Year Ended December 31,
    2008   2007
 
Weighted-average fair value
  $10.33   $15.34
Risk-free interest rate
  3.55%   4.22%
Expected option life
  6.69 years   6.69 years
Expected volatility
  47.61%   30.64%
Dividend yield
  0%   0%
 
Employee Stock Purchase Plan
 
Based on the Company’s employee stock purchase plan, eligible full-time and part-time employees are able to contribute up to 15% of their base compensation into this plan, subject to a fair market value limit of $25,000 per person per year as defined by the Internal Revenue Service (IRS). Effective January 1, 2008, employees are able to purchase Company common stock at a 15% discount to the lower of the fair market value of the Company’s common stock on the initial or final trading dates of each six-month offering period. Offering periods begin on January 1 and July 1 of each year. The fair value of the six-month “look-back” option in the Company’s employee stock purchase plan is estimated by adding the fair value of 0.15 of one share of stock to the fair value of 0.85 of an option on one share of stock. The Company issued 56,654 shares of common stock and recognized $0.7 million expense in “Selling and administrative expenses” and $0.1 million in “Operating costs and expenses” for the year


70


 

 
PATRIOT COAL CORPORATION
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
ended December 31, 2008 related to its employee stock purchase plan. The Company issued no shares of common stock and recognized no expense for the year ended December 31, 2007 related to its employee stock purchase plan.
 
(24)   Summary Quarterly Financial Information (Unaudited)
 
A summary of the unaudited quarterly results of operations for the years ended December 31, 2008 and 2007, is presented below. Patriot common stock is listed on the New York Stock Exchange under the symbol “PCX.”
 
                                 
    Year Ended December 31, 2008  
    First
    Second
    Third
    Fourth
 
    Quarter     Quarter     Quarter     Quarter  
    (Dollars in thousands except per share and stock price data)  
 
Revenues
  $ 284,334     $ 339,680     $ 489,583     $ 541,025  
Operating profit (loss)
    (4,905 )     16,917       72,394       64,738  
Net income (loss) attributable to Patriot
    (3,066 )     11,236       71,199       63,359  
Basic earnings per share
  $ (0.06 )   $ 0.21     $ 0.99     $ 0.82  
Diluted earnings per share
  $ (0.06 )   $ 0.21     $ 0.99     $ 0.82  
Weighted average shares used in calculating basic earnings per share
    53,518,744       53,512,286       71,681,084       77,382,195  
Stock price — high and low prices
  $ 28.49-$16.77     $ 80.69-$23.48     $ 76.22-$26.92     $ 26.85-$5.26  
 
                                 
    Year Ended December 31, 2007  
    First
    Second
    Third
    Fourth
 
    Quarter     Quarter     Quarter     Quarter  
    (Dollars in thousands except per share and stock price data)  
 
Revenues
  $ 269,663     $ 256,221     $ 293,301     $ 254,177  
Operating loss
    (10,698 )     (4,392 )     (39,823 )     (50,440 )
Net loss attributable to Patriot
    (11,951 )     (5,814 )     (39,451 )     (49,652 )
Basic and diluted loss attributable to common stockholders per share
    N/A       N/A       N/A     $ (0.93 )
Weighted average shares used in calculating basic earnings per share
    N/A       N/A       N/A       53,511,478  
Stock price — high and low prices
    N/A       N/A       N/A     $ 21.50-$13.58  


71


 

PATRIOT COAL CORPORATION
 
DECEMBER 31, 2008
 
                                         
    Balance
    Charged to
                Balance
 
    Beginning
    Costs and
                at End of
 
Description
  of Period     Expenses     Deductions(1)     Other     Period  
    (Dollars in thousands)  
 
Year Ended December 31, 2006
                                       
Reserves deducted from asset accounts:
                                       
Advance royalty recoupment reserve
  $ 4,836     $     $     $ (120 )(2)   $ 4,716  
Reserve for materials and supplies
    1,519             (61 )           1,458  
Allowance for doubtful accounts
    92       160                   252  
Year Ended December 31, 2007
                                       
Reserves deducted from asset accounts:
                                       
Advance royalty recoupment reserve
    4,716                   (1,985 )(3)     2,731  
Reserve for materials and supplies
    1,458       74             (1,252 )(3)     280  
Allowance for doubtful accounts
    252             (1 )           251  
Year Ended December 31, 2008
                                       
Reserves deducted from asset accounts:
                                       
Advance royalty recoupment reserve
    2,731                   12 (4)     2,743  
Reserve for materials and supplies
    280       288             843 (4)     1,411  
Allowance for doubtful accounts
    251       399       (110 )           540  
 
 
(1) Reserves utilized, unless otherwise indicated.
 
(2) Peabody restructured entities which resulted in the reclassification of advances and related reserves.
 
(3) Balance transferred to Peabody as part of Patriot spin-off.
 
(4) Balance reflects Magnum activity since acquisition on July 23, 2008.


72

BROKERAGE PARTNERS