PEABODY ENERGY CORP - 10-Q Quarterly Report

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SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934

For the quarterly period ended June 30, 2002
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Commission File Number 1-16463
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PEABODY ENERGY CORPORATION
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(Exact name of registrant as specified in its charter)

DELAWARE 13-4004153
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)

701 MARKET STREET, ST. LOUIS, MISSOURI 63101-1826
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(Address of principal executive offices) (Zip Code)

(314) 342-3400
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(Registrant's telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. [X] Yes [ ] No

Number of shares outstanding of each of the Registrant's classes of Common
Stock, as of July 31, 2002: Common Stock, par value $0.01 per share, 52,179,904
shares outstanding.

INDEX

PART I - FINANCIAL INFORMATION

Item 1. Financial Statements.

PEABODY ENERGY CORPORATION
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Dollars in thousands, except share and per share information)

See accompanying notes to unaudited condensed consolidated financial statements.

2

PEABODY ENERGY CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except share and per share information)

See accompanying notes to unaudited condensed consolidated financial statements.

3

PEABODY ENERGY CORPORATION
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)

See accompanying notes to unaudited condensed consolidated financial statements.

4

PEABODY ENERGY CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2002

(1) BASIS OF PRESENTATION

The condensed consolidated financial statements include the accounts of
Peabody Energy Corporation (the "Company") and its controlled affiliates. All
significant intercompany transactions, profits and balances have been eliminated
in consolidation.

The consolidated statements of operations and cash flows for the six
months ended June 30, 2001 include the results of the Company's Australian
operations, which were sold in January 2001.

The accompanying condensed consolidated financial statements as of June
30, 2002 and for the quarters and six months ended June 30, 2002 and 2001, and
the notes thereto, are unaudited. However, in the opinion of management, these
financial statements reflect all adjustments necessary for a fair presentation
of the results of the periods presented. The balance sheet information as of
December 31, 2001 has been derived from the Company's audited consolidated
balance sheet. The results of operations for the quarter and six months ended
June 30, 2002 are not necessarily indicative of the results to be expected for
the year ending December 31, 2002.

In July 2001, the Company changed its fiscal year-end from March 31 to
December 31. This change was first effective with respect to the nine months
ended December 31, 2001.

(2) SECONDARY OFFERING

On April 5, 2002, certain shareholders of the Company, including the
Company's largest shareholder, Lehman Brothers Merchant Banking Partners II L.P.
and affiliates (collectively "Lehman Brothers") sold 9,000,000 shares of common
stock. Selling shareholders received all net proceeds. The Company did not sell
any shares through the offering. The underwriters of the secondary offering were
granted the right to purchase up to an additional 1,100,000 shares of common
stock to cover over-allotments. The underwriters exercised the over-allotment
option, and on May 8, 2002, purchased an additional 148,000 shares. Lehman
Brothers sold, in the aggregate, 8,155,000 shares in the offering, and their
beneficial ownership of the Company declined from 57% to 41%.

(3) EXTRAORDINARY LOSS FROM EARLY EXTINGUISHMENT OF DEBT

During the six months ended June 30, 2001, the Company used
substantially all of the net proceeds from its initial public offering and the
sale of its Australian operations to repay debt. The Company repaid the
remaining $580.0 million in outstanding term loans under its Senior Credit
Facilities and used $100.0 million to repay borrowings under the revolving
credit facility that were used to repay a portion of the Company's 5%
Subordinated Note. The Company also used $173.0 million of proceeds from the
offering to repurchase $80.0 million in principal of the Senior Notes and $80.0
million in principal of the Senior Subordinated Notes pursuant to a tender
offer. All of these debt repayments, except for $455.0 million of the term loan
repayments, took place in the quarter ended June 30, 2001. The extraordinary
losses of $27.6 million and $36.1 million, net of income taxes, for the quarter
and six months ended June 30, 2001, respectively, represent the excess of cash
paid over the carrying value of debt retired and the accelerated write-off of
debt issuance costs related to the debt repaid.

(4) ADOPTION OF NEW ACCOUNTING STANDARDS

Effective January 1, 2002, the Company adopted Statement of Financial
Accounting Standards ("SFAS") No. 141, "Business Combinations," and SFAS No.
142, "Goodwill and Other Intangible Assets." The adoption of SFAS Nos. 141 and
142 did not have a material effect on the Company's financial condition or
results of operations.

Also effective January 1, 2002, the Company adopted SFAS No. 144,
"Accounting for the Impairment or Disposal of Long-Lived Assets." The provisions
of this statement provide a single accounting model for measuring impairment of
long-lived assets. The adoption of SFAS No. 144 did not have a material effect
on the Company's financial condition or results of operations.

5

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, continued

(5) COAL INVENTORY

Inventories consist of the following (dollars in thousands):

(6) ASSETS AND LIABILITIES FROM COAL AND EMISSION ALLOWANCE TRADING
ACTIVITIES

Coal and emission allowance trading activities are accounted for using
the fair value method, as required by Emerging Issues Task Force (EITF) Issue
No. 98-10, "Accounting for Contracts Involved in Energy Trading and Risk
Management Activities." Under such method, the derivative commodity instruments
(forwards, options and swaps) with third parties are reflected at market value
and are included in "Assets and liabilities from coal and emission allowance
trading activities" in the consolidated balance sheets. In the absence of quoted
values, financial commodity instruments are valued at fair value, considering
the net present value of the underlying sales and purchase obligations and the
volatility of the underlying commodity. Subsequent changes in market value are
recorded as unrealized gains or losses in "Other revenues" in the period of
change. Realized gains and losses on financially settled transactions are
recorded as part of "Other revenues" as they occur. Physically settled
transactions are recorded on a gross basis within "Sales" and "Operating costs
and expenses."

EITF Issue No. 98-10 permitted the reporting of gains or losses on
energy trading contracts on a gross or net basis in the income statement. In
June 2002, the EITF discussed Issue No. 02-3, "Recognition and Reporting of
Gains and Losses on Energy Trading Contracts under EITF Issues No. 98-10,
'Accounting for Contracts Involved in Energy Trading and Risk Management
Activities,' and No. 00-17, 'Measuring the Fair Value of Energy-Related
Contracts in Applying Issue No. 98-10.'" EITF Issue No. 02-3 reexamined the
issue of whether gains and losses on energy trading contracts should be reported
gross or net in the income statement. In July 2002, the EITF published its
consensus that all mark-to-market gains and losses on energy trading contracts
should be shown net in the income statement, even if settled physically. This
new consensus is effective for financial statements issued for periods ending
after July 15, 2002. Since the Company already reports financially settled
transactions and unrealized mark-to-market gains on a net basis, this revision
had no impact on those transactions. However, beginning in the quarter ending
September 30, 2002, the Company's physically settled trading transactions will
be recorded on a net basis as a part of "Other revenues," rather than on a gross
basis within "Sales" and "Operating costs and expenses." The effect of this
change on the Company's total revenues is not significant, and the change has no
impact on operating profit, net income, or earnings per share.

The fair value of the financial instruments related to coal and
emission allowance trading activities as of June 30, 2002, are set forth below
(dollars in thousands):

Eighty-eight percent of the contracts in the Company's trading
portfolio as of June 30, 2002 were valued utilizing prices from over-the-counter
market sources. The remaining 12% of the Company's contracts were valued based
on over-the-counter market source prices adjusted for differences in coal
quality and content, as well as contract duration.

6

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, continued

As of June 30, 2002, the timing of the realization of the value of the
Company's trading portfolio was as follows:

At June 30, 2002, 78% of the Company's credit exposure related to coal
and emission allowance trading activities was with counterparties that are
investment grade.

The Company's coal trading operations traded 17.1 million tons and 7.8
million tons for the quarters ended June 30, 2002 and 2001, respectively, and
45.3 millions tons and 22.1 million tons for the six months ended June 30, 2002
and 2001, respectively.

(7) EARNINGS PER SHARE

Quarter and Six Months Ended June 30, 2001

Prior to its initial public offering in May 2001, the Company applied
the "two-class method" of computing earnings per share as prescribed in SFAS No.
128, "Earnings Per Share." In accordance with SFAS No. 128, income or loss is
allocated to preferred stock, Class A common stock and Class B common stock on a
pro-rata basis. Basic and diluted earnings per share is calculated by dividing
income from continuing operations, gain from disposal of discontinued
operations, extraordinary loss from early extinguishment of debt and net income
(loss), respectively, that is attributed to the Company's Class A and Class B
common shares by the weighted average number of common shares outstanding for
each class of common stock.

A reconciliation of income from continuing operations, gain from
disposal of discontinued operations, extraordinary loss from early
extinguishment of debt and net income (loss) follows (dollars in thousands):

7

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, continued

In connection with the Company's initial public offering, all outstanding
shares of preferred stock, Class A common stock and Class B common stock were
converted into a single class of common stock on a one-for-one basis. For
purposes of the weighted average share calculations for the quarter and six
months ended June 30, 2001, this conversion was assumed to occur as of April 1,
2001. A reconciliation of the weighted average shares outstanding as of June 30,
2002 and 2001, respectively, follows:

(8) COMPREHENSIVE INCOME

The following table sets forth the components of comprehensive income
(loss) for the quarter and six months ended June 30, 2002 and 2001, respectively
(dollars in thousands):

As a result of the sale of its Australian operations, the Company
recorded a reduction of the foreign currency translation adjustment account
during the six months ended June 30, 2001.

(9) SEGMENT INFORMATION

The Company reports its operations through two reportable operating
segments: "U.S. Mining" and "Trading and Brokerage." The principal business of
the U.S. Mining segment is mining, preparation and sale of its steam coal, sold
primarily to electric utilities, and metallurgical coal, sold to steel and coke
producers. The Trading and Brokerage segment's principal business is the
marketing and trading of coal and emission allowances. "Other" consists
primarily of corporate overhead not directly attributable to the U.S. Mining or
Trading and Brokerage operating segments, and resource management activities.

The U.S. Mining segment results below also include costs related to
past mining activities and a portion of consolidated net gains on property
disposals. Past mining activities and net gains on property disposals are
discussed separately from U.S. Mining operations results in Item 2.,
Management's Discussion and Analysis of Financial Condition and Results of
Operations.

8

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, continued

Operating segment results for the quarters and six months ended June
30, 2002 and 2001 are as follows (dollars in thousands):

(1) Includes the pretax gain on the sale of the Company's Australian operations
of $171.7 million.

A reconciliation of segment operating profit to consolidated income
before income taxes follows (dollars in thousands):

(10) COMMITMENTS AND CONTINGENCIES

Environmental

Environmental claims have been asserted against a subsidiary of the
Company at 18 sites in the United States. Some of these claims are based on the
Comprehensive Environmental Response Compensation and Liability Act of 1980, as
amended, and on similar state statutes. The majority of these sites are related
to activities of former subsidiaries of the Company.

The Company's policy is to accrue environmental cleanup-related costs of a
noncapital nature when those costs are believed to be probable and can be
reasonably estimated. The quantification of environmental exposures requires an
assessment of many factors, including changing laws and regulations,
advancements in environmental technologies, the quality of information available
related to specific sites, the assessment stage of each site investigation,
preliminary findings and the length of time involved in remediation or
settlement. For certain sites, the Company also assesses the financial
capability of other potentially responsible parties and, where allegations are
based on tentative findings, the reasonableness of the Company's apportionment.
The Company has not anticipated any recoveries from insurance carriers or other

9

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, continued

potentially responsible third parties in the estimation of liabilities recorded
on its consolidated balance sheets. The undiscounted liabilities for
environmental cleanup-related costs recorded as part of "Accrued reclamation and
other environmental liabilities" were $45.9 million and $46.6 million at June
30, 2002 and December 31, 2001, respectively. This amount represents those costs
that the Company believes are probable and reasonably estimable.

Navajo Nation

On June 18, 1999, the Navajo Nation served the Company's subsidiaries,
Peabody Holding Company, Inc., Peabody Coal Company and Peabody Western Coal
Company, with a complaint that had been filed in the U.S. District Court for the
District of Columbia. Other defendants in the litigation are one customer, one
current employee and one former employee. The Navajo Nation has alleged 16
claims, including Civil Racketeer Influenced and Corrupt Organizations Act, or
RICO, violations and fraud and tortious interference with contractual
relationships. The complaint alleges that the defendants jointly participated in
unlawful activity to obtain favorable coal lease amendments. Plaintiff also
alleges that defendants interfered with the fiduciary relationship between the
United States and the Navajo Nation. The plaintiff is seeking various remedies
including actual damages of at least $600 million, which could be trebled under
the RICO counts, punitive damages of at least $1 billion, a determination that
Peabody Western Coal Company's two coal leases for the Kayenta and Black Mesa
mines have terminated due to a breach of these leases and a reformation of the
two coal leases to adjust the royalty rate to 20%. All defendants have filed
motions to dismiss the complaint. On March 15, 2001, the court denied the
Peabody defendants' motions to dismiss. Discovery for this litigation has
commenced.

In March 2000, the Hopi Tribe filed a motion to intervene in this lawsuit.
The Hopi Tribe has alleged seven claims, including fraud. The Hopi Tribe is
seeking various remedies, including unspecified actual and punitive damages and
reformation of its coal lease. On March 15, 2001, the court granted the Hopi
Tribe's motion. On April 17, 2001, the Company filed a motion to dismiss the
Hopi complaint. On October 31, 2001, the court denied the Company's motion to
dismiss the Hopi complaint.

On February 21, 2002, the Company's subsidiaries commenced a lawsuit
against the Navajo Nation in the U.S. District Court for the District of Arizona
seeking enforcement of an arbitration award or, alternatively, to compel
arbitration pursuant to the April 1, 1998 Arbitration Agreement with the Navajo
Nation. On February 22, 2002, the Company's subsidiaries filed in the U.S.
District for the District of Columbia a motion for leave to file an amended
answer and conditional counterclaim. The counterclaim is conditional because the
Company's subsidiaries contend that the lease provisions the Navajo Nation seeks
to invalidate have previously been upheld in an arbitration proceeding and are
not subject to further litigation. On March 4, 2002, the Company's subsidiaries
filed in the U.S. District Court for the District of Columbia a motion to
transfer that case to Arizona or, alternatively, to stay the District of
Columbia litigation. On March 29, 2002, the Navajo Nation filed a motion to
dismiss the Arizona litigation and an alternative motion to transfer the Arizona
litigation to the District of Columbia. On June 24, 2002, the U.S. District
Court for the District of Columbia denied the Company's subsidiaries' motion to
transfer and motion to stay. On July 15, 2002, the Company's subsidiaries filed
an appeal of that decision with the District of Columbia Court of Appeals.

While the outcome of litigation is subject to uncertainties, based on the
Company's preliminary evaluation of the issues and the potential impact on us,
we believe this matter will be resolved without a material adverse effect on the
Company's financial condition or results of operations.

Salt River Project Agricultural Improvement and Power District--Price Review

In May 1997, Salt River Project Agricultural Improvement and Power
District, or Salt River, acting for all owners of the Navajo Generating Station,
exercised their contractual option to review certain cumulative cost changes
during a five-year period from 1992 to 1996. Peabody Western sells approximately
7 to 8 million tons of coal per year to the owners of the Navajo Generation
Station under a long-term contract. In July 1999, Salt River notified Peabody
Western that it believed the owners were entitled to a price decrease of $1.92
per ton as a result of the review. Salt River also claimed entitlement to a
retroactive price adjustment to January 1997 and that an overbilling of $50.5
million had occurred during the same five-year period. In October 1999, Peabody
Western notified Salt River that it believed it was entitled to a $2.00 per ton
price increase as a result of the review. The parties were unable to settle the
pricing dispute and Peabody Western filed a demand for arbitration in September
2000. The arbitration hearing was held from April 8 to April 12, 2002. On July
20, 2002, Peabody Western received a favorable decision from the arbitrators.
The decision increases the price of coal by approximately $0.50 per ton from
1997 through 2001 and thereafter. The Company estimates the benefit in the
second half of calendar 2002 related to prior shipments is approximately $20
million. The exact impact of the ruling on the pricing of coal sales from
January 1, 2002 forward will not be determined until Salt River completes a
review of the cumulative cost changes under the contract for the years 1997
through 2001.

10

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, continued

On February 12, 2001, in a related action, Salt River, again acting for
all owners of the Navajo Generating Station, filed a lawsuit against Peabody
Western in the Superior Court in Maricopa County in Arizona. This lawsuit sought
to compel arbitration of issues that Peabody Western did not believe were
subject to arbitration, namely, (1) the effective date of any price change
resulting from the resolution of the price review arbitration discussed above
and (2) the validity of Salt River's $50.5 million claim for alleged overcharges
by Peabody Western for the period from 1992 through 1996 (the five-year period
that was the subject of the price review). If the court declined to compel
arbitration of these issues, the lawsuit alternatively requested that the court
find in favor of Salt River on these issues. The Company removed this matter to
the U.S. District Court for the District of Arizona.

On October 3, 2001, the U.S. District Court issued an order that compelled
arbitration with respect to the effective date of any price change and
conditionally compelling arbitration with respect to the validity of Salt
River's $50.5 million claim. Although we filed an appeal of this decision with
the U.S. Ninth Circuit Court of Appeals, the arbitrators received testimony on
these claims during the April hearing. The arbitrators' July 20, 2002 ruling
rejected Salt River's $50.5 million overcharge claim and stated that the
effective date of the price change resulting from the review was January 1,
1997. The Company is evaluating the impact of the arbitrators' decision on its
pending appeal.

Citizens Power

In connection with the sale of Citizens Power, the Company has indemnified
the buyer from certain losses resulting from specified power contracts and
guarantees. No claims have been asserted against the Company under this
indemnity.

Other

In addition, the Company at times becomes a party to claims, lawsuits,
arbitration proceedings and administrative procedures in the ordinary course of
business. Management believes that the ultimate resolution of pending or
threatened proceedings will not have a material effect on the financial
position, results of operations or liquidity of the Company.

At June 30, 2002, purchase commitments for capital expenditures were
approximately $117.9 million.

11

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, continued

(11) SUPPLEMENTAL GUARANTOR/NON-GUARANTOR FINANCIAL INFORMATION

In accordance with the indentures governing the Senior Notes and Senior
Subordinated Notes, certain wholly-owned U.S. subsidiaries of the Company have
fully and unconditionally guaranteed the Senior Notes and Senior Subordinated
Notes on a joint and several basis. Separate financial statements and other
disclosures concerning the Guarantor Subsidiaries are not presented because
management believes that such information is not material to the holders of the
Senior Notes and Senior Subordinated Notes. The following unaudited condensed
historical financial statement information is provided for such
Guarantor/Non-Guarantor Subsidiaries.

PEABODY ENERGY CORPORATION
UNAUDITED SUPPLEMENTAL CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
QUARTER ENDED JUNE 30, 2002
(In thousands)

12

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, continued

PEABODY ENERGY CORPORATION
UNAUDITED SUPPLEMENTAL CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
QUARTER ENDED JUNE 30, 2001
(In thousands)

13

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, continued

PEABODY ENERGY CORPORATION
UNAUDITED SUPPLEMENTAL CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
SIX MONTHS ENDED JUNE 30, 2002
(In thousands)

14

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, continued

PEABODY ENERGY CORPORATION
UNAUDITED SUPPLEMENTAL CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
SIX MONTHS ENDED JUNE 30, 2001
(In thousands)

15

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, continued

PEABODY ENERGY CORPORATION
UNAUDITED SUPPLEMENTAL CONDENSED CONSOLIDATED BALANCE SHEETS
JUNE 30, 2002
(In thousands)

16

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, continued

PEABODY ENERGY CORPORATION
SUPPLEMENTAL CONDENSED CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 2001
(In thousands)

17

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, continued

PEABODY ENERGY CORPORATION
UNAUDITED SUPPLEMENTAL CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
SIX MONTHS ENDED JUNE 30, 2002
(In thousands)

18

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, continued

PEABODY ENERGY CORPORATION
UNAUDITED SUPPLEMENTAL CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
SIX MONTHS ENDED JUNE 30, 2001
(In thousands)

(12) SUBSEQUENT EVENT

On July 23, 2002, the Board of Directors of the Company adopted a
preferred share purchase rights plan (the "Rights Plan"). In connection with the
Rights Plan, the Board of Directors of the Company declared a dividend of one
preferred share purchase right (a "Right") for each outstanding share of common
stock, par value $0.01 per share, of the Company. The Rights dividend is payable
on August 12, 2002 to the stockholders of record on that date. The description
and terms of the Rights are set forth in an Agreement, dated as of July 24,
2002, between the Company and EquiServe Trust Company, N.A., as Rights Agent.

The Rights have certain anti-takeover effects. The Rights will cause
substantial dilution to a person or group that attempts to acquire the Company
on terms not approved by the Company's 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 of Directors since the Rights may be redeemed by the
Company at a redemption price of $0.001 per Right prior to the time that a
person or group has acquired beneficial ownership of fifteen percent or more of
the common stock of the Company. In addition, the Board of Directors is
authorized to reduce the 15% threshold to not less than 10%.

19

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.

CAUTIONARY NOTICE REGARDING FORWARD-LOOKING STATEMENTS

This quarterly report includes statements of our expectations, intentions,
plans and beliefs that constitute "forward-looking statements" within the
meaning of Section 27A of the Securities Act of 1933 and Section 21E of the
Securities Exchange Act of 1934 and are intended to come within the safe harbor
protection provided by those sections. These statements relate to future events
or our future financial performance. We use words such as "anticipate,"
"believe," "expect," "may," "project," "will" or other similar words to identify
forward-looking statements.

Without limiting the foregoing, all statements relating to our future
outlook, anticipated capital expenditures, future cash flows and borrowings, and
sources of funding are forward-looking statements. These forward-looking
statements are based on numerous assumptions that we believe are reasonable, but
they are open to a wide range of uncertainties and business risks and actual
results may differ materially from those discussed in these statements.

Among the factors that could cause actual results to differ materially
are:

o general economic conditions;

o milder than normal summer weather;

o credit, market and performance risk associated with our
customers;

o modification or termination of our long-term coal supply
agreements;

o reduction of purchases by major customers;

o transportation performance and costs;

o risks inherent to mining, including geologic conditions;

o government regulation of the mining industry;

o replacement of recoverable reserves;

o implementation of new accounting standards;

o inflationary trends and interest rates; and

o other factors, including those discussed in "Legal
Proceedings."

When considering these forward-looking statements, you should keep in mind
the cautionary statements in this document and all documents incorporated by
reference. We will not update these statements unless the securities laws
require us to do so.

FISCAL YEAR CHANGE

In July 2001, we changed our fiscal year end from March 31 to December 31.
The change was first effective with respect to the nine months ended December
31, 2001.

FACTORS AFFECTING COMPARABILITY

Sale of Australian Operations

In December 2000, we signed a share purchase agreement for the transfer of
the stock in two U.K. holding companies which, in turn, owned our Australian
subsidiaries, to a subsidiary of Rio Tinto Limited. Our Australian operations
consisted of interests in six coal mines, as well as mining services in
Brisbane, Australia. The final sale price was $446.8 million in cash, plus the
assumption of all liabilities. During the quarter ended March 31, 2001, we
received $455.0 million related to the sale, which closed on January 29, 2001.
We recorded a $171.7 million pretax gain on the sale.

20

Discontinued Operations

In August 2000, we sold Citizens Power, our subsidiary that marketed and
traded electric power and energy-related commodity risk management products, to
Edison Mission Energy. We classified Citizens Power as a discontinued operation
as of March 31, 2000, and recorded an estimated loss on the sale of $78.3
million, net of income taxes. During the year ended March 31, 2001, we reduced
our loss on the sale by $12.9 million; $1.2 million of the loss reduction was
recorded in the quarter ended March 31, 2001. These reductions of the estimated
loss reflected higher estimated proceeds from the monetization of Citizens'
power contracts as part of the wind-down of Citizens' operations.

QUARTER ENDED JUNE 30, 2002 COMPARED TO QUARTER ENDED JUNE 30, 2001

Sales. Sales for the quarter ended June 30, 2002 increased $46.4 million,
to $672.3 million, a 7.4% increase from the prior year quarter. The sales
increase was driven by pricing increases in all regions, largely due to
multi-year contracts signed in 2001. Our average sales price was 4.2% higher
than the prior year quarter. The average pricing increase was slightly mitigated
by sales mix, as higher priced tons in the Appalachia and Midwest regions
represented a lower percentage of overall sales in the current quarter compared
to the prior year quarter.

Sales volume was 48.3 million tons for the current quarter, compared to
46.8 million tons for the prior quarter, an increase of 3.2%. Higher sales
volume at our trading and brokerage operations led the increase. Volumes at our
Powder River Basin and Southwest operations increased slightly from prior year
levels, while volume at our Appalachia and Midwest operations decreased from
prior year levels due to mild weather in eight of the last ten months, which
increased customer stockpiles and softened demand.

Powder River Basin sales increased $35.7 million, mainly due to improved
pricing from contracts signed in 2001, combined with slightly higher sales
volume. Appalachian sales increased $5.5 million as a result of improved pricing
from contracts signed in 2001, partially offset by lower volume from the
suspension of the Big Mountain mine in response to soft demand. Midwest region
sales decreased $16.9 million, as higher prices were offset by lower volume due
to a delay in the startup of two new mines, combined with weaker demand for
coal. Finally, sales from brokerage and trading activities increased $19.5
million due to a 2.0 million ton volume increase related to physically settled
trading transactions, as our trading function was active in the over-the-counter
market during the quarter.

Other Revenues. Other revenues decreased $0.8 million to $30.5 million in
the current quarter. Revenues from trading operations increased $10.6 million in
current quarter, primarily due to mark-to-market income of $10.0 million related
to a forward sale with sourcing flexibility that will settle during 2003 and
2004. This increase was largely offset by a $9.7 million decrease in coal
royalty income in the current quarter, as the prior year quarter included a $9.0
million non-refundable advance royalty.

Selling and Administrative Expenses. Selling and administrative expenses
of $20.8 million were $1.7 million lower than the prior year quarter, as we
reduced corporate expenses in response to difficult market conditions.

Net Gain on Property and Equipment Disposals. Net gain on property and
equipment disposals of $2.8 million was $4.3 million lower than the prior year
quarter. The current quarter included a $2.4 million gain related to a rail
track sale, while the prior year quarter included a $6.4 million gain on the
sale of certain idle coal reserves.

Operating Profit. Operating profit increased $5.2 million, or 10.4%, for
the quarter ended June 30, 2002. The increase was driven by higher operating
profit of $17.1 million from U.S. mining operations (excluding operating costs
related to past mining activities and net gains on property disposals) as a
result of higher prices, combined with strong cost containment efforts.

In the west, the Powder River Basin region's operating profit increased
$8.2 million as improved prices and slightly higher volume overcame higher
royalty and tax expenses associated with improved prices, and higher repair and
maintenance costs.

In the east, the Appalachia region's operating profit increased $4.1
million due to strong sales price improvement and per ton mining costs that,
excluding the effect of higher royalty and tax expenses associated with higher
prices and the cost of the Big Mountain suspension, were lower than the prior
year quarter. Operating profit in the Midwest region increased $5.6 million
compared to the prior year quarter, as slightly lower sales levels were more
than offset by lower fuel and maintenance and repair costs.

21

Operating profit from trading and brokerage operations increased $8.6
million over the prior year quarter, primarily due to the $10.0 million trading
transaction discussed above in "Other Revenues." In addition, our tons traded
more than doubled from 7.8 million tons in the prior year quarter to 17.1
million tons in the current year quarter.

Operating costs related to past mining activities were $8.8 million higher
in the current quarter, primarily due to $15.3 million of excise tax refunds
included in the prior year quarter, versus only $2.3 million in the current
quarter.

Operating profit was also affected by:

- Lower coal royalty income and profit from resource management
activities of $9.1 million
- Lower selling and administrative costs of $1.7 million
- Lower net gains on property and equipment disposals of $4.3 million

Interest Expense. Interest expense for the quarter was $26.0 million, a
$8.5 million decrease, or 24.6%, from the prior year quarter. The decrease in
borrowing cost was due to the significant long-term debt repayments made since
December 31, 2000. Utilizing proceeds from the sale of our Australian operations
in January 2001 and our initial public offering in May 2001, we reduced
long-term debt by approximately $0.8 billion from December 31, 2000 to June 30,
2002. Currently, our debt balance is approximately $1.08 billion.

Income Taxes. For the quarter ended June 30, 2002, income tax expense was
$1.4 million on income before income taxes and minority interests of $29.8
million, compared to income tax expense of $4.3 million on income before income
taxes and minority interests of $16.8 million in the prior year quarter. Our
effective income tax rate was 5.0% for the quarter ended June 30, 2002, which
resulted from the decrease in our effective tax rate from 15.0% for the quarter
ended March 31, 2002 to 10.0% for the six months ended June 30, 2002. Our
consolidated tax position is impacted by available net operating loss
carryforwards and the percentage depletion tax deduction, which creates an
alternative minimum tax situation.

Extraordinary Loss from Early Extinguishment of Debt. During the quarter
ended June 30, 2001, we recorded an extraordinary loss of $27.6 million, net of
income taxes, which represented the excess of cash paid over the carrying value
of the debt retired and the write-off of debt issuance costs associated with the
debt retired. During that quarter, we used the majority of the $451.8 million of
net proceeds from our initial public offering to repay debt.

SIX MONTHS ENDED JUNE 30, 2002 COMPARED TO SIX MONTHS ENDED JUNE 30, 2001

Sales. Sales for the six months ended June 30, 2002 for the U.S.
operations (which represents all of our operations, except for Australian
operations sold in January 2001) increased $90.1 million, to $1,360.7 million, a
7.1% increase from the prior year period. The sales increase was driven by
pricing increases in all regions, largely due to multi-year contracts signed in
2001. The U.S. operations' average sales price was 3.4% higher than the prior
year period. The average pricing increase was slightly mitigated by sales mix,
as higher priced tons in the Appalachia and Midwest regions represented a lower
percentage of overall sales in the current period compared to the prior year
period.

U.S. operations' sales volume for the six months ended June 30, 2002 was
98.1 million tons, compared to 94.7 million tons for the prior year period, an
increase of 3.6%. Higher sales volume at our Powder River Basin, Southwest and
trading and brokerage operations led the increase, while volume at our
Appalachia and Midwest operations declined from prior year levels due to mild
weather in eight of the last ten months, which increased customer stockpiles and
softened demand.

Total sales for the current year period increased $74.0 million, or 5.8%,
from the prior year period. Sales from Australian operations included in the
prior year period were $16.0 million, from sales volume of 1.0 million tons.

Powder River Basin sales increased $78.1 million, due to improved pricing
and slightly higher volume. Appalachian sales increased $7.7 million, as a
result of improved pricing which overcame lower volume from the suspension of
the Big Mountain mine in response to soft demand resulting from mild weather and
a slower U.S. economy. Sales in the Southwest region increased $2.4 million as
pricing and volume were slightly above prior year levels. Midwest region sales
decreased $22.7 million, as higher prices were offset by lower volume due to a
delay in the startup of two new mines in the region, combined with softer coal
demand in the current year. Finally, sales from brokerage and trading activities
increased $23.1 million due to a 3.5 million ton volume increase related to
physically settled trading transactions, as our trading function was active in
the over-the-counter market.

Other Revenues. Other revenues for the six months ended June 30, 2002
decreased $2.8 million from the prior year period. U.S. operations' other
revenue increased $1.7 million, as revenues from trading and brokerage
operations increased $17.8 million, primarily due to improved trading results
and mark-to-market income from the trading transaction discussed

22

above in "Other Revenues." This increase was partially offset by significantly
lower coal royalty revenues. Other revenues in the prior year period included a
$9.0 million non-refundable advance royalty and $4.5 million of mining services
revenues from our Australian operations.

Depreciation, Depletion and Amortization. Total depreciation, depletion
and amortization expense decreased $2.8 million to $117.3 million for the six
months ended June 30, 2002. Depreciation, depletion and amortization expense
from Australian operations of $2.2 million was included in the six months ended
June 30, 2001.

Selling and Administrative Expenses. Selling and administrative expenses
of $47.1 million for the six months ended June 30, 2002 were $7.8 million lower
than the prior year period, due to the reduction of corporate expenses in
response to difficult market conditions in the current year, combined with stock
compensation charges recorded in the prior year period related in part to our
initial public offering.

Gain on Sale of Australian Operations. On January 29, 2001, we sold our
Australian operations to Coal & Allied, a 71%-owned subsidiary of Rio Tinto
Limited. The selling price was $446.8 million, plus the assumption of all
liabilities. We recorded a pretax gain of $171.7 million on the sale. The gain
on sale was $124.2 million after taxes, or $2.81 per diluted common share for
the six months ended June 30, 2001.

Net Gain on Property and Equipment Disposals. Net gain on property and
equipment disposals of $3.1 million was $4.6 million lower than the prior year
period. The current period included a $2.4 million gain related to a rail track
sale, while the prior year period included a $6.4 million gain on the sale of
certain idle coal reserves.

Operating Profit. Operating profit from U.S. operations increased $27.4
million, or 33.1%, to $110.2 million for the six months ended June 30, 2002.
Overall, operating profit decreased $148.6 million compared to the prior year
period, which included operating profit of $4.3 million from Australian
operations and the $171.7 million pretax gain on the sale of Australian
operations discussed above. The increase at the U.S. operations was driven by
higher operating profit of $36.0 million from mining operations (excluding
operating costs related to past mining activities and net gains on property
disposals) as a result of higher prices combined with strong cost containment
efforts.

In the west, the Powder River Basin region's operating profit increased
$18.0 million as higher volume and improved prices overcame higher royalty and
tax expenses associated with improved prices and higher repair and maintenance
costs. The Southwest region's operating profit decreased $8.4 million. Two
outages of its coal transportation pipeline contributed to higher costs in the
current year period, and maintenance and repairs were accelerated to coincide
with the outages.

In the east, the Appalachia region's operating profit increased $17.8
million due to strong sales price improvement and per ton mining costs that,
excluding the effect of higher royalty and tax expenses associated with higher
prices and lower volume due to the suspension of the Big Mountain mine, were
lower than the prior year six months. Operating profit in the Midwest region
increased $8.6 million compared to the prior year period, as lower sales levels
were more than offset by improved pricing and lower fuel and maintenance and
repair costs.

Operating profit from trading and brokerage operations increased $13.0
million over the prior year period, primarily due to the $10.0 million
transaction discussed above in "Quarter Ended June 30, 2002 Compared to Quarter
Ended June 30, 2001 - Other Revenues." In addition, our trading volume more than
doubled from 22.1 million tons traded in the prior year period to 45.3 million
tons traded in the six months ended June 30, 2002.

Operating costs related to past mining activities were $13.5 million
higher in the six months ended June 30, 2002, primarily due to $15.3 million of
excise tax refunds included in the prior year period, versus only $5.5 million
in the current year. In addition, the current year period includes higher closed
and suspended mine costs and workers' compensation charges.

U.S. operations' operating profit was also affected by:

- Lower coal royalty income and profit from resource management
activities of $12.7 million
- Lower selling and administrative costs of $7.8 million
- Lower net gains on property and equipment disposals of $4.6 million

Interest Expense. Interest expense for the six months ended June 30, 2002
was $50.9 million, a decrease of $27.8 million, or 35.3%, from the prior year
period. The decrease in borrowing cost was due to the significant long-term debt
repayments made since December 31, 2000. Utilizing proceeds from the sale of our
Australian operations and our initial

23

public offering in May 2001, we reduced long-term debt by approximately $0.8
billion from December 31, 2000 to June 30, 2002. Currently, our debt balance is
approximately $1.08 billion.

Interest Income. Interest income decreased $2.0 million, to $1.1 million,
for the six months ended June 30, 2002. The prior year period included interest
earned on cash received from the sale of our Australian operations in January
2001.

Income Taxes. For the six months ended June 30, 2002, income tax expense
was $6.0 million on income before income taxes and minority interests of $60.3
million, compared to income tax expense of $43.3 million on income before income
taxes and minority interests of $183.1 million in the prior year period. Our
effective income tax rate was 10.0% for the six months ended June 30, 2002. Our
consolidated tax position is impacted by available net operating loss
carryforwards and the percentage depletion tax deduction, which creates an
alternative minimum tax situation, and in the prior year by the sale of our
Australian operations.

Gain from Disposal of Discontinued Operations. During the six months ended
June 30, 2001, we reduced our loss on the sale of Citizens Power by $1.2
million.

Extraordinary Loss from Early Extinguishment of Debt. During the six
months ended June 30, 2001, we repaid debt using proceeds from the sale of our
Australian operations and our initial public offering. We recorded an
extraordinary loss of $36.1 million, net of income taxes, which represented the
excess of cash paid over the carrying value of the debt retired and the
write-off of debt issuance costs associated with the debt retired.

LIQUIDITY AND CAPITAL RESOURCES

Cash provided by operating activities was $60.5 million for the six months
ended June 30, 2002, an increase of $37.9 million from the prior year period.
Current year income from continuing operations, excluding the after-tax effect
of the gain on sale of Australian operations, was $36.7 million higher than the
prior year period. Working capital cash usages were $21.1 million higher in the
current year period due primarily to soft market conditions, but were partially
offset by lower reclamation and workers' compensation spending in the current
year period. Cash flow in the prior year six months benefited from $15.0 million
of proceeds received related to the expansion of our accounts receivable
securitization program and contained $4.3 million of cash used related to
Australian operations that were sold in January 2001.

Net cash used in investing activities was $122.2 million for the six
months ended June 30, 2002, compared to cash provided by investing activities of
$385.7 million in the prior year period. The prior year period included $455.0
million of proceeds from the sale of our Australian operations, and $16.9
million of proceeds related to the sale of Citizens Power. Capital expenditures
increased $20.4 million, to $105.5 million, in the current year period. These
capital expenditures were primarily for the replacement of mining equipment, the
expansion of capacity at certain mines and projects to improve the efficiency of
mining operations.

Net cash provided by financing activities was $31.9 million for the six
months ended June 30, 2002, compared with cash used in financing activities of
$410.2 million in the prior year period. The prior year includes $451.8 million
of net proceeds from our initial public offering. Debt repayments were $868.2
million higher in the prior year period, principally as a result of the usage of
proceeds received from the sale of our Australian operations and our initial
public offering to repay debt. In the current year, we have higher net revolving
line of credit borrowings of $58.8 million. The prior year period also included
a $19.9 million dividend received from our Australian operations. In addition,
we paid dividends to our shareholders of $10.4 million in the current year
period.

As of June 30, 2002, our total indebtedness consisted of the following
(dollars in thousands):

9.625% Senior Subordinated Notes ("Senior Subordinated Notes") due 2008 $ 391,440
8.875% Senior Notes ("Senior Notes") due 2008 316,456
5.0% Subordinated Note 82,757
Senior unsecured notes under various agreements 83,571
Unsecured revolving credit agreement 89,774
Revolving Credit Facility under Senior Credit Facility 74,600
Other 45,724
----------
$1,084,322
==========

24

As of June 30, 2002, our revolving credit and letter of credit borrowing
facilities included the $480.0 million Revolving Credit Facility under our
Senior Credit Facility and Black Beauty's $120.0 million revolving credit
facility. The Revolving Credit Facility has a borrowing sub-limit of $350.0
million and a letter of credit sub-limit of $330.0 million. Together, these
facilities total $600.0 million, and have a total of $470.0 million available
for borrowing.

As of June 30, 2002, outstanding borrowings under the Revolving Credit
Facility were $74.6 million. Black Beauty's revolving credit facility borrowings
totaled $89.8 million. We were in compliance with the restrictive covenants of
all of our and our subsidiaries' debt agreements as of June 30, 2002.

In March 2000, we established an accounts receivable securitization
program. Under the program, undivided interests in a pool of eligible trade
receivables that have been contributed to our wholly-owned, bankruptcy-remote
subsidiary are sold, without recourse, to a multi-seller, asset-backed
commercial paper conduit ("Conduit"). Purchases by the Conduit are financed with
the sale of highly rated commercial paper. We used proceeds from the sale of the
accounts receivable to repay long-term debt, effectively reducing our overall
borrowing costs. The securitization program is currently scheduled to expire in
2007. Under the provisions of Statement of Financial Accounting Standards
("SFAS") No. 125, "Accounting for Transfers and Servicing of Financial Assets
and Extinguishments of Liabilities," (as amended by SFAS No. 140) the
securitization transactions have been recorded as sales, with those accounts
receivable sold to the Conduit removed from the consolidated balance sheet. The
amount of undivided interests in accounts receivable sold to the Conduit was
$140.0 million as of June 30, 2002 and December 31, 2001.

We have designated interest rate swaps with notional amounts totaling
$150.0 million as a fair value hedge of our Senior Notes. Under the swaps, we
pay a floating rate based upon the six-month LIBOR rate for a period of seven
years ending May 15, 2008. The applicable rate was 6.07% as of June 30, 2002. We
realized interest savings of $2.1 million during the six months ended June 30,
2002.

We had $117.9 million of commitments for capital expenditures at June 30,
2002, that are primarily related to acquiring additional coal reserves and
mining equipment in 2002. Total capital expenditures for calendar year 2002 are
expected to range from $180 million to $200 million, and have been and will be
primarily used to acquire additional low sulfur coal reserves, develop existing
reserves, replace or add equipment and fund cost reduction initiatives. We
anticipate funding these capital expenditures primarily through operating cash
flow. We believe the risk of generating lower than anticipated operating cash
flow in 2002 is reduced by our high level of sales commitments (99% of 2002
planned production) and lower borrowing costs as a result of our significant
debt reductions.

OTHER

Recent Accounting Pronouncements. In June 2001, the Financial Accounting
Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS)
No. 143, "Accounting for Asset Retirement Obligations." SFAS No. 143 addresses
accounting and reporting for obligations associated with the retirement of
tangible long-lived assets and the associated asset retirement costs. This
Statement is effective for fiscal years beginning after June 15, 2002 (effective
January 1, 2003 for the Company). We are currently assessing the impact of this
new Statement.

In May 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements
No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections
as of April 2002." SFAS No. 145 addresses Accounting for Asset Retirement
Obligations." SFAS No. 145 requires that gains and losses from the
extinguishment of debt should be classified as extraordinary items only if they
meet the criteria in Accounting Principles Board Opinion 30, "Reporting the
Results of Operations-Reporting the Effects of Disposal of a Segment of a
Business, and Extraordinary, Unusual and Infrequently Occurring Events and
Transactions." In addition, SFAS No. 145 requires that certain lease
modifications that have economic effects similar to sale-leaseback transactions
be accounted for in the same manner as sale-leaseback transactions. This
Statement is effective for fiscal years beginning after May 15, 2002 (effective
January 1, 2003 for the Company). We are currently assessing the impact of this
new Statement.

In July 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities." SFAS No. 146 addresses financial
accounting and reporting for costs associated with exit or disposal activities,
and nullifies EITF Issue No. 94-3, "Liability Recognition for Certain Employee
Termination Benefits and Other Costs to Exit an Activity (including Certain
Costs Incurred in a Restructuring)." This Statement requires that a liability
for a cost associated with an exit or disposal activity be recognized and
measured initially at fair value only when the liability is incurred. This
Statement is effective for exit or disposal activities that are initiated after
December 31, 2002.

25

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

Trading Activities

We market and trade coal and emission allowances. These activities give
rise to market risk, which represents the potential loss that can be caused by a
change in the market value of a particular commitment. We actively measure,
monitor and adjust traded position levels to remain within market risk limits
prescribed by management. For example, we have policies in place that limit the
amount of total exposure we may assume at any point in time.

We account for coal and emission allowance trading using the fair value
method, which requires us to reflect financial instruments with third parties,
such as forwards, futures, options and swaps, at market value in the
consolidated financial statements.

We perform a value at risk analysis on our trading portfolio, which
includes over-the-counter and brokerage trading of coal and emission allowances.
Our value at risk model is based on the industry standard risk-metrics
variance/co-variance approach. This captures our exposure related to both option
and forward positions. Our value at risk model assumes a fifteen-day holding
period and a 95% one-tailed confidence interval.

The use of value at risk allows management to aggregate market risks
across products in the portfolio, compare risk on a consistent basis and
identify the drivers of risk. Due to the subjectivity in the choice of the
liquidation period, reliance on historical data to calibrate the models and the
inherent limitations in the value at risk methodology, including the use of
delta/gamma adjustments related to options, we perform regular stress, back
testing and scenario analysis to estimate the impacts of market changes on the
value of the portfolio. The results of these analyses are used to supplement the
value at risk methodology and identify additional market related risks.

During the six months ended June 30, 2002, the low, high and average
values at risk for our coal trading portfolio were $0.3 million, $3.9 million
and $1.8 million, respectively. Our emission allowance value at risk averaged
$0.1 million during the six months ended June 30, 2002, and did not exceed $0.2
million during that period. Sixty-two percent of the value of our trading
portfolio will be realized by the end of calendar 2003, and ninety-four percent
of the value of our trading portfolio will be realized by the end of calendar
2004.

We also monitor other types of risk associated with our coal and emission
allowance trading activities, including market liquidity, counterparty
nonperformance and position valuation.

Non-trading Activities

We manage our commodity price risk for non-trading purposes through the
use of long-term coal supply agreements, rather than through the use of
derivative instruments. We currently have sales commitments for 99% of our
planned calendar 2002 production.

Some of the products used in our mining activities, such as diesel fuel,
are subject to price volatility. We, through our suppliers, utilize forward
contracts to manage the exposure related to this volatility.

We have exposure to changes in interest rates due to our existing level of
indebtedness. As of June 30, 2002, after taking into consideration the effects
of interest rate swaps, we had $725.6 million of fixed-rate borrowings and
$358.7 million of variable-rate borrowings outstanding. A one percentage point
increase in interest rates would result in an annualized increase to interest
expense of $3.6 million on our variable-rate borrowings. With respect to our
fixed-rate borrowings, a one percentage point increase in interest rates would
result in a $37.9 million decrease in the fair value of these borrowings.

26

PART II - OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS.

Navajo Nation

See Note 10 to the unaudited condensed consolidated financial statements
included in Part I, Item 1 of this report relating to certain legal proceedings
brought against us by the Navajo Nation and Hopi Tribe.

Salt River Project Agricultural Improvement and Power District-Price Review

See Note 10 to the unaudited condensed consolidated financial statements
included in Part I, Item 1 of this report relating to certain legal and
arbitration proceedings involving the Salt River Project Agricultural
Improvement and Power District.

Department of Justice

During 2001, along with other coal producers in the Powder River Basin in
Wyoming, we received a request for information from the U.S. Department of
Justice regarding an alleged agreement to restrict production of coal from this
region. In June 2002, we received notification from the U.S. Department of
Justice that it had closed that investigation.

Kentuckians for the Commonwealth v. Rivenburgh

On May 8, 2002, the U.S. District Court for the Southern District of West
Virginia issued an injunction against the U.S. Army Corps of Engineers from
issuing any new Section 404 Clean Water Act permits that involved the placement
of fill without a primary constructive purpose for the fill. On June 17, 2002,
the Court denied a motion for a stay that was filed by a coal association and
the federal government. On July 3, 2002, the defendants filed an appeal with the
Fourth Circuit Court of Appeals. Unless this decision is reversed, it may affect
our subsidiaries' ability to extend the life of their preparation plants or open
new mines in the future.

While the outcome of litigation is subject to uncertainties, based on our
preliminary evaluation of the issues and the potential impact on us, we believe
this matter will be resolved without a material adverse effect on our financial
condition or results of operations.

West Virginia Flooding Litigation

Three of our subsidiaries have been named in four separate complaints
filed in Boone, Kanawha and Wyoming Counties, West Virginia. These cases
collectively include 622 plaintiffs who are seeking damages for property damage
and personal injuries arising out of flooding that occurred in southern West
Virginia in July of 2001. The plaintiffs have sued coal, timber, railroad and
land companies under the theory that mining, construction of haul roads and
removal of timber caused natural surface waters to be diverted in an unnatural
way, thereby causing damage to the plaintiffs. The West Virginia Supreme Court
has ruled that these four cases, along with over 10 additional flood damage
cases not involving our subsidiaries, be handled pursuant to the Court's Mass
Litigation rules. As a result of this ruling, the cases have been transferred to
the Circuit Court of Raleigh County in West Virginia to be handled by a panel
consisting of three circuit court judges. They will, among other things,
determine whether the individual cases should be consolidated or returned to
their original circuit courts.

While the outcome of litigation is subject to uncertainties, based on our
preliminary evaluation of the issues and the potential impact on us, we believe
this matter will be resolved without a material adverse effect on our financial
condition or results of operations.

ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS.

Please see Note 12 to the accompanying unaudited condensed consolidated
financial statements relating to the recent adoption by our Board of Directors
of a preferred share purchase rights plan.

27

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.

The Annual Meeting of Stockholders was held on May 3, 2002. The following
persons were elected to serve as directors for terms expiring in 2005 and
received the number of votes set forth opposite their respective names:

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.

(a) Exhibits

See Exhibit Index at page 30 of this report.

(b) Reports on Form 8-K

On April 9, 2002, we filed a Form 8-K under Item 5, Other Events,
announcing a secondary offering of 9,000,000 shares of common stock by
certain shareholders of the Company.

28

SIGNATURE

Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.

PEABODY ENERGY CORPORATION

Date: August 7, 2002 By: RICHARD A. NAVARRE
------------------------------------------------
Richard A. Navarre
Executive Vice President and Chief Financial Officer
(Principal Financial Officer)

29

EXHIBIT INDEX

The exhibits below are numbered in accordance with the Exhibit Table of Item 601
of Regulation S-K.

* Filed herewith.

30