In December 2011, Armstrong Energy entered into a series of transactions with affiliates and/or subsidiaries of Peabody Energy (NYSE:BTU), under which Armstrong Energy acquired additional property near its existing and planned mines in western Kentucky.
This newly-acquired property contains an estimated total of 7.7 million clean recoverable tons of coal, with the company also entering into leases for an estimated 14 million clean recoverable tons.
In addition, Armstrong said in a Feb. 10 Form S-1/A filing that it entered into a joint venture relating to coal reserves near its Parkway mine. In connection with the joint venture, Peabody has agreed to contribute about 25 million tons of clean recoverable coal reserves located in Muhlenberg County, Ky., and Armstrong agreed to contribute mining assets to the joint venture. Armstrong and Peabody have also agreed to contribute 51% and 49%, respectively, of the cash sufficient to complete the development of the mine and sufficient for down payments on mining equipment. Armstrong will manage the joint venture’s day-to-day operations and the development of the mine in exchange for a $0.50 per ton sold management fee. Peabody will receive a $0.25 per ton commission on all coal sales by the joint venture.
Armstrong and Peabody entered into an asset purchase agreement under which Armstrong acquired from Peabody its rights and interests in certain owned and leased coal reserves located in Muhlenberg County in exchange for: a cash payment by us of about $8.9m; a promissory note in the aggregate principal amount of approximately $4.4m; and an overriding royalty to Peabody to the extent Armstrong mines in excess of certain tonnages from the property as set forth in the asset purchase agreement.
In December 2011, Armstrong and Midwest Coal Reserves of Kentucky LLC, an affiliate of Peabody, entered into a contract to sell and lease real estate under which Armstrong acquired from Midwest Coal its right, title and interest in and to #9-seam coal reserves in Union County, Ky. In addition, Midwest Coal agreed to lease to Armstrong approximately 2,000 acres of #9-seam coal. In consideration of the sale and lease of real property, Armstrong agreed to deliver: about $6m in cash; a promissory note in the aggregate principal amount of about $3m; and an overriding royalty of 2% of the gross selling price on each ton of coal produced and sold from the coal reserves that were purchased (thus excluding the leased coal).
Armstrong Energy, under operating subsidiary Armstrong Coal, got started in the western Kentucky coal business in 2006, in part on property acquired from Peabody. Peabody in October 2007 spun off the rest of its existing mines in western Kentucky in an IPO under Patriot Coal (NYSE:PCX), taking Peabody out of the coal producing business in the region but still in possession of major, undeveloped coal reserves.
Armstrong Energy plans its own IPO, with the Form S-1/A still not showing an offer price for those shares. The company expects to apply to list its common stock on the Nasdaq Global Market under the symbol ARMS. The Feb. 10 filing was the third update of a Form S-1 that was initially filed with the SEC in October 2011.
Armstrong grew fast from 2006 start
Armstrong is a diversified producer of low-chlorine, high-sulfur thermal coal from western Kentucky, with both surface and underground mines. It markets coal primarily to electric utility companies as fuel for their steam-powered generators. Based on 2010 production, it was the sixth largest producer in the Illinois Basin and the second largest in western Kentucky.
Armstrong commenced production in the second quarter of 2008 and currently operates six mines, including four surface and two underground, and is seeking permits for four additional mines. It controls approximately 319 million tons of proven and probable coal reserves. The reserves and operations are located in Ohio, Muhlenberg, Union and Webster counties. It also owns and operates three coal processing plants. The location of the coal reserves and mines, adjacent to the Green and Ohio rivers, together with its river dock coal handling and rail loadout facilities, allow Armstrong to optimize coal blending and handling, and provide customers with rail, barge and truck transportation options.
Armstrong’s revenue has increased from zero in 2007 to $220.6m in 2010, which it achieved despite a period of recession-driven declines in U.S. demand for coal and a challenging environment in the credit markets. For the year ended Dec. 31, 2010, it generated operating income of $19.2m and adjusted EBITDA of $41.1m. Operating income and adjusted EBITDA for the nine months ended Sept. 30, 2011, were $6.4m and $32.1m, respectively.
In 2010, Armstrong produced 5.6 million tons of coal from three surface and two underground mines. During the first nine months of fiscal 2011, it produced 5.1 million tons of coal, with seven mines in operation. It currently expects a significant increase in production for 2011 compared to 2010. It is contractually committed to sell 7.6 million tons of coal in 2011, which represents substantially all of its currently estimated production for 2011.
As of Sept. 30, 2011, the company was contractually committed to sell 8.8 million tons of coal in 2012 and 8.1 million tons of coal in 2013, which represents 99% and 83% of expected total coal sales in 2012 and 2013, respectively. Major customers include nearby utilities Louisville Gas and Electric, Kentucky Utilities, the Tennessee Valley Authority and Owensboro Municipal Utilities.
New mines in the planning stages
During the first nine months of 2011 the company operated three underground mines (Big Run, Kronos, and Parkway) and four surface mines (Midway, East Fork, Equality Boot and Lewis Creek). During the first nine months of 2010, it only had four mines in operation, as production at the Equality Boot mine did not commence until January 2011, Lewis Creek in June 2011 and Kronos in September 2011.
The company anticipates opening the Lewis Creek underground mine in 2013 and the Ceralvo underground mine in 2015, both located in Ohio County, assuming that it receives all necessary permits. Both mines will produce coal from the West Kentucky #9 seam utilizing two continuous miner super sections operating concurrently. Once fully operational, the Lewis Creek and Ceralvo mines are projected to produce about 1 million tons each of clean coal per year. There are approximately 22 million tons of proven and probable reserves at each of the Lewis Creek and Ceralvo reserves.
Also, Armstrong expects to open the Hickory Ridge, Ken and Maddox surface mines in 2013 and 2014. These mines will produce thermal coal from primarily the West Kentucky #14, #13, #13A and #11 seams. The Hickory Ridge, Ken and Maddox mines have about 23 million tons in the aggregate of proven and probable reserves.
Armstrong’s sales and marketing functions are handled from its St. Louis, Mo., headquarters with assistance from its Madisonville, Ky., operations center. Prior to 2011, the majority of its coal sales were made through the use of third-party independent contractors who were paid a per-ton commission with respect to the coal they brokered for sale. Commencing in 2011, the majority of new coal sales have been made through an in-house Director of Coal Sales.
Not mentioned in the S-1/A is the fact that coal sales agent Delta Coals LLC on Jan. 6 filed a second amended complaint against Armstrong Coal that accuses Armstrong of trying to cut Delta Coals out of coal sales business that Delta Coals helped arrange with TVA and Tampa Electric. The original version of the lawsuit was filed in April 2011 in the U.S. District Court for the Middle District of Tennessee. The original complaint focused on business that Delta Coals helped arrange with TVA, while the two latest versions add new complaints related to Tampa Electric. Armstrong has said in court filings that it has violated no operable sales agency agreement with Delta Coals.
TVA, LGE contract details unveiled
In 2010, Armstrong sold coal to eight domestic customers. In that year, it derived approximately 76% of total coal revenues from sales to its two largest customers — TVA and Louisville Gas and Electric (LGE).
Armstrong said it currently has two multi-year coal supply agreements with LGE. The first agreement was entered into in 2008, as amended, and expires in 2016. It calls for 2.1 million tons annually through 2015 and 0.9 million tons in 2016. Pricing ranges from $28.19 to $30.25 per ton over the term of the agreement subject to certain additional quality related adjustments. There is no price reopener provision in this agreement.
The second agreement with LGE, which was entered into in 2009, calls for annual delivery of 1.25 million tons from 2011 through 2013 and 0.75 million tons from 2014 through 2016. In addition to typical quality adjustments, the price ranges from $42 to $45 per ton from 2011 through 2013. The agreement then provides that either party may elect at its sole option to reopen the agreement for negotiations with respect to price and/or other terms as it concerns all coal to be delivered in 2014 and beyond. Should either party seek to reopen the agreement (which must be done no later than April 1, 2013) and the parties are unable to reach a mutually acceptable agreement as to those terms being renegotiated, the agreement will terminate as of Dec. 31, 2013.
Armstrong also have two multi-year coal supply agreements with TVA . The agreement with TVA that was entered into in 2007, as amended, calls for the delivery of 1 million tons annually in 2011 and 2 million tons from 2012 through 2018. The price ranges from $40.57 to $41.68 per ton in 2011 and 2012. The agreement then provides that either party may elect at its sole option to reopen the agreement for negotiations with respect to price and/or other terms as it concerns all coal to be delivered in 2013 and beyond. Should either party seek to reopen the agreement (which must be done by no later than April 1, 2012) and the parties are unable to reach a mutually acceptable agreement as to those terms being renegotiated, the agreement will terminate as of Dec. 31, 2012. The agreement also provides for typical quality adjustments. In addition, commencing on July 1, 2011, TVA has the unilateral right to terminate the agreement upon 60 days written notice, in which case TVA is required to pay a termination fee equal to 10% of the base price multiplied by the remaining number of tons to be delivered under the contract.
A second agreement with TVA that was entered into in 2008 calls for delivery of between 0.9 million and 1.1 million tons annually from 2009-2013. The price ranges from $56 to $58 between 2011 and 2013. The agreement then provides that either party may elect at its sole option to reopen the agreement for negotiations with respect to price and/or other terms as it concerns all coal to be delivered in 2012 and 2013. TVA exercised its option under the agreement. As a result the parties reached an agreement to reprice the coal to be delivered in 2012 and 2013 with pricing from $54.25 to $55.88 per ton.
Coal reserve affiliate also headed for IPO
An affiliate, Armstrong Resource Partners, which is being taken public in a separate IPO, was formed to manage and lease coal properties and collect royalties in western Kentucky. Armstrong Energy holds a 0.4% equity interest in Armstrong Resource Partners through a wholly-owned subsidiary, Elk Creek GP LLC, which is the general partner of Armstrong Resource Partners.
The outstanding limited partnership interests of Armstrong Resource Partners, representing 99.6% of its equity interests, are owned by investment funds managed by Yorktown Partners LLC. Armstrong Energy is majority-owned by Yorktown. Of Armstrong Energy’s total controlled reserves of 319 million tons, 66 million tons (21%) are owned 100% by Armstrong Resource Partners, and 138 million tons (43%) are held by Armstrong Energy and Armstrong Resource Partners as joint tenants in common with 60.55% and 39.45% interests, respectively.