Acquisition

9 Months Ended

Sep. 30, 2012

Acquisition

Acquisition

Note 2—Acquisition

        On November 18, 2010, the Company announced its intent to acquire all of the outstanding common shares of Western Coal. In connection with the acquisition, the Company acquired high quality metallurgical coal mines in Northeast British Columbia (Canada), high quality metallurgical coal and compliant thermal coal mines located in West Virginia (United States), and a high quality anthracite coal mine located in South Wales (United Kingdom). The acquisition of Western Coal substantially increased the Company's reserves available for future production, the majority of which is high-quality metallurgical coal, and created a diverse geographical footprint with strategic access to high-growth steel-producing countries in both the Atlantic and Pacific basins.

        On November 17, 2010, the Company entered into a share purchase agreement with various funds advised by Audley Capital to purchase approximately 54.5 million common shares, or 19.8%, of the outstanding common shares of Western Coal for $11.50 Canadian dollars per share in two separate transactions. On December 2, 2010 the Company entered into an arrangement agreement with Western Coal to acquire all the remaining outstanding common shares of Western Coal for $11.50 Canadian dollars per share in cash or 0.114 of a Walter Energy share, or for a combination thereof at the holder's election, subject to proration.

        In January 2011, the Company completed the first transaction to acquire 25,274,745 common shares of Western Coal, or 9.15% of the outstanding shares, from funds advised by Audley Capital. The shares were purchased for $293.7 million in cash and had a fair value of $314.2 million on April 1, 2011. The Company recognized a gain on April 1, 2011 of $20.5 million as a result of remeasuring to fair value the Western Coal shares acquired from Audley Capital which was included in other income in the Condensed Consolidated Statements of Operations and Comprehensive Income for the nine months ended September 30, 2011. On April 1, 2011, the Company acquired the remaining outstanding common shares of Western Coal (including the second Audley Capital transaction) for a combination of $2.2 billion in cash and the issuance of 8,951,558 common shares of Walter Energy valued at $1.2 billion. The fair value of Walter Energy's common stock on April 1, 2011 was $136.75 per share based on the closing value on the New York Stock Exchange. The cash portion was funded with part of the proceeds from the new $2.7 billion credit facility discussed in Note 7. All of the outstanding options to purchase Western Coal common shares that were not exercised prior to the acquisition were exchanged for fully-vested and immediately exercisable options to purchase shares of Walter Energy common stock. The Company issued 193,498 stock options in exchange for the Western Coal stock options outstanding as of April 1, 2011. The stock options issued had a fair value of $15.5 million, which was estimated using the Black-Scholes option pricing model. The outstanding warrants of Western Coal were not directly affected by the acquisition. Instead, upon exercise each warrant entitled the holder to receive cash and shares of Walter Energy common stock that would have been issued if the warrants had been exercised immediately before closing the acquisition. During the nine months ended September 30, 2012, the warrants were exercised (or expired) resulting in a cash payment of $11.5 million and the issuance of additional shares of 18,938. As of September 30, 2012, no warrants of Western Coal were outstanding.

        The purchase consideration has been allocated to the assets acquired and liabilities assumed based upon their estimated fair values at the date of acquisition. Fair values were determined using the income, cost and market price valuation methods as deemed appropriate. During the 2012 first quarter, the Company completed the valuation of the assets and liabilities with the assistance of an independent third party and recorded refinement adjustments to the preliminary purchase price allocation. These refinements were primarily around the areas of acquired mineral interests including estimates for future costs, production volumes and timing which resulted in a $94.0 million increase in fair value allocated to mineral interests as compared to the December 31, 2011 preliminary fair value. This also resulted in a decrease in goodwill of $57.8 million and the deferred tax liability was increased by $25.5 million reflecting an increase in future depletion expense not deductible for tax. Retrospective application of the changes made to the allocation of the purchase consideration in the 2012 first quarter increased retained earnings, a component of stockholders' equity, as of December 31, 2011 and net income by $14.4 million for the year ended December 31, 2011. The increase to retained earnings resulting from the change in net income was primarily due to a decrease in mineral interests depletion related to 2011. The following table summarizes the Company's recast and previously reported December 31, 2011 consolidated balance sheet amounts (in thousands):

	Recast December 31, 2011(1)		December 31, 2011(2)
ASSETS
Inventories	$	240,437	$	242,607
Other current assets	$	45,649	$	45,627
Mineral interests, net	$	3,056,258	$	2,946,113
Property, plant and equipment, net	$	1,631,333	$	1,637,182
Goodwill	$	1,066,754	$	1,124,597
LIABILITIES AND STOCKHOLDERS' EQUITY
Other current liabilities	$	63,757	$	59,827
Deferred income taxes	$	1,029,336	$	1,003,383
Retained earnings	$	744,939	$	730,517

(1)

As presented in the September 30, 2012 condensed consolidated financial statements herein.

(2)

As previously presented in the consolidated financial statements in the Company's Annual Report on Form 10-K for the year ended December 31, 2011.

        Retrospective application of the changes made to the allocation of the purchase consideration in the 2012 first quarter increased net income previously reported by $10.9 million and $18.0 million for the three and nine months ended September 30, 2011, respectively. The increases to net income were primarily due to a decrease in mineral interests depletion during the periods. The following table summarizes the Company's recast and previously reported three and nine months ended September 30, 2011 Condensed Consolidated Statements of Operations amounts (in thousands):

	Recast September 30, 2011(1)		September 30, 2011(2)
For the three months ended:
Sales	$	683,730	$	685,052
Cost of sales (exclusive of depreciation and depletion)		420,690		425,487
Depreciation and depletion		57,144		63,046
Operating income		158,027		148,650
Income before income tax expense		117,282		107,905
Income tax expense		30,202		31,684
Net income	$	87,080	$	76,221
Net income per share:
Basic	$	1.40	$	1.22
Diluted	$	1.39	$	1.21
For the nine months ended:
Sales	$	1,854,892	$	1,858,343
Cost of sales (exclusive of depreciation and depletion)		1,105,224		1,106,008
Depreciation and depletion		157,972		180,830
Operating income		442,257		422,066
Income before income tax expense		390,728		370,537
Income tax expense		107,382		105,145
Net income	$	283,346	$	265,392
Net income per share:
Basic	$	4.75	$	4.45
Diluted	$	4.72	$	4.43

(1)

As presented in the September 30, 2012 condensed financial statements herein.

(2)

As previously presented in the condensed consolidated financial statements in the Company's Form 10-Q for the three and nine months ended September 30, 2011.

        The following table summarizes the Company's recast and previously reported September 30, 2011 Condensed Consolidated Statement of Cash Flows amounts (in thousands):

	For the nine months ended September 30,
	Recast 2011(1)			2011(2)
Net Income	$	283,346		$	265,392
Adjustments to reconcile net income to net cash flows provided by (used in) operating activities:
Depreciation and depletion	$	157,972		$	180,830
Deferred income tax credit	$	(16,901	)	$	(19,138	)
Other	$	8,349		$	29,098
Decrease (increase) in current assets, net of effect of business acquisitions:
Inventories	$	21,856		$	(1,560	)

(1)

As presented in the September 30, 2012 condensed consolidated financial statements herein.

(2)

As previously presented in the condensed consolidated financial statements in the Company's Form 10-Q for the nine months ended September 30, 2011.

        The following tables summarize the purchase consideration, the preliminary purchase price allocation reported in the Company's Annual Report on Form 10-K for the year ended December 31, 2011, the final purchase price allocation, and the applicable recast adjustments made upon finalization during the quarter ended March 31, 2012 (in thousands):

Purchase consideration:
Cash	$	2,173,080
Fair value of shares of common stock issued		1,224,126
Fair value of stock options issued and warrants		34,765
Fair value of consideration transferred		3,431,971
Fair value of equity interest in Western Coal held before the acquisition		314,231
Total consideration	$	3,746,202

	Preliminary as of December 31, 2011		Adjustments			Final
Fair value of assets acquired and liabilities assumed:
Cash and cash equivalents	$	34,065	$	—		$	34,065
Receivables		163,668		—			163,668
Inventories		121,229		—			121,229
Other current assets		86,475		23			86,498
Mineral interests		2,992,000		94,000			3,086,000
Property, plant and equipment		560,894		(6,702	)		554,192
Goodwill		1,122,884		(57,844	)		1,065,040
Other long-term assets		54,150		—			54,150
Total assets		5,135,365		29,477			5,164,842
Accounts payable and accrued liabilities		184,983		—			184,983
Other current liabilities		82,175		3,930			86,105
Deferred tax liability		1,021,161		25,547			1,046,708
Other long-term liabilities		100,844		—			100,844
Total liabilities		1,389,163		29,477			1,418,640
Net assets acquired	$	3,746,202	$	—		$	3,746,202

        Goodwill represents the excess of the purchase consideration transferred over the fair value of the identifiable assets acquired and liabilities assumed. The factors that contribute to the recognition of goodwill include Western Coal's (i) historical cash flows and income levels, (ii) reputation in its markets, (iii) strength of its personnel, (iv) efficiency of its operations, and (v) future cash flows and income growth projections. Goodwill has been assigned to the Canadian and U.K. Operations segment and the U.S. Operations segment in the amounts of $992.4 million and $72.6 million, respectively. None of the goodwill is expected to be tax deductible. The Company incurred acquisition costs related to the purchase of approximately $6.1 million and $23.1 million during the three and nine months ended September 30, 2011, respectively. These costs were included in selling, general and administrative expenses in the Company's Condensed Consolidated Statements of Operations and Comprehensive Income.

        The unaudited supplemental pro forma information presented below includes the effects of the Western Coal acquisition as if it had been completed as of January 1, 2010, along with the effects of the recast adjustments described herein. The pro forma results include (i) the impact of certain estimated fair value adjustments, including additional estimated depreciation and depletion expense associated with the acquired mineral interests and property, plant and equipment and (ii) interest expense associated with debt used to fund the acquisition. Accordingly, the following unaudited pro forma financial information should not be considered indicative of either future results or results that might have occurred had the acquisition been consummated as of January 1, 2010 (in thousands):

	For the nine months ended September 30, 2011
Revenues	$	2,092,560
Net income	$	338,106