March 26, 2007

 

Dear Shareholder:

 

You are cordially invited to attend the 2007 Annual Meeting of Shareholders of Peabody Energy Corporation (the “Company”), which will be held on Tuesday, May 1, 2007, at 10:00 A.M., Central Time, at the Ritz-Carlton Hotel, 100 Carondelet Plaza, Clayton, Missouri 63105.

 

During this meeting, shareholders will vote on the following items:

 

 

The accompanying Notice of Annual Meeting of Shareholders and Proxy Statement contain complete details on these items and other matters. We also will be reporting on the Company’s operations and responding to shareholder questions. If you have questions that you would like to raise at the meeting, we encourage you to submit written questions in advance (by mail or e-mail) to the Corporate Secretary. This will help us respond to your questions during the meeting. If you would like to e-mail your questions, please send them to stockholder.questions@peabodyenergy.com.

 

Your understanding of and participation in the Annual Meeting is important, regardless of the number of shares you hold. To ensure your representation, we encourage you to vote over the telephone or Internet or to complete and return the enclosed proxy card as soon as possible. If you attend the Annual Meeting, you may then revoke your proxy and vote in person if you so desire.

 

Thank you for your continued support of Peabody Energy. We look forward to seeing you on May 1.

 

Very truly yours,

 

 

Gregory H. Boyce

President & Chief Executive Officer

PEABODY ENERGY CORPORATION
701 Market Street
St. Louis, Missouri 63101-1826

 

NOTICE OF ANNUAL MEETING OF SHAREHOLDERS

 

Peabody Energy Corporation (the “Company”) will hold its Annual Meeting of Shareholders at the Ritz-Carlton Hotel, 100 Carondelet Plaza, Clayton, Missouri, 63105 on Tuesday, May 1, 2007, at 10:00 A.M., Central Time, to:

 

 

The Board of Directors has fixed March 9, 2007 as the record date for determining shareholders who will be entitled to receive notice of and vote at the Annual Meeting or any adjournment. Each share of Common Stock is entitled to one vote. As of the record date, there were 264,690,754 shares of Common Stock outstanding.

 

If you own shares of the Company’s Common Stock as of March 9, 2007, you can vote those shares by completing and mailing the enclosed proxy card or by attending the Annual Meeting and voting in person. Shareholders of record also may submit their proxies electronically or by telephone as follows:

 

 

An admittance card or other proof of ownership is required to attend the Annual Meeting. Please retain the top portion of your proxy card for this purpose. Also, please indicate your intention to attend the Annual Meeting by checking the appropriate box on the proxy card, or, if voting by the Internet or by telephone, when prompted. If your shares are held by a bank or broker, you will need to ask them for an admission card in the form of a confirmation of beneficial ownership. If you do not receive a confirmation of beneficial ownership or other admittance card from your bank or broker, you must bring proof of share ownership (such as a copy of your brokerage statement) to the Annual Meeting.

 

Your vote is important. Whether or not you plan to attend the Annual Meeting, please cast your vote by telephone or the Internet, or complete, date and sign the enclosed proxy card and return it in the envelope provided. If you attend the meeting, you may withdraw your proxy and vote in person, if you so choose.

 

Jeffery L. Klinger

Vice President, General Counsel

and Corporate Secretary

 

March 26, 2007

 

TABLE OF CONTENTS

 

PEABODY ENERGY CORPORATION
PROXY STATEMENT
FOR THE
2007 ANNUAL MEETING OF SHAREHOLDERS

 

QUESTIONS AND ANSWERS ABOUT THE ANNUAL MEETING AND VOTING

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

In accordance with the terms of the Company’s certificate of incorporation, the Board of Directors is divided into three classes, with each class serving a staggered three-year term. At this year’s Annual Meeting, the terms of current Class III Directors will expire. The terms of Class I Directors and Class II Directors will expire at the Annual Meetings to be held in 2008 and 2009, respectively.

 

The Board of Directors has nominated the following individuals for election as Class III Directors with terms expiring in 2010: William A. Coley, Irl F. Engelhardt, William C. Rusnack, John F. Turner and Alan H. Washkowitz. Each of the nominees currently is serving as a director of the Company. All nominees have consented to serve for the new term. Should any one or more of the nominees become unavailable for election, your proxy authorizes us to vote for such other persons, if any, as the Board of Directors may recommend.

 

The Board of Directors recommends that you vote “For” each of the Class III director nominees named below.

 

WILLIAM A. COLEY, age 63, has been a director of the Company since March 2004. Since March 2005, Mr. Coley has served as Chief Executive Officer and Director of British Energy Group plc, the U.K.’s largest electricity producer. He was previously a non-executive director of British Energy. Mr. Coley served as President of Duke Power, the U.S.-based global energy company, from 1997 until his retirement in February 2003. During his 37-year career at Duke Power, Mr. Coley held various officer level positions in the engineering, operations and senior management areas, including Vice President, Operations (1984-1986), Vice President, Central Division (1986-1988), Senior Vice President, Power Delivery (1988-1990), Senior Vice President, Customer Operations (1990-1991), Executive Vice President, Customer Group (1991-1994) and President, Associated Enterprises Group (1994-1997). Mr. Coley was elected to the board of Duke Power in 1990 and was named President following Duke Power’s acquisition of PanEnergy in 1997. Mr. Coley earned his B.S. in electrical engineering from Georgia Institute of Technology and is a registered professional engineer. He is also a director of CT Communications, Inc.

 

IRL F. ENGELHARDT, age 60, has been a director of the Company and has served as Chairman since 1998. Mr. Engelhardt served as Chief Executive Officer of the Company from 1998 to 2005 and as Chief Executive Officer of a predecessor of the Company from 1990 to 1998. He also served as Chairman of a predecessor of the Company from 1993 to 1998 and as President from 1990 to 1995. After joining a predecessor of the Company in 1979, he held various officer level positions in the executive, sales, business development and administrative areas, including Chairman of Peabody Resources Ltd. (Australia) and Chairman of Citizens Power LLC. Mr. Engelhardt also served as Co-Chief Executive Officer and executive director of The Energy Group from February 1997 to May 1998, Chairman of Cornerstone Construction & Materials, Inc. from September 1994 to May 1995 and Chairman of Suburban Propane Company from May 1995 to February 1996. He also served as a director and Group Vice President of Hanson Industries from 1995 to 1996. He also previously served as Chairman of the National Mining Association, the Coal Industry Advisory Board of the International Energy Agency, the Center for Energy and Economic Development and the Coal Utilization Research Council, as well as Co-Chairman of the Coal Based Generation Stakeholders Group. He serves on the Boards of Directors of Valero Energy Corporation and The Williams Companies, Inc., and is Chair of The Federal Reserve Bank of St. Louis.

 

WILLIAM C. RUSNACK, age 62, has been a director of the Company since January 2002. Mr. Rusnack is the former President and Chief Executive Officer of Premcor Inc., one of the largest independent oil refiners in the United States prior to its acquisition by Valero Energy Corporation in

2005. He served as President, Chief Executive Officer and Director of Premcor from 1998 to February 2002. Prior to joining Premcor, Mr. Rusnack was President of ARCO Products Company, the refining and marketing division of Atlantic Richfield Company. During a 31-year career at ARCO, he was also President of ARCO Transportation Company and Vice President of Corporate Planning. He is also a director of Sempra Energy and Flowserve Corporation.

 

JOHN F. TURNER, age 65, has been a director of the Company since July 2005, when his appointment was approved by the Board of Directors upon recommendation by the Nominating & Corporate Governance Committee. Mr. Turner served as Assistant Secretary of State for the Bureau of Oceans and International Environmental and Scientific Affairs from November 2001 to July 2005. Mr. Turner was previously President and Chief Executive Officer of The Conservation Fund, a national nonprofit organization dedicated to public-private partnerships to protect land and water resources. He was director of the U.S. Fish and Wildlife Service from 1989 and 1993. Mr. Turner also served in the Wyoming state legislature for 19 years and is a past president of the Wyoming State Senate. He serves as a consultant to The Conservation Fund. Mr. Turner also serves as a board member of the University of Wyoming, Ruckelshaus Institute of Environment and Natural Resources and as a Visiting Professor of Environment and Natural Resources at the University. He is also a director of International Paper Company and Ashland, Inc.

 

ALAN H. WASHKOWITZ, age 66, has been a director of the Company since 1998. Until July 2005, Mr. Washkowitz was a Managing Director of Lehman Brothers Inc., an investment-banking firm (“Lehman Brothers”) and part of the firm’s Merchant Banking Group, responsible for oversight of Lehman Brothers Merchant Banking Partners II L.P. He joined Kuhn Loeb & Co. in 1968 and became a general partner of Lehman Brothers in 1978 when it acquired Kuhn Loeb & Co. Prior to joining the Merchant Banking Group, he headed Lehman Brothers’ Financial Restructuring Group. Mr. Washkowitz serves on the Board of Visitors of the Faculty of Law for Columbia University, and on the Advisory Board for the Columbia University Center on Corporate Governance. He is also a director of L-3 Communications Corporation.

 

B. R. BROWN, age 74, has been a director of the Company since December 2003. Mr. Brown is the retired Chairman, President and Chief Executive Officer of CONSOL Energy, Inc., a domestic coal and gas producer and energy services provider. He served as Chairman, President and Chief Executive Officer of CONSOL and predecessor companies from 1978 to 1998. He also served as a Senior Vice President of E. I. du Pont de Nemours & Co., CONSOL’s controlling shareholder, from 1981 to 1991. Before joining CONSOL, Mr. Brown was a Senior Vice President at Conoco. From 1990 to 1995, he also was President and Chief Executive Officer of Remington Arms Company, Inc. Mr. Brown has previously served as Director and Chairman of the Bituminous Coal Operators Association Negotiating Committee, Chairman of the National Mining Association, and Chairman of the Coal Industry Advisory Board of the International Energy Agency. He is currently a director of Delta Trust & Bank and Remington Arms Company, Inc.

 

HENRY GIVENS, JR., PhD, age 74, has been a director of the Company since March 2004. Dr. Givens is President of Harris-Stowe State University in St. Louis, Missouri, a position he has held since 1979. Dr. Givens is actively involved with several civic and charitable boards and has received over one hundred national, state and local awards and recognitions. He earned his baccalaureate degree at Lincoln University in Missouri, his master’s degree at the University of Illinois and his PhD at St. Louis University. Dr. Givens is also a director of The Laclede Group Inc. and serves on the advisory board of U.S. Bank, N.A. (St. Louis).

 

JAMES R. SCHLESINGER, PhD, age 78, has been a director of the Company since 2001. Dr. Schlesinger is Chairman of the Board of Trustees of MITRE Corporation, a not-for-profit corporation that provides systems engineering, research and development and information technology support to the government, a position he has held since 1985. He also serves as senior advisor to Lehman Brothers and as Trustee for the Center for Strategic and International Studies. Dr. Schlesinger served as U.S. Secretary of Energy from 1977 to 1979. He also held senior executive positions for three U.S. Presidents, serving as Chairman of the U.S. Atomic Energy Commission from 1971 to 1973, Director of the Central Intelligence Agency in 1973 and Secretary of Defense from 1973 to 1975. He also serves as a consultant to the Department of Defense, the Department of State and the Department of Homeland Security. Other past positions include Assistant Director of the Office of Management and Budget, Director of Strategic Studies at the Rand Corporation, Associate Professor of Economics at the University of Virginia and consultant to the Federal Reserve Board of Governors. Dr. Schlesinger is also a director of Evergreen Energy Inc. and Sandia Corporation.

 

SANDRA VAN TREASE, age 46, has been a director of the Company since January 2003. Ms. Van Trease is Group President, BJC HealthCare, a position she has held since September 2004. BJC Healthcare is one of the largest nonprofit healthcare organizations, delivering services to residents in the greater St. Louis, southern Illinois and mid-Missouri regions. Prior to joining BJC Healthcare, Ms. Van Trease served as President and Chief Executive Officer of UNICARE, an operating affiliate of WellPoint Health Networks Inc., from 2002 to September 2004. Ms. Van Trease also served as President, Chief Financial Officer and Chief Operating Officer of RightCHOICE Managed Care, Inc. from 2000 to 2002, and as Executive Vice President, Chief Financial Officer and Chief Operating Officer from 1997 to 2000. Prior to joining RightCHOICE in 1994, she was a Senior Audit Manager with Price Waterhouse LLP. She is a Certified Public Accountant and Certified Management Accountant. Ms. Van Trease is also a director of Enterprise Financial Services Corporation.

 

GREGORY H. BOYCE, age 52, has been a director of the Company since March 2005. Mr. Boyce was named Chief Executive Officer Elect of the Company in March 2005, and assumed the position of Chief Executive Officer in January 2006. He also serves as President of the Company, a position he has held since October 2003. He was Chief Operating Officer of the Company from October 2003 to December 2005. He previously served as Chief Executive — Energy of Rio Tinto plc (an international natural resource company) from 2000 to 2003. Other prior positions include President and Chief Executive Officer of Kennecott Energy Company from 1994 to 1999 and President of Kennecott Minerals Company from 1993 to 1994. He has extensive engineering and operating experience with Kennecott and also served as Executive Assistant to the Vice Chairman of Standard Oil of Ohio from 1983 to 1984. Mr. Boyce is Co-Chairman of the Coal Based Generation Stakeholders Group, and a member of the Coal Industry Advisory Board of the International Energy Agency, the Advisory Council of the University of Arizona’s Department of Mining and Geological Engineering and the National Council of the School of Engineering and Applied Science at Washington University in St. Louis. He is a board member of the Center for Energy and Economic Development, the National Mining Association and the National Coal Council, and a past board member of the Western Regional Council, Mountain States Employers Council and Wyoming Business Council.

 

WILLIAM E. JAMES, age 61, has been a director of the Company since 2001. Since July 2000, Mr. James has been Founding Partner of RockPort Capital Partners LLC, a venture fund specializing in energy and environmental technology and advanced materials. He is also Chairman of RockPort Group, a holding company engaged in international oil trading, banking and communications. Prior to joining RockPort, Mr. James co-founded and served as Chairman and Chief Executive Officer of Citizens Power

LLC, a leading power marketer. He also co-founded the non-profit Citizens Energy Corporation and served as the Chairman and Chief Executive Officer of Citizens Corporation, its for-profit subsidiary, from 1987 to 1996. Mr. James periodically provides consulting services to Lehman Brothers on matters unrelated to the Company.

 

ROBERT B. KARN III, age 65, has been a director of the Company since January 2003. Mr. Karn is a financial consultant and former managing partner in financial and economic consulting with Arthur Andersen LLP in St. Louis. Before retiring from Arthur Andersen in 1998, Mr. Karn served in a variety of accounting, audit and financial roles over a 33-year career, including Managing Partner in charge of the global coal mining practice from 1981 through 1998. He is a Certified Public Accountant and has served as a Panel Arbitrator with the American Arbitration Association. Mr. Karn is also a director of Natural Resource Partners L.P., a coal-oriented master limited partnership that is listed on the New York Stock Exchange, the Fiduciary/Claymore MLP Opportunity Fund and the Fiduciary/Claymore Dynamic Equity Fund.

 

HENRY E. LENTZ, age 62, has been a director of the Company since 1998. Mr. Lentz is currently employed as an Advisory Director by Lehman Brothers. He joined Lehman Brothers in 1971 and became a Managing Director in 1976. He left the firm in 1988 to become Vice Chairman of Wasserstein Perella Group, Inc., an investment banking firm. In 1993, he returned to Lehman Brothers as a Managing Director and served as head of the firm’s worldwide energy practice. In 1996, he joined Lehman Brothers’ Merchant Banking Group as a Principal and in January 2003 became a consultant to the Merchant Banking Group. He assumed his current role with Lehman Brothers effective January 2004. Mr. Lentz is also a director of Rowan Companies, Inc. and CARBO Ceramics, Inc.

 

BLANCHE M. TOUHILL, PhD, age 75, has been a director of the Company since 2001. Dr. Touhill is Chancellor Emeritus and Professor Emeritus at the University of Missouri — St. Louis. She previously served as Chancellor and Professor of History and Education at the University of Missouri — St. Louis from 1991 through 2002. Prior to her appointment as Chancellor, Dr. Touhill held the positions of Vice Chancellor for Academic Affairs and Interim Chancellor at the University of Missouri — St. Louis. Dr. Touhill also has served on the Boards of Directors of Trans World Airlines and Delta Dental. She holds bachelor’s and doctoral degrees in history and a master’s degree in geography from St. Louis University.

 

As required by the rules of the New York Stock Exchange (“NYSE”), the Board of Directors evaluates the independence of its members at least annually, and at other appropriate times when a change in circumstances could potentially impact the independence or effectiveness of one or more directors (e.g., in connection with a change in employment status or other significant status changes). This process is administered by the Nominating & Corporate Governance Committee of the Board of Directors, which consists entirely of directors who are independent under applicable NYSE rules. After carefully considering all relevant relationships with the Company, the Nominating & Corporate Governance Committee submits its recommendations regarding independence to the full Board, which then makes an affirmative determination with respect to each director.

 

In making independence determinations, the Nominating & Corporate Governance Committee and the Board consider all relevant facts and circumstances, including (1) the nature of any relationships with the Company, (2) the significance of the relationship to the Company, the other organization and the individual director, (3) whether or not the relationship is solely a business relationship in the ordinary course of the Company’s and the other organization’s businesses and does not afford the director any

special benefits, and (4) any commercial, industrial, banking, consulting, legal, accounting, charitable and familial relationships. For purposes of this determination, the Board deems any relationships that have expired for more than three years to be immaterial.

 

After considering the standards for independence adopted by the NYSE and various other factors as described herein, the Board of Directors has determined that all directors other than Messrs. Boyce and Engelhardt are independent. None of the directors other than Messrs. Boyce and Engelhardt receives any compensation from the Company other than customary director and committee fees.

 

The Board has determined that Directors Brown, Coley, Karn, Turner and Van Trease are independent, based upon the fact that they have no relationships with the Company (other than serving as directors). The Board has also determined that Directors Givens, James, Lentz, Rusnack, Schlesinger, Touhill and Washkowitz are independent after evaluating their relationships with the Company and concluding that such relationships are immaterial. All such relationships are outlined below.

 

Mr. Rusnack and Drs. Givens and Touhill serve as trustees of the St. Louis Science Center, a non-profit organization that receives annual contributions of approximately $25,000 from the Company. Dr. Givens also serves as President of Harris-Stowe State University, which receives annual contributions of $25,000 from the Company. The Board has concluded that these relationships are not material, since the Company’s contributions represent less than 1% of each institution’s total annual charitable contributions. In addition to the foregoing, Dr. Givens serves on the regional advisory board of U.S. Bank, N.A. (St. Louis), which is a participating lender under the Company’s senior credit facility and provides various other commercial banking services to the Company. These banking services are offered to the Company on the same general terms and conditions as other large commercial customers. The Company’s directors did not solicit these commercial relationships and were not involved in any related discussions or deliberations.

 

Certain of the Company’s directors, Messrs. James, Lentz, Schlesinger and Washkowitz, have been employed by or served as consultants to Lehman Brothers Inc. within the past three years. The Board has determined that these employment and consulting relationships involve matters unrelated to the Company, and that these relationships are not material to the Company. Their specific relationships with Lehman Brothers are described in more detail in the biographies set forth on pages 6 through 8 of this Proxy Statement. When evaluating the materiality of these relationships to the Company, the Board considered the fact that Lehman Brothers Merchant Banking Partners II L.P. and other affiliates of Lehman Brothers (collectively, the “Merchant Banking Fund”) owned a significant percentage of the Company’s stock prior to completely selling its holdings in March 2004.¹ The Board also considered the fact that the Company has paid Lehman Brothers fees from time to time for investment banking and related services. These fees have not been significant to the Company or Lehman Brothers, and since March 2004 all such fees have been reviewed and approved in advance by the independent Audit Committee. Directors who are affiliated with Lehman Brothers do not participate in any decisions or discussions related to these services, and they do not receive any benefit from related fees. After careful consideration, the Board of Directors has determined that these relationships do not impair, or appear to impair, the directors’ independent judgment.

 

For 2006, the Company paid fees of $11.5 million to Lehman Brothers compared to $2.1 million in 2005 and $1.4 million in 2004. The fees were higher in 2006 than the two prior years because the Company utilized Lehman Brothers’ services, along with several other investment banks, in establishing

 

 

¹ Prior to May 2001, the Merchant Banking Fund owned in excess of 90% of the Company’s outstanding Common Stock. Over the ensuing three-year period, the Merchant Banking Fund sold all of its Company holdings through a series of registered public offerings, falling below a 50% controlling interest level in April 2002 and completing its exit in March 2004.

the Company’s $2.75 billion senior unsecured credit facility, and in offering its $900 million senior notes and $732 million convertible junior subordinated debentures. These services, as well as other ordinary course financial services, were provided to the Company on the same general terms and conditions as provided to other large commercial customers. The Company’s directors did not solicit these relationships and were not involved in any related discussions or deliberations.

 

The Board of Directors met thirteen times in 2006. During that period, each incumbent director attended 75% or more of the aggregate number of meetings of the Board and the committees on which he or she served, and average attendance was 93%. Mr. Engelhardt serves as chairman at all meetings of the Board of Directors, including portions of meetings where all directors are present. Pursuant to the Company’s Corporate Governance Guidelines, the non-management directors meet in executive session at least quarterly. In past years, the chair of each executive session was selected in advance by the Chair of the Nominating & Corporate Governance Committee and was rotated at each meeting so that (i) the same non-management director did not lead two consecutive sessions, and (ii) to the extent practical, each non-management director had an opportunity to serve as chair before repeating the rotational cycle. This year, to enhance consistency from meeting to meeting, the Board changed its policy so that the chair of each executive session rotates among the chairs of the Audit Committee, Compensation Committee and Nominating & Corporate Governance Committee. During 2006, the Company’s non-management directors met in executive session seven times.

 

The Board has appointed four standing committees from among its members to assist it in carrying out its obligations. These committees are the Audit Committee, Compensation Committee, Executive Committee and Nominating & Corporate Governance Committee. Each standing committee has adopted a formal charter that describes in more detail its purpose, organizational structure and responsibilities. A copy of each committee charter can be found on the Company’s website (www.peabodyenergy.com) by clicking on “Investors,” and then “Corporate Governance” and is available in print to any shareholder who requests it. Information on our website is not considered part of this Proxy Statement. A description of each committee and its current membership follows:

 

Compensation Committee

 

The members of the Compensation Committee are Robert B. Karn III (Chair), B. R. Brown and William E. James. The Board of Directors has affirmatively determined that, in its judgment, all members of the Compensation Committee are independent under rules established by the New York Stock Exchange.

 

The Compensation Committee met eight times during 2006. Some of the primary responsibilities of the Compensation Committee include the following:

 

 

 

Executive Committee

 

The members of the Executive Committee are Gregory H. Boyce (Chair), William A. Coley, Irl F. Engelhardt, Henry E. Lentz and William C. Rusnack. The Executive Committee met three times during 2006.

 

When the Board of Directors is not in session, the Executive Committee has all of the power and authority as delegated by the Board of Directors, except with respect to:

 

 

Nominating & Corporate Governance Committee

 

The members of the Nominating & Corporate Governance Committee are Blanche M. Touhill (Chair), Henry Givens, Jr., James R. Schlesinger, John F. Turner and Alan H. Washkowitz. The Board of Directors has affirmatively determined that, in its judgment, all members of the Nominating & Corporate Governance Committee are independent under New York Stock Exchange rules.

 

The Nominating & Corporate Governance Committee met seven times during 2006. Some of the primary responsibilities of the Nominating & Corporate Governance Committee include the following:

 

 

 

Audit Committee

 

The members of the Audit Committee are William C. Rusnack (Chair), Robert B. Karn III and Sandra Van Trease. The Board of Directors has affirmatively determined that, in its judgment, all members of the Audit Committee are independent under New York Stock Exchange and SEC rules. The Board of Directors also has determined that each of Messrs. Rusnack and Karn and Ms. Van Trease is an “audit committee financial expert” under SEC rules.

 

The Audit Committee met ten times during 2006. The Audit Committee’s primary purpose is to provide assistance to the Board of Directors in fulfilling its oversight responsibility with respect to:

 

 

Some of the primary responsibilities of the Audit Committee include the following:

 

 

The Audit Committee has reviewed and discussed the Company’s audited financial statements and management’s report on internal control over financial reporting as of and for the fiscal year ended December 31, 2006 with management and Ernst & Young LLP, the Company’s independent registered public accounting firm. Management is responsible for the Company’s internal control over financial reporting and the financial statements, while Ernst & Young is responsible for conducting its audit in accordance with generally accepted auditing standards including Standard No. 2, An Audit of Internal Control Over Financial Reporting Performed in Conjunction with an Audit of Financial Statements, and expressing opinions on the Company’s financial statements in accordance with U.S. generally accepted accounting principles and management’s report on internal control over financial reporting.

 

The Audit Committee reviewed with Ernst & Young the overall scope and plans for their audit of the Company’s financial statements and management’s report on internal control over financial reporting. The Audit Committee also discussed with Ernst & Young matters relating to the quality and acceptability of the Company’s accounting principles, as applied in its financial reporting processes, as required by Statement of Auditing Standards (SAS) No. 61, as amended by SAS No. 90. In addition, the Audit Committee reviewed and discussed with Ernst & Young the auditor’s independence from management and the Company, as well as the matters included in written disclosures received from Ernst & Young as required by Independence Standards Board Standard No. 1, Independence Discussions with Audit Committees. As part of its review, the Audit Committee reviewed fees paid to Ernst & Young and considered whether Ernst & Young’s performance of non-audit services for the Company was compatible with the auditor’s independence.

 

Based on the reviews and discussions referred to above, the Audit Committee recommended to the Board of Directors that the audited financial statements and management’s report on internal control over financial reporting be included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2006 for filing with the Securities and Exchange Commission.

 

MEMBERS OF THE AUDIT COMMITTEE:

 

WILLIAM C. RUSNACK, CHAIR
ROBERT B. KARN III
SANDRA VAN TREASE

 

Ernst & Young LLP served as the Company’s independent registered public accounting firm for the fiscal years ended December 31, 2006 and December 31, 2005.

 

The following fees were paid to Ernst & Young for services rendered during the Company’s last two fiscal years:

 

 

 

Under procedures established by the Board of Directors, the Audit Committee is required to pre-approve all audit and non-audit services performed by the Company’s independent registered public accounting firm to ensure that the provisions of such services do not impair such firm’s independence. The Audit Committee may delegate its pre-approval authority to one or more of its members, but not to management. The member or members to whom such authority is delegated shall report any pre-approval decisions to the Audit Committee at its next scheduled meeting.

 

Each fiscal year, the Audit Committee reviews with management and the independent registered public accounting firm the types of services that are likely to be required throughout the year. Those services are comprised of four categories, including audit services, audit-related services, tax services and all other permissible services. At that time, the Audit Committee pre-approves a list of specific services that may be provided within each of these categories, and sets fee limits for each specific service or project. Management is then authorized to engage the independent registered public accounting firm to perform the pre-approved services as needed throughout the year, subject to providing the Audit Committee with regular updates. The Audit Committee reviews the amount of all billings submitted by the independent registered public accounting firm on a regular basis to ensure that their services do not exceed pre-defined limits. The Audit Committee must review and approve in advance, on a case-by-case basis, all other projects, services and fees to be performed by or paid to the independent registered public accounting firm. The Audit Committee also must approve in advance any fees for pre-approved services that exceed the pre-established limits, as described above.

 

Under Company policy and/or applicable rules and regulations, the Company’s independent registered public accounting firm is prohibited from providing the following types of services to the Company: (1) bookkeeping or other services related to the Company’s accounting records or financial statements, (2) financial information systems design and implementation, (3) appraisal or valuation services, fairness opinions or contribution-in-kind reports, (4) actuarial services, (5) internal audit outsourcing services, (6) management functions, (7) human resources, (8) broker-dealer, investment advisor or investment banking services, (9) legal services, (10) expert services unrelated to audit, (11) any services entailing a contingent fee or commission, and (12) tax services to an officer of the Company whose role is in a financial oversight capacity.

 

During the fiscal year ended December 31, 2006, all of the services described under the headings “Audit-Related Fees,” “Tax Fees” and “All Other Fees” were approved by the Audit Committee pursuant to the procedures described above.

 

Good corporate governance has been a priority at Peabody Energy for many years. The Company’s key governance practices are outlined in its Corporate Governance Guidelines, committee charters, and Code of Business Conduct and Ethics. These documents can be found on the Company’s Corporate Governance webpage (www.peabodyenergy.com on the Internet) by clicking on “Investors” and then “Corporate Governance,” and are available in print to any shareholder upon request. Information on our website is not considered part of this Proxy Statement. The Code of Business Conduct and Ethics applies

to the Company’s directors, Chief Executive Officer, Chief Financial Officer, Controller and other Company personnel.

 

The Nominating & Corporate Governance Committee of the Board of Directors is responsible for reviewing the Corporate Governance Guidelines from time to time and reporting and making recommendations to the Board concerning corporate governance matters. Each year, the Nominating & Corporate Governance Committee, with the assistance of outside experts, reviews the Company’s corporate governance practices, not only to ensure that they comply with applicable laws and NYSE listing requirements, but also to ensure that they continue to reflect what the Committee believes are best practices and promote the best interests of the Company and its shareholders.

 

Recently, the Board of Directors carefully considered the Company’s director election process and reached a consensus view that the Company should move toward adoption of a majority voting standard applicable in uncontested elections. The Board intends to have such a standard in place for the 2008 Annual Meeting of Shareholders. The Nominating & Corporate Governance Committee of the Board is presently reviewing this matter at the direction of the Board and anticipates presenting a bylaw amendment for Board approval sufficiently in advance of the 2008 Annual Meeting.

 

To facilitate succession planning, the Board established a mandatory director retirement policy in 2006. Under the new policy, directors are not eligible for appointment or reelection after reaching age 75. Directors who turn 75 during their term will continue to serve the remainder of their term.

 

The Board also took the following actions relative to its governance practices in 2006, including:

 

 

The Board of Directors has adopted the following procedures for shareholders and other interested persons to send communications to the Board, individual directors and/or Committee Chairs (collectively, “Shareholder Communications”):

 

Shareholders and other interested persons seeking to communicate with the Board should submit their written comments to the Chairman, Peabody Energy Corporation, 701 Market Street, St. Louis, Missouri 63101. The Chairman will forward such Shareholder Communications to each Board member (excluding routine advertisements and business solicitations, as instructed by the Board), and provide a report on the disposition of matters stated in such communications at the next regular meeting of the Board of Directors. If a Shareholder Communication (excluding routine advertisements and business solicitations) is addressed to a specific individual director or Committee Chair, the Chairman will forward that communication to the named director, and will discuss with that director whether the full Board and/or one of its committees should address the subject matter.

 

If a Shareholder Communication raises concerns about the ethical conduct of management or the Company, it should be sent directly to the Company’s Chief Legal Officer at 701 Market Street, St. Louis, Missouri 63101. The Chief Legal Officer will promptly forward a copy of such Shareholder Communication to the Chairman of the Audit Committee and, if appropriate, the Chairman of the Board, and take such actions as they authorize to ensure that the subject matter is addressed by the appropriate Board committee, management and/or the full Board.

 

If a shareholder or other interested person seeks to communicate exclusively with the Company’s non-management directors, such Shareholder Communications should be sent directly to the Corporate Secretary who will forward any such communications directly to the Chair of the Nominating & Corporate Governance Committee. The Corporate Secretary will first consult with and receive the approval of the Chair of the Nominating & Corporate Governance Committee before disclosing or otherwise discussing the communication with members of management or directors who are members of management.

 

At the direction of the Board, the Company reserves the right to screen all materials sent to its directors for potential security risks and/or harassment purposes.

 

Shareholders also have an opportunity to communicate with the Board of Directors at the Company’s Annual Meeting of Shareholders. Pursuant to Board policy, each director is expected to attend the Annual Meeting in person, subject to occasional excused absences due to illness or unavoidable conflicts. Each of the Company’s directors attended the last Annual Meeting of Shareholders in May 2006.

 

The Board of Directors believes that one of its primary goals is to advise management on strategy and to monitor the Company’s performance. The Board also believes that the best way to accomplish this goal is by choosing directors who possess a diversity of experience, knowledge and skills that are particularly relevant and helpful to the Company. As such, current Board members possess a wide array of skills and experience in the coal industry, related energy industries and other important areas, including finance and accounting, operations, environmental management, education, governmental affairs and administration, and healthcare. When evaluating potential members, the Board seeks to enlist the services of candidates who possess high ethical standards and a combination of skills and experience which the Board determines are the most appropriate to meet its objectives. The Board believes all candidates should be committed to creating value over the long term and to serving the best interests of the Company and all of its shareholders.

 

The Nominating & Corporate Governance Committee (“Committee”) is responsible for identifying, evaluating and recommending qualified candidates for election to the Board of Directors. The Committee will consider director candidates submitted by shareholders. Any shareholder wishing to submit a candidate for consideration should send the following information to the Corporate Secretary, Peabody Energy Corporation, 701 Market Street, St. Louis, Missouri 63101:

 

 

The Corporate Secretary will promptly forward such materials to the Committee Chair and the Chairman of the Board. The Corporate Secretary also will maintain copies of such materials for future reference by the Committee when filling Board positions.

 

Shareholders may submit potential director candidates at any time pursuant to these procedures. The Committee will consider such candidates if a vacancy arises or if the Board decides to expand its membership, and at such other times as the Committee deems necessary or appropriate. Separate procedures apply if a shareholder wishes to nominate a director candidate at the 2008 Annual Meeting. Those procedures are described on page 52 of this Proxy Statement under the heading “Information About Shareholder Proposals.”

 

Pursuant to its charter, the Committee must review with the Board of Directors, at least annually, the requisite qualifications, independence, skills and characteristics of Board candidates, members and the Board as a whole. When assessing potential new directors, the Committee considers individuals from various and diverse backgrounds. While the selection of qualified directors is a complex and subjective process that requires consideration of many intangible factors, the Committee believes that candidates should generally meet the following criteria:

 

 

The Committee will consider candidates submitted by a variety of sources (including, without limit, incumbent directors, shareholders, Company management and third-party search firms) when filling vacancies and/or expanding the Board. If a vacancy arises or the Board decides to expand its membership, the Committee generally asks each director to submit a list of potential candidates for consideration. The Committee then evaluates each potential candidate’s educational background, employment history, outside commitments and other relevant factors to determine whether he/she is potentially qualified to serve on the Board. At that time, the Committee also will consider potential nominees submitted by shareholders in accordance with the procedures described above. The Committee seeks to identify and recruit the best available candidates, and it intends to evaluate qualified shareholder nominees on the same basis as those submitted by Board members or other sources.

 

After completing this process, the Committee will determine whether one or more candidates are sufficiently qualified to warrant further investigation. If the process yields one or more desirable candidates, the Committee will rank them by order of preference, depending on their respective qualifications and the Company’s needs. The Committee Chair, or another director designated by the Committee Chair, will then contact the preferred candidate(s) to evaluate their potential interest and to set up interviews with members of the Committee. All such interviews are held in person, and include only the candidate and the independent Committee members. Based upon interview results and appropriate

background checks, the Committee then decides whether it will recommend the candidate’s nomination to the full Board.

 

The Committee believes this process has consistently produced highly qualified, independent Board members to date. However, the Committee may choose, from time to time, to use additional resources (including independent third-party search firms) after determining that such resources could enhance a particular director search. The Committee has not used third-party firms for prior searches.

 

The following table sets forth information as of March 1, 2007 with respect to persons or entities who are known to beneficially own more than 5% of the Company’s outstanding Common Stock, each director, each executive officer named in the Summary Compensation Table below, and all directors and executive officers as a group.

 

 

 

 

The Company’s executive officers and directors and persons beneficially holding more than ten percent of the Company’s Common Stock are required under the Securities Exchange Act of 1934 to file reports of ownership and changes in ownership of Company Common Stock with the Securities and Exchange Commission and the New York Stock Exchange. The Company files these reports of ownership and changes in ownership on behalf of its executive officers and directors. To the best of the Company’s knowledge, based solely on its review of the copies of such reports furnished to the Company during the fiscal year ended December 31, 2006, filings with the Commission and written representations from certain reporting persons that no additional reports were required, all required reports were timely filed.

 

 

COMPENSATION DISCUSSION AND ANALYSIS

 

Overview of Compensation Philosophy and Program

 

The objective of the Company’s executive compensation program is to attract, retain and motivate key executives to enhance long-term profitability and create shareholder value. Compensation programs are designed to align incentives for executives with achievement of the Company’s business strategies:

 

 

The Company’s compensation program is based on the following policies and objectives:

 

 

 

 

 

With these policies and objectives in mind, the Compensation Committee has approved a compensation structure for the named executive officers that incorporates four key components: base salary, annual incentive payments, long-term incentive compensation consisting of stock options and performance units, and retirement and other benefits.

 

Role of the Compensation Committee

 

The Compensation Committee is comprised entirely of independent directors and has responsibility for review and approval of evaluation and compensation of the Company’s executives, excluding the Chief Executive Officer. The Committee has overall responsibility for monitoring the performance of the Company’s executives and evaluating and approving the Company’s executive compensation plans, policies and programs. The Committee also reviews and approves executive participation in any company-wide benefit plans. In addition, the Committee oversees the Company’s annual and long-term incentive plans and programs and periodically assesses the Company’s director compensation program.

 

The Board of Directors has established a Special Committee of the Board, comprised of the members of the Compensation Committee and the other independent members of the Board of Directors, which reviews and approves the Chief Executive Officer’s compensation, including base salary, annual incentive and long-term incentive compensation, deferred compensation, perquisites, equity compensation, employment agreements, severance arrangements, retirement and other post-employment benefits and change-in-control benefits (in each case, as and when appropriate). In determining the Chief Executive Officer’s compensation, the Special Committee reviews and approves corporate goals and objectives relevant to such compensation and evaluates the Chief Executive Officer’s performance in light of those goals and objectives. In determining the long-term incentive component of the Chief Executive Officer’s compensation, the Special Committee considers, among other things, the Company’s performance and relative shareholder return, the value of similar incentive awards to similarly situated chief executive officers at comparable companies, and awards previously made to the Chief Executive Officer.

 

Deductibility of Compensation Expenses

 

Pursuant to Section 162(m) under the Internal Revenue Code, certain compensation paid to executive officers in excess of $1 million is not tax deductible, except to the extent such excess constitutes performance-based compensation. Prior to May 2005, the limit on deductibility did not apply to plans in existence prior to the Company’s initial public offering in 2001. The Committee has and will continue to carefully consider the impact of Section 162(m) when establishing incentive compensation

plans that apply to periods after May 2005. As a result, a significant portion of the Company’s executive compensation satisfies the requirements for deductibility under Section 162(m). At the same time, the Committee considers its primary goal to design compensation strategies that further the best interests of the Company and its shareholders. In certain cases, the Compensation Committee may determine that the amount of tax deductions lost is insignificant when compared to the potential opportunity a compensation program provides for creating shareholder value. The Compensation Committee therefore retains the ability to evaluate the performance of the Company’s executive officers and to pay appropriate compensation, even if it may result in the non-deductibility of certain compensation.

 

Role of the Compensation Consultant

 

The Compensation group in Peabody’s Human Resources Department supports the Compensation Committee in its work. In addition, the Committee has the authority under its charter to engage the services of outside advisors, experts and others to assist the Committee. In accordance with this authority, the Committee engaged Towers Perrin for guidance on executive compensation issues in 2005 and early 2006. In 2006, in connection with an annual review of the Company’s compensation practices, the Committee issued a “request for proposal” to several outside compensation advisors, and after a thorough review, the Committee changed its outside compensation advisor to Mercer Human Resource Consulting for all matters related to Chief Executive Officer and other executive compensation.

 

Review of External Data

 

Each year, the Compensation Committee commissions a compensation analysis conducted by its outside compensation consultant to determine whether the Company’s executive compensation programs are consistent with those of other publicly held companies of similar size and in a similar industry. For positions that require specific industry knowledge and experience, the Company uses a mining comparator group for benchmarking purposes. This helps to ensure the Company’s executive compensation levels are competitive relative to the companies with which the Company competes for industry-specific talent. The mining comparator group is composed of CONSOL Energy, Inc., Arch Coal, Inc., Massey Energy Company, Alpha Natural Resources, Inc., Foundation Coal Holdings, Inc., International Coal Group, Inc., James River Coal Company, and Westmoreland Coal Company. Talent for other key roles in the organization can be acquired across a broader spectrum of companies. As such, the Company utilizes both the above-mentioned mining comparator group and a group of publicly held companies of similar size and complexity to assess competitiveness. This group of companies is composed of Phelps Dodge Corporation, Air Products & Chemicals, Inc., Rohm and Haas Company, Praxair, Inc., ITT Corporation, Anadarko Petroleum Corporation, Eastman Chemical Company, Monsanto Company, Smith International, Inc., Goodrich Corporation, Timken Company, Rockwell Automation, National Oilwell Varco, Inc., Ecolab, Inc., Newmont Mining Corporation, SPX Corporation, Freeport-McMoRan Copper & Gold, Inc., Southern Copper Corporation, Lubrizol Corporation, Teck Cominco Ltd., and Barrick Gold Corporation. In addition the Company reviews international companies such as Anglo American, plc, Rio Tinto, plc, and BHP Billiton Limited when relevant compensation data is available.

 

Overall, the outside consultants confirmed that the Company’s executive compensation programs, as structured, are competitive. Based upon the review of the compensation plans discussed below, peer group compensation levels and assessments of individual and corporate performance, the Compensation Committee assisted by the outside consultants determined that the value and design of the Company’s executive compensation programs are appropriate.

 

2006 Executive Compensation Components

 

For the year ended December 31, 2006, the principal components of compensation for the named executive officers were:

 

 

Annual Base Salary

 

In general, base salary for each employee, including the named executive officers, is established based on the individual’s job responsibilities, performance and experience; the Company’s overall budget for merit increases; and the competitive environment. In 2006, Peabody provided a base pay increase to its employees, but in accordance with the Company’s philosophy of providing a strong link between pay and performance, the exact amount of the increase (if any) varied among employees based on their performance levels.

 

For the Company’s executive officers, the Compensation Committee reviewed the base salaries of the Chief Executive Officer and his direct reports to ensure competitiveness in the marketplace. Consistent with Peabody’s philosophy, adjustments (and in the case of the Chief Executive Officer, approved by the Special Committee of the Board of Directors) were made based on market information and individual performance. The Compensation Committee will continue to review the base salaries of the named executive officers to ensure they take into account performance, experience and retention value and that salary levels continue to be competitive with companies of similar size and complexity.

 

Annual Incentive Compensation

 

The Company’s annual incentive compensation plan provides opportunities for key executives to earn annual cash incentive payments tied to the successful achievement of pre-established objectives that support the business strategy.

 

Named executive officers are assigned threshold, target and maximum incentive levels. If performance does not meet the threshold level, no incentive is earned. At threshold levels, the incentive that can be earned generally equals 50% of the target incentive. Under the plan, the target incentive is established through an analysis of compensation for comparable positions in industries of similar size and complexity and is intended to provide a competitive level of compensation when participants, including the named executive officers, achieve their performance objectives.

 

Target incentive payouts generally are received for achieving budgeted financial and safety goals, and meeting individual performance goals. The Company’s philosophy is to set stretch goals at budget. Maximum incentive payments generally are received when financial goals and individual performance goals are significantly exceeded. A participant’s annual incentive opportunity is based upon his or her level of participation in the plan.

 

Awards for the named executive officers are based on achievement of corporate and individual performance goals. Achievement of corporate goals is determined by comparing the Company’s actual performance against objective goals, and achievement of individual goals is determined by evaluating a combination of both objective and subjective performance measures. All goals are established by the Company, and goals for the named executive officers, excluding the Chief Executive Officer, are reviewed and approved by the Compensation Committee for each calendar year. The Special Committee

of the Board of Directors reviews and approves goals for the Chief Executive Officer for each calendar year.

 

The Compensation Committee reviews and approves annual incentive payouts to the named executive officers, excluding the Chief Executive Officer. The Special Committee of the Board of Directors reviews and approves annual incentive payouts to the Chief Executive Officer.

 

2006 Annual Incentive Payouts

 

For 2006, the performance measures for the named executive officers included goals for Adjusted EBITDA, Return on Invested Capital, Safety and Individual Performance. In 2006, the Company exceeded its targeted goals for both Adjusted EBITDA and Return on Invested Capital. However, the safety target, set at a 15% improvement over 2005’s actual record results, was not achieved. Safety performance, however, for 2006 was the Company’s second best year of performance in its history.

 

In 2006, the Chief Executive Officer, the Chief Financial Officer and the other named executive officers earned annual incentive payouts, as reflected in the ““Non-Equity Incentive Plan Compensation” column of the Summary Compensation Table on page 32 of this Proxy Statement. Other eligible executives received payouts under the same annual incentive plan. Annual incentive payouts for 2006 were based on the Company’s achievement of goals for Adjusted EBITDA, Return on Invested Capital, Safety and Individual Performance. In determining final incentive awards, the Chief Executive Officer has discretion for his direct reports up to the maximum allowable award, provided such award is approved by the Compensation Committee; and the Special Committee of the Board has discretion for the Chief Executive Officer and Chairman up to the maximum allowable award.

 

The following table shows the target annual incentive payout and the applicable payout range (each shown as a percentage of base salary) for each of the named executive officers and the actual annual incentive award received for 2006. The payout range for each executive is based on his or her position with the Company.

 

2006 Annual Incentives

 

 

Long-Term Incentive Compensation

 

The Company’s long-term incentive compensation plan provides opportunities for key executives to earn payments if certain pre-established long-term (greater than one year) objectives are successfully achieved.

 

The Compensation Committee approved a long-term incentive opportunity for each of the named executive officers through annual awards of stock options and performance units. The targeted value of these awards generally is split evenly between stock options and performance units. The Compensation Committee intends that these long-term incentive opportunities be competitive and based on actual Company performance. When evaluating awards to be granted, the Compensation Committee and the

Special Committee of the Board of Directors consider competitive market data and the retention value of the individual executives.

 

Stock Options

 

The Company’s stock option program is a long-term plan designed to create a direct link between executive compensation and increased shareholder value, provide an opportunity for increased equity ownership by executives, and maintain competitive levels of total compensation.

 

The Compensation Committee and Special Committee of the Board of Directors meet in December of each year to evaluate, review and approve the annual stock option award design and level of award for each named executive officer and the Chief Executive Officer. The process for stock option awards is to approve grants prospectively. For example, the annual stock option awards are approved in December for granting on the first business day in January at the Company’s closing market price per share. At times, the Compensation Committee and/or Special Committee of the Board of Directors may approve stock option awards other than the first business day of the year, because of promotions or new hires. In these cases the Compensation Committee approves the award in advance of the grant date, and the stock option grant is awarded on the determined date at the Company’s closing market price per share. The Company uses a Black-Scholes valuation model to establish the expected value of all stock option grants.

 

All stock options are granted at an exercise price equal to the closing market price of the Company’s Common Stock on the date of grant. Accordingly, those stock options will have intrinsic value to employees only if the market price of the Common Stock increases after that date. Stock options generally vest in one-third increments over a period of three years or cliff vest after three years; however, options will immediately vest upon a change of control of the Company or a recapitalization event or upon the holder’s death or disability. If the holder terminates employment without good reason (as defined in his or her employment agreement), all unvested stock options are forfeited. Stock options expire ten years from the date of grant.

 

Performance Units

 

Similar to the stock option program, the Company’s performance unit program is a long-term plan designed to create a direct link between executive compensation and increased shareholder value, and maintain competitive levels of total compensation. Certain key executives are eligible to receive long-term incentive awards in the form of performance units.

 

Performance units granted in 2006 will be payable, if earned, in shares of the Company’s Common Stock. The value of the performance units is tied to the relative performance of the Company’s Common Stock and a three-year Adjusted EBITDA Return on Invested Capital measure. The percentage of the performance units earned is based on the Company’s total shareholder return (“TSR”) over a period beginning January 3, 2006 and ending December 31, 2008 relative to an industry comparator group (the Industry Peer Group) and the S&P MidCap 400 Index (together weighted as 50% of the total award) and Adjusted EBITDA Return on Invested Capital (weighted as 50% of the total award). TSR measures cumulative stock price appreciation plus dividends. The Industry Peer Group is generally perceived to be subject to similar market conditions and investor reactions as the Company. At the time of the 2006 award, the Company was included in the S&P MidCap 400 Index. The Industry Peer Group is weighted at 30% of the total award, while the S&P MidCap 400 Index is weighted at 20% of the total reward.

 

Performance unit payout formulas are as follows:

 

 

 

Performance units are issued at a price that equals the average closing market price per share of the Company’s Common Stock during the four weeks of trading immediately following the date of grant.

 

The Company’s TSR over the performance period is based on the average closing price during the first four weeks and the last four weeks of trading in the performance cycle. Units vest over, and are payable subject to the achievement of performance goals at the conclusion of, the measurement period. Upon a change of control of the Company, a recapitalization event or the holder’s retirement or termination without cause, the holder would receive from the Company payment in proportion to the number of vested performance units based upon performance as of the date the event occurs. Upon the holder’s death or disability, the holder would receive from the Company payment for 100% of performance units outstanding as of the date the event occurs. If the holder terminates employment without good reason (as defined in his or her employment agreement), all performance units are forfeited.

 

Retirement Benefits

 

Defined Contribution Plan

 

The Company maintains a defined contribution retirement plan and other health and welfare benefit plans for its employees. Named executive officers participate in these plans on the same terms as other eligible employees, subject to any legal limits on the amount that may be contributed by or paid to executives under the plans.

 

Pension Plan

 

The Company’s Salaried Employees Retirement Plan, or pension plan, is a “defined benefit” plan. The pension plan provides a monthly annuity to eligible salaried employees when they retire. An employee must have at least five years of service to be vested in the pension plan. A full benefit is available to a retiree at age 62. A retiree can begin receiving a benefit as early as age 55; however, a 4% reduction factor applies for each year a retiree receives a benefit prior to age 62.

 

The Company announced in February 1999 that the pension plan would be phased out beginning January 1, 2001. Certain transition benefits were introduced based on the age and service of the employee

at December 31, 2000: (1) employees age 50 or older continue to accrue service at 100%; (2) employees between the ages of 45 and 49 or under age 45 with 20 years or more of service continue to accrue service at the rate of 50% for each year of service worked after December 31, 2000; and (3) employees under age 45 with less than 20 years of service have had their pension benefits frozen. In all cases, final average earnings for retirement purposes are capped at December 31, 2000 levels.

 

Excess Defined Benefit and Excess Defined Contribution Retirement Plan

 

The Company maintains one excess defined benefit retirement plan and one excess defined contribution plan that provide retirement benefits to executives whose pay exceeds legislative limits for qualified benefit plans, which include the named executive officers.

 

Other Benefits Provided by the Company

 

The following benefits are provided by the Company to the named executive officers and all other employees.

 

Medical Benefits.  Employees have a choice of three coverage options. Each option covers the same services and supplies, but differs in the amount of its deductibles, co-payments and out-of-pocket limits. Employees located in St. Louis can also elect coverage through an HMO. Employees pay on average 20% of the monthly cost.

 

Dental Benefits.  The plan covers preventive, basic and major services for employees and their dependents. Orthodontia care is also provided for eligible dependents. Preventive care is covered at 100%. Basic services are covered at 80% and major and orthodontia services at 60% after the applicable deductibles are met. The plan has an annual maximum of $1,000 for preventive, basic and major care and a lifetime maximum of $1,000 for orthodontia. Employees pay on average 20% of the monthly cost.

 

Vision Benefits.  Employees can elect optional vision coverage, and pay the entire cost. If this coverage is elected, benefits are provided for eye examinations once every 12 months. Vision care benefits also include coverage for eyeglass lenses and frames, or contact lenses, once every 24 months.

 

Employee Retirement Account.  Employees can elect to put 1% to 60% of salary into the plan, up to limits determined by the IRS using before-tax money, after-tax money, or both. The company matches 100% of contributions up to 6% of base salary. Employees may also be eligible for an additional annual performance contribution equal to as much as 6% of base salary, based on the Company’s performance for the fiscal year. Amounts that exceed the IRS limits are placed in a supplemental plan, if the executive makes such an election.

 

Employee Stock Purchase Plan (ESPP).  Through the ESPP, employees have the opportunity to purchase Peabody Energy stock at a discount. Employees can choose to participate in the plan at any rate between 1% and 15% of base salary for the offering period and can purchase up to $25,000 of shares at fair market value in a calendar year. At the end of the offering period, contributions are used to buy shares of Peabody Energy stock at a discounted price. The price for the shares is 85% of the closing market price on the first or last day of the offering period, whichever is lower.

 

Life Insurance.  Employees receive a basic benefit equal to one times annual base salary. In addition, employees may choose additional coverage, from one to four times annual base salary, through the supplemental life insurance program. Coverage is also available for a spouse in the amount of $10,000 or $20,000 and/or eligible children in the amounts of $5,000 or $10,000 per child.

 

Business Travel Accident.  For accidental death, paralysis, or loss of hands, feet, hearing or sight due to an accident while traveling for the Company, the plan pays all or part of a “principal sum”

depending on the loss. This principal sum is equal to five times base annual salary, with a $500,000 maximum and $150,000 minimum.

 

Accidental Death and Dismemberment (AD&D).  The company provides a benefit equal to three times annual base salary. All or a portion of the coverage amount is paid for the loss of hands, feet, sight, speech, hearing or paralysis. In addition, through the optional AD&D program, employees may choose supplemental coverage in any amount from $10,000 to $500,000, in multiples of $10,000. Employees may also choose optional AD&D coverage for their family. Coverage for their spouse and eligible dependent children will be based on a percentage of their own optional coverage amount.

 

Short-Term Disability.  If an employee becomes disabled, the Company provides a short-term disability benefit for up to 180 days. For employees with less than five years service, the plan pays 100% of monthly basic salary for the first 30 days of disability and 60% for 150 additional days of disability. For employees with five or more years of service, the plan pays 100% of basic monthly salary for up to 180 days of disability.

 

Long-Term Disability (LTD).  If an employee is disabled for longer than 180 days, the LTD plan begins to pay a monthly benefit equal to 60% of basic monthly salary.

 

Health Care Flexible Spending Account.  Employees can deposit before-tax money from $120 to $5,000 per year into an account through payroll deductions to pay for a wide range of health care expenses not covered by the medical, dental, vision plan, including some over-the-counter drugs, deductibles and co-payments.

 

Dependent Care Flexible Spending Account.  Employees can deposit before-tax money from $120 to $5,000 per year into an account through payroll deductions to pay for day care for a child or dependent disabled adult.

 

Vacation.  All employees are eligible for vacation based on years of service. Each executive, including the named executive officers, is eligible for 20 days of vacation each year.

 

Holidays.  The company provides 12 paid holidays each year.

 

Perquisites

 

The Company provided certain perquisites to senior management in 2006.

 

Company Aircraft.  The Company’s aircraft may be used in the following situations:

 

 

Other Perquisites.  The Company does not provide or reimburse for country club memberships for any officers, nor provides vehicles. Upgrades to existing home security systems that were substandard were made available to members of senior management.

 

Stock Ownership Guidelines

 

Both Management and the Board of Directors believe the Company’s executives and directors should acquire and retain a significant amount of Company Common Stock in order to further align their interests with those of shareholders.

 

Under the Company’s share ownership guidelines, the Chief Executive Officer is encouraged to acquire and retain Company Common Stock having a value equal to at least five times his or her base salary. Other named executive officers are encouraged to acquire and retain Company Common Stock having a value equal to at least three times their base salary. All such executives are encouraged to meet these ownership levels within five years after assuming their executive positions.

 

The following table summarizes the named executive officers’ ownership of Company Common Stock as of December 31, 2006.

 

Named Executive Officer Stock Ownership

 

 

 

Also under the Company’s share ownership guidelines for directors, directors are encouraged to acquire and retain Company Common Stock having a value equal to at least three times their annual retainer. Directors are encouraged to meet these ownership levels by the later of December 31, 2007 or three years after joining the Board.

 

The following table summarizes the Director ownership of Company Common Stock as of December 31, 2006.

 

Director Stock Ownership

 

 

 

Employment Agreements

 

To remain competitive in the market, and to attract and retain executives key to the success of its business, the Company has entered into employment agreements with each of the named executive officers and with certain other key executives.

 

The Chief Executive Officer’s employment agreement provides for a three-year term that extends day-to-day so that there is at all times remaining a term of three years. Following a termination without cause or resignation for good reason, the Chief Executive Officer would be entitled to the following benefits, payable in either (a) equal installments over three years or (b) a lump sum, as determined by the Board of Directors: (1) three times base salary and (2) three times the higher of (A) the target annual incentive or (B) the average of the actual annual incentive paid in the three prior years. In addition, he would be entitled to a one-time prorated annual incentive for the year of termination (based on the Company’s actual performance multiplied by a fraction, the numerator of which is the number of business days he was employed during the year of termination, and the denominator of which is the total number of business days during that year), payable when annual incentives, if any, are paid to other executives. He would also be entitled to receive qualified and nonqualified retirement, life insurance, medical and other benefits for three years. In addition, following a termination without cause or resignation for good reason (as defined in the employment agreement), he would be paid a lump sum of $800,000. If the Chief Executive Officer were to terminate for any reason on or after age 55 or die

or became disabled, the lump sum of $800,000 would also be paid. Upon termination without cause, resignation for good reason, death, disability, or termination for any reason after reaching age 55, he would be entitled to deferred compensation payable in cash in one of the following amounts: if termination occurred (a) prior to age 55, the greater of (i) the cash equivalent of the fair market value of 80,000 shares of Company Common Stock on October 1, 2003 plus interest or (ii) an amount equal to the fair market value of 80,000 shares on the date of termination; (b) on or after age 55 but prior to age 62, the greater of (i) the amount referenced in (a) on the date of termination, (ii) $1.6 million, reduced by 0.333% for each month that termination occurs before reaching age 62, or (iii) the fair market value of 80,000 shares on the date of termination; (c) on or after age 62, the greater of the amount referenced in (b) on the date of termination or $1.6 million. If he were to terminate for any other reason prior to reaching age 55, the deferred compensation amount would be forfeited.

 

Other named executive officers’ employment agreements have two-year terms which extend day-to-day so that there is at all times a remaining term of two years. The other key executives are entitled to the following benefits, payable in either (a) equal installments over two years or (b) a lump sum, as determined by the Chief Executive Officer and Board of Directors: (1) two times base salary and (2) two times the higher of (A) the target annual incentive or (B) the average of the actual annual incentive paid in the three prior years. In addition, the other executives are entitled to (1) a one-time prorated annual incentive for the year of termination (based on the Company’s actual performance multiplied by a fraction, the numerator of which is the number of business days the executive officer was employed during the year of termination, and the denominator of which is the total number of business days during that year), payable when annual incentives, if any, are paid to the Company’s other executives, and (2) qualified and nonqualified pension, life insurance, medical and other benefits for the two-year period following termination.

 

Under all executives’ employment agreements, the Company is not obligated to provide any benefits under tax qualified plans that are not permitted by the terms of each plan or by applicable law or that could jeopardize the plan’s tax status. Continuing benefit coverage will terminate to the extent an executive is offered or obtains comparable coverage from any other employer. The employment agreements provide for confidentiality during and following employment, and include a noncompetition and nonsolicitation agreement that is effective during and for one year following employment. If an executive breaches any of his or her confidentiality, noncompetition or nonsolicitation agreements, the executive will forfeit any unpaid amounts or benefits. To the extent that excise taxes are incurred by an executive as a result of “excess parachute payments,” as defined by IRS regulations, the Company will pay additional amounts so that executives would be in the same financial position as if the excise taxes were not incurred.

 

The Compensation Committee has reviewed and discussed with management the Company’s disclosures under “Compensation Discussion and Analysis” beginning on page 19 of this Proxy Statement.

 

Based on such review and discussion, the Compensation Committee recommended to the Board of Directors that the Compensation Discussion and Analysis be included in this Proxy Statement and incorporated by reference in the Company’s annual report on Form 10-K for the fiscal year ended December 31, 2006 for filing with the Securities and Exchange Commission.

 

MEMBERS OF THE COMPENSATION COMMITTEE:

 

ROBERT B. KARN III, CHAIR
B. R. BROWN
WILLIAM E. JAMES

 

The following table summarizes the total compensation paid to the Chief Executive Officer, the Chief Financial Officer and the three other most highly compensated executive officers for their service to the Company during the fiscal year ended December 31, 2006.

 

 

 

 

All Other Compensation

 

The following table sets forth detail of the amounts reported in the “All Other Compensation” column of the Summary Compensation Table.

 

 

 

The following table sets forth information concerning the grant of plan-based awards to each of the named executive officers during the year ended December 31, 2006. Each named executive officer received performance units and stock option awards at the beginning of the year.

 

 

 

 

Employment agreements with the named executive officers are described under the caption “Employment Agreements” in the Compensation Discussion and Analysis on page 29 of this Proxy Statement.

 

The following table sets forth detail about the outstanding equity awards for each of the named executive officers as of December 31, 2006. The Company cautions that the amount ultimately realized by the named executive officers from the outstanding equity awards will likely vary based on a number of factors, including the Company’s actual operating performance, stock price fluctuations and the timing of exercises and sales. In the case of equity incentive awards, the amount ultimately realized will also likely vary with the Company’s stock performance relative to an Industry Peer Group and the S&P MidCap 400 Index, and the Company’s Adjusted EBITDA Return on Invested Capital.

 

A substantial portion of the outstanding equity awards for the named executive officers, other than Mr. Boyce, is attributable to stock options granted to them prior to the Company’s May 2001 initial public offering (“IPO”). These options were granted in 1998 in connection with a leveraged buyout transaction or “LBO” involving Peabody Energy’s acquisition of Peabody Holding Company. The size and terms of the pre-IPO stock options or “LBO grants” were determined according to standard practices at that time for private companies. The LBO grants, many of which remain unexercised, were designed to be competitive in the industry marketplace for top executives, to compensate the management group on a basis commensurate with the risks associated with a highly leveraged transaction, to reward performance and to align their interests with the Company’s owners. The LBO grants vest in November 2007 and July 2010, and expire in May 2008 and January 2011, respectively.

 

All unexercisable options and unvested shares or units of stock reflected in the table below are subject to forfeiture by the holder if the holder terminates employment without good reason (as defined in the holder’s employment agreement).