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Executives

Ted Pile – Director, Corporate Communications

Michael Quillen – Chairman and CEO

Kevin Crutchfield – President

Analysts

Jim Rollyson – Raymond James

Luther Lu – Friedman Billings Ramsey

Michael Dudas – Bear Stearns

Shneur Gershuni – UBS

Brian Gamble – Simmons & Company

Mark Caruso – Millennium Management

Jeremy Sussman – Natixis Bleichroeder

Alpha Natural Resources Inc. (ANR) Q3 2008 Earnings Call Transcript October 29, 2008 11:00 AM ET

Operator

Good morning. My name is Monica and I will be your conference operator today. At this time I would like to welcome everyone to the Alpha Natural Resources third quarter 2008 results conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks there will be a question-and-answer session. (Operator instructions)

Mr. Pile, you may begin your conference.

Ted Pile

Thank you, Monica, and thanks to everyone out there for joining us this morning for Alpha Natural Resources third quarter 2008 earnings call. Our Chairman and CEO, Mike Quillen, and our President, Kevin Crutchfield, will make some prepared remarks this morning, then we'll open it up to your questions.

During this call and webcast Alpha management will make some forward-looking statements. Actual results may differ materially from these statements and these statements should be considered in the context of the risk factors contained in the press release we issued this morning and which is posted on our Web site and in our Form 10-K and other SEC filings which you can also access through the Investor Relations section of Alpha's Web site.

As a reminder, a replay of the call will be available several ways, either by telephone, the number and access code also appearing in this morning's earnings release, by logging on to our Web site at www.alphanr.com and also as a podcast available in the IR section of our Web site as well.

I'll turn it over to Mike now.

Michael Quillen

Thank you, Ted, and good morning. As always, I'll start off with few comments about safety performance. In our press release we highlighted the continuation of positive results on our two main safety metrics, reported incidence and lost time injuries, both of which are better than last year and better than the benchmark for similar mining operations. People aren't statistics though and every lost time energy affects people and their family members. For that reason we're always working on continuous improvement in our safety training, behavioral awareness programs or technologies in our everyday practices and we're seeing results. But we haven't gotten to zero, so in a sense we still have work to do.

Another issue involving our people has been mentioned quite a bit during this reporting season and that's the issue of availability of miners. It's clear that there is not enough experienced miners to go around and certainly, not enough to support some of the industry's announced expansion plans. Consistency and productivity have been impacted across the industry and this will continue for the foreseeable future.

We were pleased to see our turnover rate drop after we introduced our employee appreciation and retention program back in May, but now it's returned to where it was, almost 12% on an annualized basis. What are we doing about it? First, we're aggressively seeking employees, hiring them and overstaffing operations in some cases. We've ramped up our Red Hat program for inexperienced miners with a 10% growth target. We're recruiting heavily in vo-tech and engineering schools and other venues.

We're getting a lot of resumes through job fairs, colleges and state employment centers and we're reviewing our wage scales and benefits and are evaluating where we need to make adjustments.

In other words, we're working hard in attacking this critical issue on multiple fronts. But unfortunately, it's an issue that took nearly a generation to create and consequently one that we and other coal producers will have to deal with for many years to come. The topic of human capital is one of the most important things we're dealing with today.

I'll turn it over to Kevin now.

Kevin Crutchfield

Thanks, Mike. I'm not going to go into detail on the financials for the quarter, which are covered in the news release we issued this morning, other than to say it was one of our best reporting periods financially with coal revenues, net income and operating cash flows all very close to the record levels we achieved in the second quarter. Per ton pricing reached a new high and per ton margins more than doubled year-over-year.

Instead of running back through the numbers, I'd like to spend some time on the cost picture and the sales and market outlook. On the cost side we've experienced some pretty dramatic increases year-over-year in our produced and processed contractor and purchase segments. While about 10% to 12% of our costs derived from non-controllable sales related items like royalties and severance taxes which vary along with coal prices, we've also seen a significant run-up in supply and material input costs.

Since about the time of our last call this trend appears to be abating. Diesel fuel costs have dropped more than $1 a gallon since the second quarter and diesel is now where it was a year ago, which is a big part of why we took significant mark-to-market charge this quarter for our underwater hedges.

Steel surcharges have accounted for more than $1 of the cost inflation in our underground mines year-over-year and these surcharges are now dropping quickly, meaning roof control costs should start to decline again. The explosive component costs have also been dropping and are now about 40% below summer time levels. And we're engaging with our strategic suppliers to get our costs down further as their raw material costs decline.

The other thing we have done with those suppliers and customers is a comprehensive credit risk analysis. Given the current instability and illiquidity in the global credit markets it's the prudent thing to do. After completing this analysis we feel the risk with other counterparties falls within acceptable risk tolerances. That said we will have to maintain a strict watch on this area as the environment around us continues to develop.

I must say through the end of September, Alpha was in excellent shape on our receivables, averaging under 30 days outstanding for the third quarter which is actually the best level we've had this year and well under what we averaged in 2007. The other thing heavily impacting cost is productivity. Mike alluded to some of the pressures we're feeling, the dearth of skilled labor and the greater number of inspections.

Incident inspections alone were up 40% just in the past year. Also we're tackling tougher geology to get to our premium marketable coals, usually with a loss of yield, and that crimps the output of clean tons as we saw in the third quarter. These trends aren't expected to abate any time soon for us or anyone else mining coal in Central App for that matter.

Now taking a look at the markets, international demand for metallurgical coals remained strong through the third quarter with September year-to-date shipments running 24% higher than year-ago levels. Alpha's average price for seaborne met coal in the quarter just ended totaled $143 a ton and was our highest on record and more than double the price we achieved in last year's third quarter.

The robust nature of seaborne markets helped us to more than double our margins year-over-year and more than absorb the cost increases that I've just outlined. But recent events in the global financial arena have injected a lot of uncertainty into the markets that didn't exist a mere three months ago. Perhaps the most concerning development has been the recent wave of announced steel production cuts everywhere from Russia, Latin America to the Middle East, North America and Asia.

Globally announced cuts for the fourth quarter are estimated to be in the range of 25 million tons of crude steel which represents about a 20% reduction. The impact on US met coal producers should not be as dramatic. In our estimation that could equate to about 2 million tons of reduced met coal demand out of the U.S. for the fourth quarter.

The main thing is coke batteries cannot just shut down. Normally they operate on a continuous basis, so the current climate would have to remain highly unstable for a protracted period before we would expect to observe substantial demand destruction in hard coking coal.

What we will see, we believe, is the throughput rate of coke batteries begin to slow down with some of the lesser qualities of coking coal being the most susceptible to pressure in both pricing as well as demand. The best low and high volt coal should not see the price erosion that will be felt by lesser quality coals.

Here in the U.S. steel mills are indicating to us that they intend to reduce their reliance on outside coke purchases and continue to run their own batteries, meaning, they will still need high quality domestically available met coal. An important thing to remember is the U.S. is short coke as is Europe. As I mentioned, it would take a prolonged scaling back of iron production to justify U.S. mills slowing down their coke batteries for any meaningful period of time.

It's no wonder that the U.S. right now, steel producers are building new coke batteries and rehabbing existing ones. We think this move towards self-reliance will lead to an additional 3 million tons to 4 million tons of met coal demand in the United States by 2011 compared with 2007 levels. We think all these facts point to why 2009 pricing has held up pretty well in the U.S., plus a few other factors have helped.

First, coking coal stockpiles at U.S. coke batteries at the end of the second quarter were down about 25% from where they were a year earlier. Second, the highest quality met coals remain in tight supply and Alpha has some of the best quality coal brands in the market. All of these factors have affected recent contracting activity.

As we said in this morning's news release, we recently reached agreement with several customers on an additional 2.5 million tons of met business at good prices, averaging $271 a ton FOB to mine. That's equivalent to about $325 a metric ton at the pore.

We continue to do subscribe to the conventional wisdom that the long-term outlook for steel on a global basis remains bullish due to tremendous infrastructure and fixed asset needs in both developed and emerging countries. Infrastructure related programs also tend to be a focus of government spending when economies weaken because they create jobs.

The subsequent recovery, when it happens, will once again place the relatively finite supply of hard coking coal resources at the forefront of buyers concerns. We just don't know at this time what the depth or duration of the global slowdown will be.

While all that's good news, the international customers who came to the bargaining table early this year now seem to be anticipating a potential slowdown of economic activity, so they no longer feel rushed to settle the business, not yet anyway.

More than likely we'll revert to the traditional contracting cycle for the majority of international business which would involve settling up as late as the first quarter of next year. When they sit down with us to discuss their needs buyers will have to be cognizant of their requirements to the end of the next contract period, which would be the first quarter of 2010 and that's 17 months from now. As we've all come to appreciate, a lot can change in that time.

In the thermal markets, since the last call we booked an additional 700,000 tons from 2008 through 2010 at a weighted average price of about $120 a ton. For 2009, we're now 94% booked on the thermal side, as of October 13th, at an average price of about $70 or 37% higher than we've realized so far this year. I might add that we committed and priced more than 5 million tons of thermal for 2010 and almost 3 million tons for 2011.

One last thing before I hand it back over to Mike. As most of you know, about two weeks ago we announced that we sold our interest in the Gallatin Materials lime venture. This was a difficult decision because we had great aspirations for this business.

It became apparent that we couldn't carry out our business plan with a one kiln operation. The decision to add a second kiln would have involved a planned capital expenditure of nearly $25 million in a period of increasing economic uncertainty.

As we were mulling through our strategic options for the business we were approached by several line producers about joint ventures and a possible sale and before long we were approached by a major U.S. producer who is willing to essentially pay us for the synergies they could gain from adding Gallatin to their existing network.

Given where we were from a strategic perspective the offer of $45 million was simply too good to refuse and we exited the business with a pretax gain of $13.6 million on an equity investment to-date of about $10 million.

While this was a decent return on investment that provided a nice infusion of cash at the end of the quarter, Alpha was already in a very good liquidity position, something that Mike is going to address now.

Michael Quillen

We've certainly faced uncertain times before in our 30-plus years in this business and when these times return it reminds us yet again that above all cash is king. It preserves your options and provides staying power.

As of the end of last week we had a record cash on hand of more than $600 million and total liquidity of close to $870 million including undrawn amounts under our revolver. Liquidity exceeds debt quite handily with very strong prospects for continued free cash flow generation based on the future committed price business we've already locked in.

Comparing our financial status within our peer group, we are one of the leaders in the industry from a liquidity standpoint as we enter very uncertain economic times. For an opportunistic type of company like Alpha, these are precisely the moments in which growth opportunities could very well materialize and much more attractive valuations than just a short while ago. An easing of the credit markets would only enhance our ability to act if we so choose.

In this morning's press release we alluded to how the uncertainty that's hammering the markets today has impaired our ability to forecast into 2009. Therefore we've elected at this point to not reaffirm or adjust our 2009 guidance that we put out at the end of July. Issuing guidance at this time can't be done with any comfortable level of assurance and so it's just not prudent to do so.

What we can say at this point in time is that even with the high level of unpredictability that we face today, we expect 2009 will be an outstanding year for the industry in general and particularly, for Alpha with expectations to significantly exceed our 2008 financial metrics including free cash flow.

For the current year 2008, at this juncture we have no definitive reasons to adjust the (inaudible) projections we issued at the end of July. But as always, there are a few things that we're keeping our eye on that could impact results.

First, purchased coal costs for the year are probably going to be about $5 a ton higher than we forecasted in July while produced and processed unit costs will probably run about $1 higher than we forecasted. Needless to say, we will examine our purchase coal activity in light of the current climate.

Second, we are experiencing some productivity shortfalls in our deep minds due to labor and regulatory oversight issues, as Kevin mentioned. We're expecting that production in quarter four will be about in line with the third quarter holiday adjusted.

Third, the sharp cut backs in steel production announced around the world puts us at some risk that scheduled boat loadings in the fourth quarter might be delayed or pushed into 2009 overseas customers. Diesel fuel pricing is also declined even further in October and that volatility could negatively impact fourth quarter results as well.

From an operational cost standpoint we're certainly pleased with lower fuel prices in spite of the shortsighted accounting treatment for hedge contracts. From an accounting standpoint it will probably be the diesel pricing outlook at the end of the quarter that will determine the financial statement impact and in this market it's hard to say where that will end up. On the positive side, however, our realizations have been strong and should remain so through the current quarter.

Lastly, just a word on the planned merger with Cliffs Natural Resources. We have set November 21st as the date of our special meeting where our stockholders will vote on the proposed merger with Cliffs. Management and our board continue to believe that the merger make a lot of strategic sense and we encourage our stockholders to vote in favor of the merger. While Alpha is in excellent shape to grow opportunistically, I just talked about, we would have a much larger platform with Cliffs to continue our growth strategy and consider meaningful game changing acquisitions.

We'll be happy to take your questions now and because of the transaction process we're involved in and the communication restraints we have to abide by, again, we are limited in what we can say about the merger agreement.

Let me just sum up by saying that although the United States and maybe the entire world is facing a financial crisis unlike anything any of us have seen in our life times, we've been through challenging times in this business many times before. We are well rehearsed on how to manage through business cycles. It can even be a time of opportunity for those who manage their liquidity well. Operator, we're ready to take questions now.

Question-and-Answer Session

Operator

(Operator instructions) Your first question comes from the line of Jim Rollyson, Raymond James.

Jim Rollyson – Raymond James

Good morning, gentlemen.

Michael Quillen

Good morning, Jim.

Jim Rollyson – Raymond James

Mike, you talked a little bit about kind of a lot of changes going on right now. Can you maybe just give us your thoughts on what you're seeing in terms of, at this stage, pricing for domestic met coal? It seems like over the calls here in the last couple weeks we've heard a lot of talk kind of low-vol prices in the higher-end of the 200 scale, $200 scale and varying qualities of high-vol kind of in the lower-end of the $200 range scale. Is that generally consistent with what you guys are seeing?

Michael Quillen

Yes, the domestic business finished up strong and those are the ranges. When you look at our average around 270, again, we've got probably the most range of qualities of anybody out there. And when the low-vol guys have come out and I guess, Baxter [ph] will report tomorrow, that will be more along the high-vol line. And then you had I think Arch [ph] reported with a little bit different product. So the numbers are ranging, bearing on the products between not really low-200s but say mid-200s, 230s up to in excess of 300 for other products and so (inaudible) the domestic business came out very well. The thing that I would like to add, and I'm sure it will be a question forthcoming is that what do we see in international business? We're one event away from the market turning back around from some of the doom and gloom that's being predicted right now. There just is still not any substantial increase, and in this environment, may be a decrease in sources of high quality met coal. So one event, this is very similar to where we were in 2007 when we got all projecting '07 one will be that good and the first half was fairly mild. And then it took off because of snows and floods. So we're – it's a fragile supply-demand environment right now, so, we're not at all in the camp that this is going to be some kind of economic disaster for 2009 because of where the steel is.

The other thing and I'm really going probably into some questions that are forthcoming, but the other thing is that when you look at the reductions in the blast furnaces of 20% and you equate that back to impact on met coal to coke, again, iron ore or coke that's direct infusion in the blast furnace are mathematically going to be adjusted, but how your met coal ties into coke and where they get that coke from will have a big part to do in that. We don't think, even though I think Kevin gave a number there that was the mathematical reduction of maybe 2 million tons mathematically, we don't even think it's going to be that high in the fourth quarter and are again in the first quarter. So we don't ever get as high as everybody gets or as low as everybody gets, but we're pretty (inaudible) optimistic about the way things will shake out for '09.

Jim Rollyson – Raymond James

That brings up maybe second question here. You obviously are sitting on a pretty good chunk of cash and presumably set to continue to generate cash to go into next year. Thoughts on how you deploy that. Is it acquisition oriented? Is it – things have been changing over the last few months, I was just kind of curious what your thought process is on CapEx going into '09.

Michael Quillen

The cash, we are very excited about our cash position and what the prospects under any scenario for '09 on our remaining tons say for the cash we'll have. Obvious candidates are out there, acquisitions and growth is certainly usually our number one thing that we're going to look at. And again, with market caps being at still – we're looking at I guess maybe all commodities, but certain coke commodities trading at some by two times and we're even under two times, so there is opportunity out there. You've got dividends and special dividends and you've got stock repurchases. But right now what we're going to do is we certainly are not going to do anything before the November 21st vote. But as we look at it we'll evaluate that probably some time post-January. We've also got a debt reduction option out there.

So my forecast is that we won't do anything with that probably for the next two months or three months. We'll see what shakes out in this crazy environment we're in economically around the world and then we'll look at those options. But again, growth is probably still the first thing that's on the top of our minds right now. As far as CapEx, where we are, we're just in that process right now. As we look at capital for '09 we will certainly announce that number when it's out there. It's probably going to be in the range – I don't want to I'm sure I've got mine managers listening to see what I'm going to say here, but I'm sure they're asking for more than they're going to get because I always did when I was a mine manager. But it's probably going to be in the 170 range to 190 range including a couple of projects we've got coming on. That's just forecasting right now, but we will update you on that, but it's somewhere in that range.

Jim Rollyson – Raymond James

Very helpful. And last question, your commentary in the press release says you've got about 9 million tons open for '010 thermal coal, which I guess was a 62%, so that implies about 14.5 million tons. Is that just the production number, because that seems a little low? And maybe the difference versus kind of run rate you're on this year for 16.5 million tons or so, the difference being purchase goal?

Michael Quillen

Yes, that's exactly correct. When we give those numbers out we don't add in the purchase coal, that's something that – we're also in the budgeting process of evaluating and that can range from a low probably while we've existed of 3 million up to a high 6 million. So that is the difference you're seeing there. We'll, again have more clarity on that as we get further into the budgeting process and see where the met opportunities are where we can move our coals into both products.

Jim Rollyson – Raymond James

Great. Thanks, guys.

Operator

Your next question comes from the line of Luther Lu.

Luther Lu – Friedman Billings Ramsey

Hi, good morning, guys.

Michael Quillen

Good morning, Luther.

Luther Lu – Friedman Billings Ramsey

For the 7 million tons of on contract in met in 2009, could you give us a little color on the quality, any crossover tons in the 7?

Kevin Crutchfield

There is a little bit of crossover, it's a whole range from what we call near met or crossover, what you're talking about, all the way up to high quality low vol. So it's got all those ranges. We recognize and we say this about every call, how much we could help everybody if we broke those qualities down into the different baskets, but again, our competitors and our customers would also love to have that information. And with 7 million uncommitted tons we're going to maximize that, which we've done in the past, to get the highest revenue we can get. And – but it's all the way across the range and that's why forecasting '09 is so difficult right now. You're looking at a spread of maybe $100 a ton on the different qualities and how you blend to that make a huge difference. If you can move up one category in this market you can pick up substantial amount of price per ton.

Luther Lu – Friedman Billings Ramsey

Okay. And you guys mentioned credit risk and stuff like that and I'm just wondering for your purchased coal, are you worried about that some of the supply sources could be – maybe because of this tough market?

Michael Quillen

Not right now. We're pretty – in fact, we're probably in the current market we're in today as we speak, I think that supply is pretty strong. I think everybody will give us every pound they've got committed to. We look at that, we don't – and we've looked at our contract, we just went through a very strategic risk analysis profile and we'll be reporting that to our board next week. And looking at our customers and our purchased coal we don't really have any concerns that we would highlight or be worried about. I think the people we're buying from are in good shape.

Luther Lu – Friedman Billings Ramsey

Okay. Finally, could you give us your diesel for the fourth quarter and for '09?

Michael Quillen

I wish I could and above that. And that's what I said in my comments is, right now as we're projecting it we're seeing it about where we are right now, but there is so much volatility in that from events around the world that – and the way that's calculated, it's off about a 32-month supply and I guess that ours is in home heating oil. And that thing could go in either direction by the end of the year and will impact the quarter. Of course, I think, as most of you do, it's something that you in your analysis back out, some don't. But, in '09, I wouldn't even have a clue what diesel fuel pricing is going to be in '09.

Luther Lu – Friedman Billings Ramsey

Not diesel prices, diesel hedge, how much you have hedged?

Michael Quillen

Excuse me – we've got that number here. It's about in the percentage wise we've got about 28 million gallons over that time period which we burn about that much a year, but that's over probably – that goes all the way into '11 I think. Hello?

Operator

And your next question comes from the line of Michael Dudas.

Michael Dudas – Bear Stearns

Good morning, gentlemen.

Kevin Crutchfield

Hi, Mike.

Michael Quillen

Good morning, Mike.

Michael Dudas – Bear Stearns

For Kevin or Mike, would you attribute maybe some of the turnover, some of the issues relative to the uncertainty that maybe the miners might feel during the merger?

Michael Quillen

I don't think so. I bet it's not one. I really don't think that's been an issue at all. Kevin can comment too, but I really – we have not heard one thing that would lead us in that direction. Kevin?

Kevin Crutchfield

No, Mike, I would agree with, Mike, that I don't think our guys are – they're obviously interested in what's going on, but there is no turnover that we could point to that's associated with pending merger.

Michael Quillen

What we've seen in the last three months is substantial base pay increases. Southern West Virginia is the toughest market right now for labor, it varies a little bit from Pennsylvania all the way down to Virginia to Eastern Kentucky, but most of what's going on right now is base pay related.

Michael Dudas – Bear Stearns

Would you see a scenario going into 2009, because of the difficult credit conditions and the great fragmentation of Central Appalachian producers, would that possibly open up some labor availability as – whether it's because of 404 issues or productivity issues or capital issues, open up some of that labor pool to some of the larger companies going into 2009, is that something that's possible?

Michael Quillen

We think so. We've actually analyzed that. I think the credit situation will certainly be one factor particularly some of the smaller producers, the regulatory environment is another. But one I really haven't seen mentioned yet, but is out there is that, we've talked in our other calls, most of its in the industry committed to our '09 capital equipment, primarily, our underground and surface production equipment back in March. And we have been contacted, as I'm sure others have, by some of the major suppliers of those production units and ask can you write a check or are you dependent on the debt market to get your equipment? And it's great to be able to say we can write you a check and therefore we're going to get our equipment for 2009, but there maybe other parties that that maybe a factor that causes them to have some issues that may in the best free up some labor.

Michael Dudas – Bear Stearns

Excellent point, Mike. My final question would be relative to – maybe a follow on to your analysis what you think in the market place. What's the likelihood – would the balance of the met coal market seem to be reasonably good into '09 and '010 for volumes, the port situation and export opportunities for the U.S., how difficult will it be for Central Appalachian production as a whole to achieve what it may produce in 2008? Would that be an optimistic scenario given all the cost currents going on right now?

Michael Quillen

I don't think it's going up. I think we really felt even before this that Central Appalachia was going to be reducing over the next three years. We continue to think that and it may even be more than we had previously thought because some of the expansion plans that people had projected probably are not as attractive as they were when they were announced. So I think it's going down. I don't know. We haven't done an analysis to say to what percentage, but my projection is that, that would go down.

Kevin Crutchfield

I think the interesting point there, Mike, is when you – and I had this exchange with someone the other day that in the face of the kind of price decks we've been looking at, the inelasticity of the basin to respond it's up – I think it's up like 3% right now year-over-year. But I think were you to see it protracted, more depressed pricing environment, I think you will see elasticity the other direction. I think you'll be shocked by both how fast tons would come off and how many would come off in some sort of protracted down cycle.

Michael Dudas – Bear Stearns

Good luck, gentlemen. Thank you.

Operator

And your next question comes from the line of Shneur Gershuni.

Shneur Gershuni – UBS

Hi, good morning, guys.

Michael Quillen

Good morning, Shneur

Shneur Gershuni – UBS

I was wondering if we can talk about the Appalachian basin just from – I guess from a cost perspective and also from an inventory perspective. You noted that emission inspections are up 40%, obviously that's impacting productivity and so forth. I was wondering if you could kind of give us your sense as to, are we at the peak? Is this going to be kind of the productivity run rate? Will it actually improve once we get through all the infractions that they keep finding, and I'm sure they all will be corrected as they create new rules and so forth? And if you could also talk about what you're doing with gas cards now that oil is down. And do you see any other costs potentially coming down? You noted steel surcharges were down about $1 a ton and so forth. So I was wondering if you could talk about that and also if you can mention where you believe inventories are for the Appalachian area for the thermal coal?

Michael Quillen

On productivity I believe in our record we think that the Eastern Appalachian mines probably hit their peak on productivity in 2001. We've seen continuing to decline on an annual basis. I think that will continue. Obviously, some of its math in certain mines because of high cost and low productivity and the market goes down a bit drop out. But, overall the conditions are just going to continue to be tough for the mine. Coal mining is about like the stock market is today. It's not for the weak or the feeble. It's a tough business. And it's going to continue that way. So I don't see a productivity increase on a per man hour basis in our future. As far as some of the costs, the gas cards, we're right now back – we set that on an index, we're right – we're back to where we started at about doubled off our index. It's about back where we are so it's holding firm.

But as far as – that's why fourth quarter – when we do all the metrics it comes out that it's about what we've predicted before because we've got steel surcharges coming down, we've got diesel fuel coming down, but we've got the offset of the hedge impact on that. If everybody takes their tons then we should be okay. But costs could be a little lower, but again, the thing – and I think lot of people miss this and we've talked about it before. The number of work days in a quarter are critical to, one, your tons produced and your tons per man hour. For example, in the third quarter, most of our vacation time, the two weeks hit in the first two weeks of July, none of it really fell over into the second quarter in June. If you take those two weeks out of a 13-week period that's about 15% less work days, we try to make some of that up with over time, again had some issues. And I haven't yet looked at the number of how the vacation – the holidays will fall in the fourth quarter, but we're probably going to – we joke about this, but it also will depend on whether deer season falls on the same week of Thanksgiving or not, and you've got to work all those things out. So I don't really see lot of hope for a productivity increase. I do see some – on the supply side some relief and particularly on the steel side which is a big part of our underground cost.

Shneur Gershuni – UBS

How about with respect to emission inspections? Do you think they'll level off, do you think they'll continue or maybe come down a little bit?

Michael Quillen

Yes, I missed. You asked about that and that does deserve a comment. I don't think the number of inspections will come down. But we want to be perfectly clear. It's not the violations or things that are getting cleared up, it's just the – them being there every day. And one way we relate to that to people that aren't in this business is it's like driving down the interstate highway with a state trooper following you all the time, it's your behavior is little bit different. When they're there it takes up time, they may want to have a safety talk amongst the employees, they stop equipment whether in production and want to inspect it for certain things. So it's just a matter that it impacts your productivity, it's not that you're doing something wrong you have to fix something, it's just a matter that when they do their inspections it has an impact on your available production time. And even if the equipment is in fine shape you still may be down, so they take a shuttle car out for 20 minutes to inspect the panel boards on it, that shuttle car is out of production for 20 minutes. And the number of inspections have caused those things happen a lot more. It's not astronomical difference in productivity; we're looking at probably around 5% to 7%. I think that's not a scientific number, but it's kind of what we're beginning to see as the impact of these inspections.

Kevin Crutchfield

Shneur, a specific example on us is we've incurred through the end of September as many emission inspection days as we did all of last year for just nine months rather than 12, just to give you some sense of what that is about 5,400 inspection days.

Michael Quillen

One other thing you asked about was inventories. Again, inventories have been depressed. We don't really see because of where we're seeing production from all of the producers that's in and out. We don't really see a big inventory increase. Obviously, weather on the thermal coal has something to do with that. Kind of odd, we had snow here yesterday in Virginia which is a little bit unusual, but a very cold early winter would certainly help from our selling viewpoint, but that could have an – our forecast right now is inventories are pretty much going to be about where they are right now. We don't see a really over production increase. Utilities with the current gas price are probably not going to look to do a whole lot to change their inventory situation right now for coal.

Shneur Gershuni – UBS

Okay. And I was wondering if can – you talked about some of the micro operators. I've got to think that the (inaudible) example for them is basically set forth [ph] at this point right now. And if the prices do fall little bit – I'm assuming that the higher cost producers. Do you expect a lot of guys come offline (inaudible) and cost to be up as well?

Michael Quillen

It's a little bit hard to forecast. I think in general you're right that lot of these guys do finance their equipment, they finance even their working capital, for example. And it's just an environment where you can't borrow money hardly for any reason. So that's why cash is so important and liquidity is important. So it is going to impact them. How much we're able to determine and recognize that's going to be a little bit difficult. I again think the regulatory environment is the go-forward to that next mines, probably. It's not going to be a linear thing, it's going to be a plateau. I'm continuing to forecast we're going to see the smaller guys go out. Some of that will be picked up by the bigger companies, for example, as some people go out. We would look to pick up, for example, buy that particular asset or pick up their people and fill in some of the holes that we've got. As we talk amongst the peer group there's a lot of vacancies across the industry at all the companies right now that we didn't have three months or four months ago. So it wouldn't be a net reduction because the bigger companies will pick up some of the void left by the people that do go out.

Shneur Gershuni – UBS

Okay, great. Thank you very much, guys.

Operator

Your next question comes from the line of Brian Gamble.

Brian Gamble – Simmons & Co.

Good morning, guys.

Michael Quillen

Good morning, Brian.

Brian Gamble – Simmons & Co.

Glad you guys are able to worry about deer season, Thanksgiving falling on the same holiday rather than worrying about sandstone in your long walls, that's good to see.

Michael Quillen

If you've ever heard me talk I'm a continuous miner guy. Long walls are either really good or really bad. In the geologic conditions we're in we like to be able to turn right or turn left; we don't want to have to always go straight ahead.

Brian Gamble – Simmons & Co.

Completely understand. Sounds like you plan to me. Just wanted to touch briefly on the last comment you made about the vacancies. Any sense of industry wide either northern (inaudible) or a combination of exactly how many positions are missing either on a percentage basis or just total manpower?

Michael Quillen

I'll tell you what, I don't have a clue what that number is, but I don't hesitate to say I bet you, it's well over 1,000 just on the public companies.

Brian Gamble – Simmons & Co.

And then on the private companies another 500 or so or do you think it's less than that?

Michael Quillen

They're about a third of the production right now so I mean – I'm just speculating, but I know what we have, and I know what some of the other operators told me they have in terms of openings right now. So I guarantee you it's above 1,000 on just the publicly.

Brian Gamble – Simmons & Co.

If you assume our vacancies are proportional to everybody else is I think you'd come up with 2,500 to 3,000.

Michael Quillen

It's a big number.

Brian Gamble – Simmons & Co.

But notwithstanding the announced expansions that would exclude those which I think we talked about before were 1,000 people to 1,400 people. So you're probably looking at 5,000 people total.

Michael Quillen

The other thing you're going to see that we monitor ourselves, but at the end of each year going into the next year there are a lot of people that came into the industry at the same time we did that will make a choice whether to work another year or whether to go ahead and retire. Of course, I certainly heard from this office all the way through the mines based on the current stock market people are going to be working longer than they had originally planned to be working. That's sure (inaudible) environments too.

Brian Gamble – Simmons & Co.

Unfortunately, I think that's very true. Do you think that the – I'm just trying to get a sense for how that headcount gets fixed. Do you think that the issues with productivity and people maybe not being able to get full – whole [ph] permits coming up soon and just all of the uncertainty on the supply side fixes that situation, prices coming off, mines closing, do you think that, that gap of 5,000 people short can start to close? Or is that actually going to determine how some operators are able to produce into 2009, 2010, just because there is nobody to hire?

Michael Quillen

I think it will close particularly on the bigger companies because I think the stress is going to be more on the smaller companies. So it will close some and we're bringing in a lot of new inexperienced miners. We've got a variety, as I mentioned, in different programs going on. We've got one we're very excited about called helmets to hardhats where we're certainly recruiting heavier people that are coming out of the military right now. So it's just something that we saw it and we were part of it in the early '70s when the industry started to grow and that's how we all got in the business. So that exact same thing is going to happen again, but it's going to take probably two years or three years to even get close to moving in that direction. But it will be a new breed of coal miners coming from legacy type families that will replace those people that are going to leave the industry in the next five years. I think there is a number out there, NMA put out how many miners would actually leave in the next 10 years, it's a big number.

Brian Gamble – Simmons & Co

That's kind of the point is that the folks you're trying to replace don't stop aging in the meantime, so the problem is moving on you all the time. And I think a lot of it comes down to are you trying to keep Central App at a 230 million ton clip or something less than that. But if you're going to keep it at a 230 million ton clip it's going to take a good while to get this problem sorted out because it's not something that we created overnight nor is it something we're going to fix overnight.

Michael Quillen

We were thinking about coming to New York with some recruiters for the investment banker pool still is available now, but I think we'll stick with the military.

Brian Gamble – Simmons & Co.

I think that's probably a good idea. Just finally, on the met coal sales you actually made for the quarter, what sort of time frame did you – I might have missed that in your prepared remarks – but what – did you make those at the beginning of the quarter or were those layered throughout the quarter? And if you try to sign that same quality spec today what would be the price you might have to take as a discount?

Michael Quillen

That's actually layered across through the various time frames, it's not anything – I don't have that right in front of me, but there's not a (inaudible). Those qualities today – what's happened is most of our domestic business is closed out for the year, and we're now going to be waiting on what the international guys do in April. As we said earlier, they were here, they were actively pursuing negotiations this summer and then when this market took a little bit of a dive they retrenched back to just a wait-and-see attitude. So – it's a pretty – that's a pretty linear across the different time frame.

Brian Gamble – Simmons & Co.

Perfect, Mike. Thanks, guys. Have a good one.

Operator

Your next question comes from the line of Mark Caruso.

Mark Caruso – Millennium Management

Good morning, guys.

Michael Quillen

Hi, Mark.

Kevin Crutchfield

Good morning, Mike.

Mark Caruso – Millennium Management

Just – actually I had two quick clarification questions for you, Mike or Kevin. On the purchased goal side, can you guess – I just want to think – if I'm thinking about this the right way. As far as for next year as we've seen costs – the pricing coming down would, in theory, the trend come down for your purchased coal? Are you actively doing that every quarter or is it a set contract for the year on how much you're going to purchase?

Michael Quillen

What we do, we set up our sales forecast for the calendar year and then see what our company production and then our contractors and the tons that we will purchase to wash at our prep plants that aren't contractors, but are pretty much tied to coming to our prep plant. And then we'll see what that delta is, and some of that we'll commit – we'll be a little conservative on that, we will commit a lot of that out there. The thing that's going to be interesting is as you've watched Alpha over the last five years or six years, in a negative market we have a little bit more opportunity for making money in the purchased coal than we do when things are booming. So there is an opportunity to increase the margins back on that. They closed obviously quite a bit during this robust market. But again, that number I don't – we don't have a number for '09 yet, but I'm not going to be surprised if it's still not around 5 million tons.

Kevin Crutchfield

Mark, we've been dialing that back a little bit of late, as you would suspect, until we can get better visibility and clarity on what's going on. But we continue to believe there will be opportunities and it will always be a very important part of our business.

Mark Caruso – Millennium Management

And as far as the costs go, you had mentioned this year obviously in a rising price environment that cost is going up. It sounds like it could be up $5. And as pricing is coming down is it fair to assume the trend is that, that will come back down?

Michael Quillen

Yes, definitely move with the market.

Mark Caruso – Millennium Management

Okay. Got you. And Mike, earlier you guys were talking about sort of the M&A opportunities that you see. Obviously, right now a lot hinges on what happens November 21st. But at this point, if I remember correctly, in the past, you had said that you could do something before that if you chose to, I just want to see if that's accurate or is everything dependent on what happens there as far as you looking at other opportunities?

Michael Quillen

We're not restricted, there's obviously a scale issue. If there was something of significant magnitude we would discuss that with Cleveland-Cliffs. But in this environment it's just been so volatile and anything, but we could have done anything, in fact, even had negotiations on some smaller things that wouldn't require Cleveland-Cliffs. But if it's anything material we would, and are obligated to be with them on that. Obviously, nothing has occurred or we would have announced it.

Mark Caruso – Millennium Management

Got you. And then if we look forward and if you were still an independent company would you say that the M&A environment going forward just as a general comment is going to be more asset focused? Or you think we might start to finally see the corporate M&A that everyone sort of was hinting at last summer?

Michael Quillen

What's the debt market going to be? I mean, I think the discussions will be active. I think, again, as you look at all of our industry peer groups pretty depressed on the multiples that we're looking at now. So depending on whether you acquire or they acquired is you're going to look at that little bit differently, but we have said all along that we think consolidation needs to happen. We think multiples are demonstratedly [ph] better on the bigger companies whether it's a Peabody or an Arch or someone like that. So we think that it is going to happen. Stock for stock transactions make a little bit of sense, but everybody has got their own debt load and their own working capital and reworking, even if you did a stock for stock deal in this environment, you're still going to have to go to the debt market and do something with what debt you got out through there. We're working – working anything with a B after it would be pretty tough in this environment. And even in the hundreds of millions is, for some people, that don't have a strong balance sheet, would be about impossible. So the opportunity is there but a lot of it will have to do with how the debt market goes.

Kevin Crutchfield

From intrinsic value standpoint, Mark, we're looking at kind of the valuations that we saw back in the '01, '02, '03 time frame. So for those who have a demonstrated track record as well as either existing liquidity or access to liquidity it would be a good time to be able to move opportunistically, that's for sure.

Mark Caruso – Millennium Management

And as far as location, are we in an environment where it still makes the most sense if someone's properties that are close to you for synergies or because valuations are so depressed and given that certain people are in better financial positions than others be more a matter of getting larger in the basis that you feel that you have scale and – ?

Michael Quillen

We wouldn't prefer one over the other. We'd look at it on our hurdle rates and our return on our investment and which gives us the best opportunity. We obviously are going to look at it to how the Street and our shareholders would view it moving out of a basement or whatever. But in general, we're going to make that analysis based on a cash flow analysis and what our return on that investment would be and that's how we'll make a decision on an acquisition.

Mark Caruso – Millennium Management

Great. Thanks, guys.

Operator

Your next question comes from the line of Jeremy Sussman.

Jeremy Sussman – Natixis Bleichroeder

Good morning.

Michael Quillen

Good morning, Jeremy.

Kevin Crutchfield

Good morning.

Jeremy Sussman – Natixis Bleichroeder

So we've all talked about the demand side but not too much about international supply. So I was wondering if you could discuss for a minute kind of what's going on in Australia. Have we seen any meaningful improvements or are they still suffering kind of from some of the supply constraints that we've seen over the last couple of years?

Michael Quillen

We've seen a slight improvement but they're still struggling with all the same issues all the rest of us are. I think the biggest thing that we're watching on the Australia side as compared to right now is the dollar value. I mean it's been pretty astounding to us what's exchange between the U.S. and the Australian dollar in the last two months. That reinforces a little bit right to their bottom line what their cost of supplies and labor everything is in Australia from where they were when they committed for their '08 business. So they're more – and obviously coupled with the ocean freights which are certainly down maybe as much as two-thirds right now from (inaudible). But as far as their productivity and the number of tons they're getting out, not a material change. It's kind of interesting, and we watch it on a daily basis what the queue is in Dalrymple Bay and Newcastle. It goes up and down without a real pattern but it hadn't materially changed.

Kevin Crutchfield

30 boats in Newcastle right now.

Michael Quillen

So it's – they're out there. But, again, I think the dollar right now is going to be a bigger factor in how they look at their production for the next year versus what they can do. They're still limited with – the ports still – we got we think it's still a year away from getting physically straightened out and then they got a rail situation and same – and they've got equipment issues. They're buying the exact same mining equipment we are, Caterpillar enjoy it, EVT and those known products. So I don't see a big increase coming on the supply side. I think, as we've always said, right now, what we're watching for '09 is the demand side. I think the supply side is not going to be dramatically changed either up or down, but probably more down than up.

Kevin Crutchfield

And Jeremy, Australia notwithstanding, you begin to look through other parts of the world, Europe and the Eastern bloc countries and they continue to have issues there and we don't see those issues abating any time soon because those are pretty problematic in areas of the Ukraine and Czechoslovakia and Poland and places like that. So I think to Mike's point, no supply response there.

Jeremy Sussman – Natixis Bleichroeder

Great. That's helpful. And then just lastly, obviously, you have taken off guidance based on pricing. I think we're all trying to figure out where that's going. But, in terms of production, last quarter, you were assuming 2.5 million tons to 3 million tons of production growth for '09. Is that still the case and is that part of the – I think it was $170 million to $190 million in CapEx you, Mike, you mentioned earlier?

Michael Quillen

The capital number, again, is just me speculating on where we may end up. I haven't seen – I haven't gotten to this level yet on where we are on capital, but that's the range that I'm looking for. On the production side, there is a direct correlation between where that pricing comes out and where that production goes. So again, we're just not going to say anything. Right now, the range is just way too broad on pricing of where our unsold and everybody's unserved international tons can go to speculate, and then that impacts how many tons we want to produce. Because of our type of mining and our purchase coal situation, we have got a lot of flexibility in how we do that. And it may be that it's more advantageous on a margin basis to buy a ton rather than produce a ton in '09. We just don't have that number yet so. Really both those metrics need to be yet decided on what to be. We're – even though guidance, I don't think anybody in any business in America today can really with confidence, project '09. I don't know one that you could, but we're going to give you got a lot of metrics so you can make assumptions on yourself. But if we give guidance right now, then we are legally obligated to update that every time something swings in a material way one way or the other. We've got enough stress without having to do that on a regular basis as quickly as things are changing.

Jeremy Sussman – Natixis Bleichroeder

That's a great point with guidance. Thanks very much, guys.

Operator

And there are no further questions at this time.

Michael Quillen

Thanks, everyone, and have a happy Halloween.

Operator

Ladies and gentlemen, this concludes today's conference call. You may now disconnect.

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Source: Alpha Natural Resources Inc. Q3 2008 Earnings Call Transcript
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