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Foundation Coal Holdings, Inc. (NYSE:FCL)

Q4 2008 Earnings Call

February 12, 2009 10:00 AM ET

Executives

Todd Allen, CFA - Vice President, Investor and Media Relations

James F. Roberts - Chairman and Chief Executive Officer

Kurt D. Kost - President and Chief Operating Officer

Frank J. Wood - Senior Vice President and Chief Financial Officer

Analysts

James Rollyson - Raymond James & Associates, Inc

Brett Levy - Jefferies & Co. Inc.

Michael Goldenberg - Luminous Management

Michael Dudas - Jeffries & Company, Inc.

Justine Fisher - Goldman Sachs

Jeremy Sussman - Natexis Bleichroeder, Inc.

Brian Gamble - Simmons & Company

Paul Forward - Stifel Nicolaus & Co., Inc.

Mark Caruso - Millennium Partners

Shneur Gershuni - UBS Investment Research

Mark Liinamaa - Morgan Stanley & Co.

Luther Lu - FBR Capital Market

Garrett Nelson - Davenport & Company

Operator

Greetings and welcome to the Foundation Coal Holdings Incorporated Fourth Quarter Financial Results Conference Call. At this time all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. (Operator Instructions). As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host, Todd Allen, VP of Investor and Media Relations for Foundation Coal Holdings Incorporated. Thank you. Mr. Allen, you may begin.

Todd Allen, CFA

Thank you, operator. Good morning everyone and thank you for joining Foundation Coal's fourth quarter 2008 earnings conference call. This call is being recorded and will be available for replay for a period of two weeks. The live call can also be heard on the Internet and will be archived on our website at www.foundationcoal.com for one year.

Joining me on today's call are Jim Roberts, Chairman and CEO of Foundation Coal, who will summarize our fourth quarter and full year 2008 results and provide a brief market outlook; Kurt Kost, our President and COO, who will address our operating results; and Frank Wood, our CFO, who will provide you the details of our financial performance.

Please let me remind you that various remarks that we make on this call concerning future expectations, plans and prospects for the company constitute forward-looking statements for the purposes of the Safe Harbor provisions under the Private Securities Litigation Reform Act of 1995.

These statements are made on the basis of management's views and assumptions regarding future events and business performance as of the time the statements are made. Actual results may differ materially from those expressed or implied. Information concerning factors that could cause actual results to differ materially from those in forward-looking statements are contained in our filings with the United States Securities and Exchange Commission, including our Annual Report on Form 10-K. Now I'd like to turn the call over to Jim Roberts. Jim?

James F. Roberts

Thank you, Todd. Good morning everyone. I am pleased to report that Foundation delivered record performance on several key metrics during the fourth quarter.

Foundation achieved record revenue, record adjusted EBITDA, record net-income and record diluted earnings per share in the fourth quarter. Specifically Foundation generated adjusted EBITDA of $121 million and diluted earnings per share of $0.93 in the fourth quarter.

This very strong performance is a direct result of record shipments from Northern Appalachia; our highest margin region, which reached 4.1 million tons in the fourth quarter due to excellent execution of both of our mines.

Production was particularly strong at the Emerald mine with the first full quarter of doing longwall operation enabled us to ramp production significantly. Strong fourth quarter results at Foundation has caused record full year adjusted EBITDA of $316 million at the high end of our guidance.

Subsequent to the end of the quarter, we announced the idling of our Laurel Creek mining complex based on it's high cost structure, current market environment and difficult mining conditions. The mining complex located in southern West Virginia produced approximately one million tons of coal in 2008.

The decision to idle Laurel Creek with lower operating cost structure in Central Appalachia modestly enhanced our EBITDA going forward, eliminating approximately $9 million of capital expenditures in 2009. Also subsequent to quarter end our Central Appalachian affiliate Kingston Resources, Inc, filed a complaint in US District Court of the western district of Pennsylvania against ArcelorMittal USA Inc, seeking enforcement of an existing coal supply agreement.

As you know when it's stated (ph) in the publicly available complaint, we're unable to comment on this pending litigation. As we looked to 2009, we expect Foundation to deliver record EBITDA and earnings per share by a significant margin, reflecting our highly hedged position and improved cost structure following the idling of Laurel Creek, balanced with current market uncertainty.

Every period of market uncertainty also brings with it opportunity. We believe small private producers are already under considerable stress and public valuations on (ph) historically low multiples. In light of today's market environment we remained vigilant in evaluating a possibility of growth through acquisition.

Now, I would like to give you our view at the current market. In this environment many people are focused on the economic crisis immediately before us. I will like to start my comments by saying that long term we continue to believe coal... the coal industry fundamentals are strong due to projected coal consumption growth in United States and the more rapid growth projected in developing economies like China and India. In the big picture the world will need much more energy over time and this growing energy need will continue to be met with coal due to its abundance and low costs.

Specifically new coal plants representing nearly 20 gigawatts of capacity are coming online in the United States between now and 2012. These new plants will increase domestic coal demand by approximately 50 to 80 million tons annually. Worldwide consumption of coal is expected increase by more than 40% by 2030. So, our long term view remains bullish.

However the current economic slowdown is negatively impacting demand for coal in near term. Prices of steam and metallurgical coal have declined and new contracting has slowed significantly, especially for metallurgical coal. Overall we expect the United States coal production needs to be reduced by... we expect that U.S. coal production needs to be reduced by approximately 50 million tons in 2009 in order to bring supply and demand in to balance.

Exports, which grew approximately 40% in 2008 to an estimated 84 million tons could come down 15 to 20 million tons in 2009, increasing domestic supply. In addition; domestic electricity generation is expected to fall between 1 and 2% as a result of reduced industrial and commercial usage. This equates to 10 to 20 million tons of U.S. reduced biggest demand. Finally, U.S. steel mills have sharply reduced production with December 2008 production down over 50% year-over-year. As steel production slows cost of met coals (ph) are returning to steel market. The exact number's difficult to ascertain, this reduced met coal consumption and lower direct industrial usage will further increase steel supply in 2009.

Granted a decrease of 4 to 6% in the U.S. coal demand is concerning. But compared to other sectors of the economy, coal is faring quite well and it demonstrates the recession, resistant nature of coal. In this environment producer are responding by closing unprofitable mines. Up to this point we believe that publicly announced production cutbacks for the United States, including the idling of our Laurel Creek facility totaled approximately 35 million tons and additional cutbacks are possible during the rest if the year.

The regulatory challenges that we have discussed on previous calls continue to persist and the four forthcoming issues at Central Appalachia remains an open question. It is clear that few permits are issued and the backlog of permit applications is growing. This is increasingly having a negative impact on surface production in the region, both in terms of tonnage and costs.

In addition the current credit crisis puts intense pressure on producers with limited liquidity. Beyond 2009 we would expect domestic steam coal consumption to resume a more normal growth rate, roughly inline with the growth in domestic electricity demand. Domestic demand from met coal and export for both met and steam coals should experience a significant increase when the global economy recovers from the current recession. Consequently the companies that can weather this economic storm will give you more (ph) benefit from higher demand from limited supply.

Today's economic environment challenges coal companies to make tough decisions and hard choices. Foundation is well positioned to handle these conditions. First, as previously stated the economic downturn is creating a temporary oversupply of coal. Foundation's position of having 97% of this planned shipments for 2009 committed and priced will allow us to manage through these headwinds and generate record earnings and EBITDA in 2009.

Second, lower prices will remove the safety net, the higher prices provided in 2008 forcing high cost mines to close. All companies will be faced with the decision to close their higher cost operations resulting in reduced production in 2009 and 2010. Foundation has already closed one operation

However because Foundation sold most of its 2009 production at or near the peak of the market in 2008 and because Foundation produces 95% of its products from low cost, large reserve, high volume lines, we're able to increase production in 2009 and generate record earnings. Also Foundation has consistently generated the free cash flow year after year.

Today we've $329 million of available liquidity from our revolver and we expect to generate additional free cash flow in 2009 to add our current liquidity position. When I look at our position in the market today, I believe Foundation is ideally positioned and worthy of a premium valuation in today's markets.

I will now turn the call over to Kurt Kost for a discussion of Foundation's operations and future plans.

Kurt D. Kost

Thank you, Jim and good morning everyone. I would first like to congratulate and thank over our entire workforce for achieving record safety performance in 2008. In fact, our overall incident rate was 27% better than in 2007. Safety is a critical part of our culture, and I am proud of our excellent safety track record.

Now, I would like to discuss our operating results, region-by-region. As Jim mentioned, we achieved record fourth quarter shipments of 4.1 million tons from Northern Appalachia, supported by a record shipments from Cumberland and as our expected, Emerald posted very strong results, thanks to the operation of both longwalls throughout the quarter, which demonstrated the mine's search (ph) capability.

Average realizations at North Appalachia also increased 9%, compared to the year ago period. While Northern Appalachian performance was very strong in the fourth quarter, we expect that the first quarter 2009 shipments will be lower; in the range of 2.4 to 2.6 million tons due to scheduled longwall moves at both, Cumberland and Emerald and a temporary interruption of normal operations at the Emerald mine due to gas levels in a sealed area of the mine.

The gas issue developed within the past few days and is currently ongoing. We are taking actions to remedy the situation and we expect normal operations to resume within the next two weeks. Following the completion of the first quarter longwall moves, we anticipate normal production levels throughout the balance of 2009. In the regular course of mining, another longwall moves is expected to take place at Cumberland late in the third quarter.

In Central Appalachia, fourth quarter 2008 shipments were $1.7 million tons, were up slightly from $1.6 million tons in the third quarter of 2008, but down approximately $0.4 million tons compared to the fourth quarter period last year, primarily due to the absence of purchased (ph) coal shipments. The Central Appalachia operation experienced the most significant increase in average realizations, which were up 59% compared to the year ago period to more than $85 per ton.

The idling of Laurel Creek effective at the end of January will reduce our Central Appalachian production by just under $1 million tons in 2009 due to the absence of 11 months of production. However, idling Laurel Creek eliminates our highest cost in production in the region and will reduce our 2009 capital expenditure requirements by an estimated $9 million.

PRB shipments were 12 million tons during the quarter, down 800,000 tons compared to the fourth quarter of 2007. The decrease in shipments primarily reflects lower shipments on certain requirement contracts with electric utilities served by our Eagle Butte mine. Fourth quarter average realizations of $10.27 in the PRB was up 15% from the fourth quarter of 2007.

Throughout 2008, we were successful on selling our PRB coal at prices near the top of the market. And we are now prepared to produce at our full capacity of 55 million tons in 2009, up from approximately 49 million tons in 2008.

Looking forward to 2009, we are focused on containing cash costs and prudently limiting our capital expenditures. With this in mind, we are continuing to evaluate our various capital projects in order to strike the optimum balance between providing the groundwork for our future operations and maximizing our cash flows in today's market environment.

For example; we are constraining the levels and adjusting the timing of capital spending on our two new in Northern Appalachian projects; the Freeport Mine and the Foundation Mine, focusing primarily on the ongoing permitting process and necessary land acquisitions in 2009, element that are less capital intensive than actual construction activities.

It is important to note that the Foundation mine will enable us to maintain our Northern Appalachian production levels as our current mines reserves deplete over the next two decades. As such, we view the development of the Foundation Mine as a necessary sustaining project.

Other growth projects, including the addition of trucks and shovels to increase PRB production capacity and the Laurel Creek (ph) project in Central Appalachia will be evaluated in future years based on market conditions.

In summary, Foundation Coal's execution in the fourth quarter was excellent and our financial results were the best in the company's history. We're pleased with these results and intend to continue to deliver strong performance in 2009 by focusing upon maintaining our high standards of safety and regulatory compliance, delivering a quality product and service to our customers, reducing controllable cost and capital expenditures and innovating productivity improvements through the involvement and input of our employees.

Now, I would like to turn the call over to Frank for a more detailed discussion of our financial performance. Frank?

Frank J. Wood

Thank you, Kurt and good morning everyone. As Jim mentioned, Foundation maintained a strong liquidity position with 329 million available under our revolving credit agreement and the company expects to continue generating positive free cash flow. Not only is our liquidity position strong today but we expect this to continue with only modest quarterly principal repayments on our term loan of 8.4 million beginning in the third quarter of 2009.

We have no other scheduled debt maturities until mid 2011 when our bank facility is scheduled to be renegotiated. And our 7.25% bonds mature in 2014. Other committed obligations, including the second installment payment on our Eagle Butte Lease by Application are manageable.

We remain very comfortable with our current capital structure and expect to remain in a strong liquidity position overall. Demonstrating our disciplined approach to cash management, capital expenditures decreased 11% to 157 million in 2008. Some of this reduction was attributable to spending that was pushed out in time and is now expected to occur in 2009.

In addition, we plan to incur a limited amount of CapEx related to permitting and land acquisitions needs associated with the Foundation and Freeport mines that Kurt discussed earlier.

Overall we anticipate that 2009 CapEx will be in the range of the 190 to 240 million, excluding the Eagle Butte LBA payment.

During the fourth quarter coal sales revenues rose 27% to 451 million and total revenues also rose 24% to 457 million. As increased realizations and the 0.9 million ton increase in shipments from the Northern Appalachia, more than offset lower shipments from Central Appalachia and the Powder River Basin.

Cost of coal sales rose to 325 million in the fourth quarter of 2008 compared with 276 million in the fourth quarter of 2007. The increase was mainly due to increases in diesel fuel, repair and maintenance and operating supplies, labor and benefits and revenue sensitive royalties and production taxes, which reflect the impact of higher realizations.

Sequentially, the cost of coal sales declined 7% from the third quarter, primarily as a result of lower purchased coal expense.

By region, fourth quarter cost of coal sales per ton in Northern Appalachia decreased 43% to $27.01 compared to the prior quarter, mainly as a result of record production. Cost of coal sales per ton in Central Appalachia also improved in the quarter decreasing 2% to 64.65 per ton compared to the third quarter, while cost of coal sales of PRB increased 2% to $8.50 per ton.

Fourth quarter net income rose 325% to a record $42.1 million or $0.93 per diluted share, compared to $9.9 million or $0.21 per diluted share in the fourth quarter of 2007. During the fourth quarter, Foundation recorded unrealized net mark-to-market gains of 1.8 million after-tax. Fourth quarter net income, excluding this special item was 40.5 million or $0.89 per diluted share, compared to 10.4 million or $0.22 per diluted share the year ago period.

Overall, we believe that Foundation's highly hedged position, limited exposure to permitting issues and surface mining at Central Appalachia, our low cost operations and our strong liquidity position have combined to lay the groundwork for record financial performance in 2009 and make Foundation one of the best positioned domestic producers in today's market environment.

With that operator, we will now open the queue for questions.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions). Our first question comes from Jim Rollyson from Raymond James. Please proceed with your question.

James Rollyson - Raymond James & Associates, Inc

Good morning everyone.

James Roberts

Hi, Jim. How are you?

James Rollyson - Raymond James & Associates, Inc

Hey Jim, if you take a look at obviously in light of Laurel Creek being idled and not withstanding the fact that first quarter is probably going to spike back-up in terms of costs with the longwall moves and the gas issue. Just looking broadly at 2009 how do you think about your cash cost relative to 2008, may be outside royalty issues?

James Roberts

Well, because the increase in production is primarily coming from the Powder River Basin. Overall the average cost will be... we think between flat and round about 12% up on a per ton basis. So we're not looking at the type of increases in costs that we incurred in 2008... in 2007 and 2008. So, the mines that we run as we stated that that most of our coal is produced from five of our largest mines. These mines are low cost mines in all of the regions. So we are looking at costs moderating significantly in 2009.

James Rollyson - Raymond James & Associates, Inc

That's great. And in light of the CapEx kind of timing differences maybe on the new developments; any update on your... I think you guys were looking at another LBA for the North Extension at Belle Ayr. Where does that stand in your mind today?

James Roberts

Jim, that's... right now that will be out probably in the first or second quarter of 2010. So we don't anticipate any additional LBA expenditures, other than Eagle Butte in 2009.

James Rollyson - Raymond James & Associates, Inc

Great. And last one, Frank just thoughts on tax rate for what you guys are looking at for 2009?

Frank Wood

Yes, Jim it's one of the hardest things, I think as we've discussed before for us to accurately estimate, but I would guess that is going to be between 15 to 25% of book income.

James Rollyson - Raymond James & Associates, Inc

Okay.

Frank Wood

If you take out some discreet items that are in our 2008 income tax expense, it actually on a run rate was closer to 15 than what those numbers would indicate. So I think 15 to 25 is probably in the ball park.

James Rollyson - Raymond James & Associates, Inc

Perfect, well, excellent quarter guys, thanks.

Operator

Our next question comes from Brett Levy from Jefferies. Please proceed with your question.

James Roberts

Hello.

Operator

Brett, your line is live.

Brett Levy - Jefferies & Co. Inc.

Yes, I am on. If you look at the currents costs of all the disruptions related to the gas issue and the longwall moves, can you kind of take us by quarter, what you think at this point the one time affect would be?

James Roberts

As we said in our remarks here, we are looking at the first quarter of this year to be and particularly Northern App, our lowest production quarter. We have longwall moves occurring at both Emerald and Cumberland and as we stated we believe the new current Emerald issue will impact us here from a week or two.

So, on a cost basis, on a per ton basis we would expect our first quarter cost to be higher and not reflective of what our annual costs would be. I think we demonstrated pretty well that when we have the both longwalls running at Emerald which we will have for the most part, approximately seven out of the 12 months this year, we will have both longwalls running at Emerald. We believe we have the capacity to recover from the lower production in the first quarter.

Brett Levy - Jefferies & Co. Inc.

All right. And then maybe ask you another way, what do you think that production hit will be in the first quarter?

James Roberts

Well, we've indicated that Northern App would be between $2.4 and 2.6 million tons. That's down from 4.1 million in the fourth quarter. Our other operations, we are not anticipating any reduction, PRB actually will be up, it will be at a higher level, annualized $55 million ton base as opposed to 49 million tons last year and Central App would be down due to impact on the production basis from Laurel Creek but actually on a shipment basis we'll be continuing to ship the coal at Laurel Creek as committed to purchased coal.

Brett Levy - Jefferies & Co. Inc.

And then just according the timing, would second quarter be fairly clean in terms of equipment moves and the gas issue should be resolved?

Kurt Kost

Yes, we're anticipating the second quarter to be... I would call representative of what our performance level should be for the reminder of the year.

James Roberts

We've vacations in that in the second quarter, but other than that from... as Kurt has said, it should be more representative.

Brett Levy - Jefferies & Co. Inc.

All right. And then in terms of the timing are any of the rulings coming down on permitting. How do you see it? I mean, I know it's a question asked every quarter. But, can you give us a little bit update in terms of sort of when do you see a ruling coming and what do think the industry's response is going to be, et cetera?

James Roberts

Well, I think the ruling that we are expecting is supposed to come out sometime in the first quarter of this year. But I haven't heard anything on it. So, I don't have any more information on the outcome certainly, or the timing then what's in the public arena right now. But, we've been waiting for it, and waiting for it. And, I hope the decision will come out here in the first quarter.

Brett Levy - Jefferies & Co. Inc.

And then the industry's response if it's unfavorable?

James Roberts

Well, we're going to have adapt to it. I think, as other companies have indicated, if it's unfavorable opinion, it doesn't necessarily mean the end of surface mining in Central Appalachia. It has definitely going to increase cost. It will eliminate some reserves, some being produced. But, we'll have to adapt to the rolling and comply with the new rules, and it'll take longer to get permits. But we don't agree that it's the end of surface mining. It will have an impact on... a negative impact from the cost point of view and certainly from the total tons that we produce from it. But, it's not... we don't think it's going eliminate the production.

Brett Levy - Jefferies & Co. Inc.

Thanks so much, guys.

Operator

Our next question comes from Michael Goldenberg with Luminous Management. Please proceed with your question.

Michael Goldenberg - Luminous Management

Good morning.

James Roberts

Good morning.

Frank Wood

Good morning, Michael.

Michael Goldenberg - Luminous Management

I wanted to talk to you about EBITDA guidance. If I'm not mistaken, in previous quarter, you issued '09 EBITDA guidance of 525 to 575, correct?

Frank Wood

That's correct.

Michael Goldenberg - Luminous Management

Are you still holding true to that, or are you confirming, or reaffirming or just not?

Frank Wood

Mike, I'm not going to confirm it or reconfirm it. We have decided to withdraw the guidance at this moment and time, there are variety of issues that are surrounding our decision. We have requirements (ph) contracts this year. We have the outcome of the litigation that we mentioned with on our contract with Kingston. We have small amount of uncommitted coal that we're not sure in this market whether it will be produced.

In normal times, these dynamics can be assessed and evaluated, and we can come up with what we believe a high confidence level within a range of guidance. And, these are just not normal times right now, certainly, not in its first quarter. So, we're just taking a cautious approach right now and deciding... we are still giving guidance, and we're giving the production guidance, we're giving CapEx guidance and we've given our realized pricing guidance.

Michael Goldenberg - Luminous Management

But these are parts that I'm having hard time understanding. You were well more hedged than any other coal producer. I mean, you are 95, 97% hedged. If I am not mistaken, in the past answering, yes, with even less hedging you would give out guidance. I understand there is litigation. I understand there are things around it. But, outside of that 200,000 ton litigation, there haven't been any other contract issued. Is that correct?

James Roberts

We have not had any other contract issues. We've had been contacted by our key players, and on opening of the issue. But, we have not ... nothing to the extent that we have at the current litigation. And we, actually there is, we fully expect all of our contracts, the values of our contracts to be fulfilled. So...

Michael Goldenberg - Luminous Management

So, with that being said, since stuff is hedged out. So is there isn't a high write-down cost as you've alluded to. 200,000 tons even if net couldn't have that much impact. And the tons that you will produce or not produce are likely to have significant impact on EBITDA or gross margins. Why the difficulty ... it feels like you're in a very solid position here?

James Roberts

I would agree with you in last my comment. We are in a solid position. We've indicated that we're going to... we expect record EBITDA and record earnings in 2009. But Michael, we're just not in a position right now to give you a range that we feel with the same level of confidence that we've had in the past.

Michael Goldenberg - Luminous Management

Okay. But, you still hold that it will be a record EBITDA. So, in worse case, you do feel that it should be higher than 360 in '08 which is the current record?

James Roberts

Absolutely. Record earnings and record EBITDA, look at the realizations and you'll have to make your own assumption.

Michael Goldenberg - Luminous Management

Yeah, I agree. Okay, thank you.

Operator

Our next question comes from Michael Dudas with Jeffries & Company. Please proceed with your question.

Michael Dudas - Jeffries & Company, Inc.

Good morning, gentlemen.

James Roberts

Good morning.

Michael Dudas - Jeffries & Company, Inc.

Jim, maybe can take us through your observations relative to the three major regions that you operate, with regard to visible customers inventories or indications of expectations of negotiations or taking coal in 2009 and beyond. And which area seem to be little more over supplied or under supplied and what the expectations you think will... how quickly these production cuts will filter through the different regions that you operate?

James Roberts

That what you say... and there is a lot there. Let me start with Northern App. Northern App continues to be for us the strongest market. Even though more recently the supplies have gone up, I would say Northern App is still more imbalanced than the other markets. Our information on stock price, Michael is a little bit dated there, if we go back to the end of December, the current days is about 48 days versus an average of about 43.

So it's little bit about normal, but we think that Northern App still remains the closest region that's within balance. And in Central App it's not a whole lot different and I think they were just so many, so much dynamics going on in Central App, it's hard to give a date when things will be back and balanced. You've this decrease in export amounts coming into play, you have the met coal drop.

So, but on the other side of that we're seeing cut backs in production and the heaviest level in Central Appalachia. So I think you're looking at back half of 2009, before we see some real balance coming into play. PRB has obviously the highest stock price, we're looking at 65 to 70 days. On the other hand, we continue to see shipment, strong shipments out of PRB and increased demand for PRB, not certainly at the levels that we had in past but if you just look at the numbers, '08 numbers were higher than '09, I am sorry... than '07. And we're not looking at much of pull back.

What I think is going to impact the PRB is whether the customers decide to take inventories down or maintain the stock price. And I don't think we know enough about that right now, obviously they take stock price down and shipments are going to be pulled back, if not I think we're going to see another year of strong shipments out of the PRB.

Operator

Our next question comes from Justine Fisher with Goldman Sachs. Please proceed with your question.

Justine Fisher - Goldman Sachs

Good morning.

James Roberts

Good morning Justine.

Kurt Kost

Good morning.

Justine Fisher - Goldman Sachs

So Northern App prices and Central App prices have traded, kind of locked up over the last year and they have done that in the past besides (ph) from in 2008. And I was wondering what... and I know you said that the inventory situation in Northern App may differ a little bit from Central App.

But I was wondering where your outlook is on those two... on the relative prices between Northern and Central because we're looking at it because costs are lower. In Northern Appalachia there may be more room for prices there to fall, so I'm wondering what your take is on the relative Northern App versus Central Approximately pricing?

James Roberts

Our experience now is that Northern App prices are still holding up more strongly than Central App. So, whether that continues for the remainder of the year, we are uncertain right now. But and keep in mind Justine there's very, very little activity going on right now. And there is not a lot business being secured and not a lot of activities (ph) out there that we have seen in the last week or so an uptick in request but generally speaking we see more strength in Northern App than Central App?

Justine Fisher - Goldman Sachs

Why do you think that's the case? I am going through a list of things that could be... exports are higher, demand or mine production none of those are kind of working in their favor there. So, why do you think we have seen most stability in Northern App.?

James Roberts

Well, I think for the reasons we have been talking about over the past couple of years, you have more scrubbers come on. You have higher... more utilities are able to use Northern App coal, it's harder and has higher heat content than Central Appalachia; it has, I won't say in all case, favorable transportation, but when you talk about the weather, our Cumberland operation, it's very, very favorable logistics. I think in Central App, you have just more noise. You have more coal coming back onto the market, more supply coming back onto the market because of the export mainly. And, I can only speak what our experience is. And, up to now, right now, we are seeing Northern App ... I am not saying it's anywhere near as strong as it was last year. I am saying in comparison to Central Appalachia, we're seeing that Northern App is holding up a little bit better.

Justine Fisher - Goldman Sachs

Okay. And then there was an article that I saw in Bloomberg the other day about Illinois Basin then cannibalizing some of Northern Apps market, again because of the addition of scrubbers, and because utilities are not able to burn some higher sulfur coal as a result. Are you guys seeing any of that type of market cannibalization because of Illinois taking away Northern App?

James Roberts

Well, we're seeing some of that. But, again, I think it's early in the game for us to put a number on that. Yeah, I think one has to watch what's going on in the Illinois Basin. It's very productive area, but very low cost. I think it'll have more, in fact in the long-term, on other regions, other than Northern Appalachia. I mean, our mines Northern Appalachia, are just so favorably located to the power uses up there. And then we have such a logistic.... again, transportation costs. But I don't think that north Illinois in the long-term will have as much impact on Northern App on other regions.

Justine Fisher - Goldman Sachs

Okay. And then, the last question, just on CapEx number, it's seems there'll still be a reasonably wide range like 190 to 240, especially given that some of that expansion projects have been taken a little bit more slowly. And given that equivalent prices and fuel prices et cetera are down. What accounts for that wide range, and what is the flexibility between the 190 and the 240 in CapEx?

Frank Wood

Well, what accounts for the wide range, Justine is on some of the more development oriented projects, we would have the option of either slowing down or speeding up expenditures depending on how we saw the business and how we saw those projects developing as the year goes on. That's part... certainly the part of range. Another part is that it's built in is that we're never able to predict with great deal of accuracy on how much dollars will carry over or falloff from one year to another. So, we have built that a little bit into the range as well.

Justine Fisher - Goldman Sachs

Okay. Thanks a lot.

Operator

Our next question comes from Jeremy Sussman with Natexis. Please proceed with your question.

Jeremy Sussman - Natexis Bleichroeder, Inc.

Hi, good morning.

James Roberts

Good morning.

Kurt Kost

Good morning.

Jeremy Sussman - Natexis Bleichroeder, Inc.

I guess the first question I had has to do with some of your opening comments on M&A. Is there any particular region that you're seeing an opportunity. You talked about valuations that were historically low. I was just wondering if you could give a little more color there.

James Roberts

No, we're not focused on any particular region, because we have operations in the two major ones. We see synergies in all through the major region. So, we're not particularly focusing on one over the other. We're looking for opportunities in all areas.

Jeremy Sussman - Natexis Bleichroeder, Inc.

Great. And then in terms of your first quarter production, you mentioned 2.4 to 2.6 million tons in Northern App, for it's like it's 4.1 this quarter. How much of that is due to the longwall moves and then how much would be due to the gas situation at Emerald?

Kurt Kost

The bulk of is related to the longwall moves, probably 90% of that change is longwall related.

Jeremy Sussman - Natexis Bleichroeder, Inc.

Okay. So, almost all of that's planned then.

Kurt Kost

Yes.

Jeremy Sussman - Natexis Bleichroeder, Inc.

Okay. And then just last question. I think you mentioned 35 million tons of production cuts that you've seen so far. Can you give us a sense of maybe a breakdown of where you've seen these coming from?

Kurt Kost

Well, I think most of them are in the Central Appalachia area. I think they have all been announced, and I don't want to mention other companies names. But, it's pretty much across to board, and almost exclusive; it's Central Appalachia and the Powder River Basin. I haven't ... I don't believe we've seen any in the Northern, very much in the Northern Appalachia region. But tonnage wise it's... it maybe even between PRB and Central App.

Jeremy Sussman - Natexis Bleichroeder, Inc.

Okay. Thanks for all your color.

Operator

Our next question comes from Brian Gamble with Simmons & Company. Please proceed with your question.

Brian Gamble - Simmons & Company

Yes. Good morning, guys.

James Roberts

Good morning.

Brian Gamble - Simmons & Company

A couple of details, real quick. The Eagle Butte lease payments, how much is left on that and how many more years you've on that thing?

Frank Wood

We've got four more years of $36 million per year. So it's sort of that act... what ever that pass comes out, I think to $154 million.

James Roberts

And then you mentioned on Laurel Creek, you have sort of commitments for most of that for the year, there will purchasing coal on have you already because you already going to shut that time, have you gone out and purchase that coal already or would it be buying that on more quarterly basis as you go through a year.

Kurt Kost

Yeah, we've got the majority of that coal pretty well locked up and committed to so, we were in good shape for meeting those requirements for the rest of the year.

Brian Gamble - Simmons & Company

Okay, and then finally on the just wanted to touch on alternatives, you just mentioned growth opportunities, and you mentioned synergies. Did that mean that Illinois Basin is out of the equation for near asset purchasing or do you view that as a region of opportunity there?

James Roberts

Yeah, we also look at that as a region of opportunity. We do have property there. We have our idle Wabash operation and I just overlooked it when I was giving my comments but we would also look at the Illinois Basin as an area of opportunity.

Brian Gamble - Simmons & Company

Okay, guys. Thank you very much.

Operator

Our next question comes from Paul Forward, Stifel Nicolaus. Please proceed with your question.

Paul Forward - Stifel Nicolaus & Co., Inc.

Good morning.

James Roberts

Good morning, Paul.

Paul Forward - Stifel Nicolaus & Co., Inc.

On the eastern US future I guess 2010-2011 projected sales levels of 18-19 million tons that was down from the previous 18.5 to 20.5 range that's you have given in the third quarter. I was wondering was the change all Laurel Creek or as you look at your other mines were there any impairments possibly at other mines that could limit their ability to produce compared to where you were about three or six months ago?

James Roberts

No, I believe it was it's all supported by the shut down of Laurel Creek plant.

Paul Forward - Stifel Nicolaus & Co., Inc.

Okay. Great and also looking at this 2.4 to 2.6 million ton range for the first quarter of '09, you had a comparable quarter for volumes in Northern Appalachia in the third quarter of '08, actually I guess sales were 2.8. When we look at the... whether it's margins from the region or bottom line for the whole company. Can we see first quarter '09 results as possibly being comparable to what you were at in the third quarter of '08 or there are other items that could offset that third quarter of '08 results that were weak in the third quarter of '08?

James Roberts

What will offset that is that we have higher production anticipated from the Powder River Basin. And we have higher margins that would be expected in all of the coal from all three regions, more than Central App and the PRB.

But, 2.4 to 2.6 is not a strong performance for the quarter. So we're indicating that it is not going to be a strong quarter overall. But, it will be mitigated somewhat by higher margins and higher production from our Western operations.

Paul Forward - Stifel Nicolaus & Co., Inc.

Okay, and is there any... I thought the inventory kicked-up during the quarter, is there any inventory in Northern App that can offset some of the production decline?

James Roberts

Not really. Inventory from us, no.

Paul Forward - Stifel Nicolaus & Co., Inc.

Right.

James Roberts

We really don't have much at all and especially with the ongoing longwall moves, probably we will eat into that very quickly, but very low, very little inventories in Northern Appalachia.

Paul Forward - Stifel Nicolaus & Co., Inc.

Okay, thank you.

Operator

Our next question comes from Mark Caruso with Millennium Partners. Please proceed with your question.

Mark Caruso - Millennium Partners

Good morning guys. I just wanted to get some clarifications. As far the coal (ph), in the release it says that you have base collars that are still above market that are not included in that and I wanted to touch base and see if there is risk to those that are being renegotiated or...

James Roberts

The collars biz, we don't include collar business in committed and priced because we don't have a fixed price on it just yet. We have no intentions of renegotiating them.

Mark Caruso - Millennium Partners

Okay. And as far as the met one goes for 2010, is that subject to the lawsuit or is that another customer?

James Roberts

That part of that would be subject to the litigation.

Mark Caruso - Millennium Partners

Okay, great. Thank you so much.

Operator

Our next question comes from Shneur Gershuni from UBS. Please proceed with your question.

Shneur Gershuni - UBS Investment Research

Hi. Good morning, guys.

James Roberts

Good morning.

Shneur Gershuni - UBS Investment Research

Most of my questions have actually been answered. But, I was wondering if sort of we can go through a couple of things here. I recognize it's flat and everybody else reports pricing out there as kind of the 60s but you kind of mentioned that there not been any RFPs out there. We're seeing incredible amount inventory out there and it seems the generation picture continues to get worse and if I do to math on gas, it says you should feel those change (ph). How comfortable do you feel about production levels in Appalachia, do you think it needs to be come down significantly more?

I recognize that you've guys done more than your fair sharing in terms of production cuts. But are there other things that you can do if the situation gets worse are there more Saturday shifts that you can take off at your other mines lines that you would be interested in slowing down. And I understand against the context of you've got hedge positions, is there a possibility there where you where you would look to close high low margin production and potentially buy the coal market and deliver on those contracts?

James Roberts

First with regard to 2009, I don't see a whole lot of room there because of our hedge position. Certainly on the small amount of uncommitted un-priced coal, if we don't get the prices we are looking for then we would take some of the steps that you just mentioned and that would be cutting back whatever overtime that we still have left in our operations. We're not calling to sell that coal at any price.

We have internal hurdles that we apply here if we don't reach those, we will not produce the coal, we won't sell it. But, at this time again it's too early. And we have so little of it, I doubt that we're in much of the position to say that we would go outside and buy coal to meet any of our contracts right now I think Laurel Creek is pretty much where that's going to be.

Shneur Gershuni - UBS Investment Research

Do you think that the industries as a whole needs to cut more aggressively and sort of meet some of the steps that you have already taken or do you think some of the cut backs that have been announced are enough at this point?

James Roberts

I don't what's been announced is enough. We've indicated that we believe that about approximately $15 million tons production need to be cut back and we're looking at a number that's some where between 35 and 40 million tons. I've mentioned earlier that it was mostly PRB and Central App, but there is also Northern App that's been announced Northern App about 8 or 9 million tons, of Northern App production that's been announced to be cut.

Now we believe more high cost unprofitable mines will be closed and announced before the end of the year.

Shneur Gershuni - UBS Investment Research

Great. In an earlier question I think it's Jeremy that actually, he talked about M&A and where you are targeting and so forth. Would you also consider a scenario a merging with an equal or being taken over the right opportunity if it looked to advance shareholder value or is you are more focused on rolling up some other smaller players that are probably on edge given the economic environment?

James Roberts

No, we don't get the opportunity that presents itself that maximizes the value to our shareholders. And whatever combination that comes in that's... we would evaluate that. We are not ruling out anything at this time.

Shneur Gershuni - UBS Investment Research

Okay. And one last question and ... that I want to return to the question, too much about guidance. But just to understand the committed in place tons that you mentioned as a percentage yield for '09 and '10 do they feel include the tons that are obviously under litigation right now and/or any other contracts that you've been contacted on or some of that been removed out of those numbers?

James Roberts

No, they include the tons that are under litigation and include all our tons that are committed in price. I don't want to make a sound like I think if other customers have pushed us. So we have going through the level where we are but the one that we'd mentioned it's mainly talk. And right now we have one issue and that's the issue that we've stated.

Shneur Gershuni - UBS Investment Research

Great, perfect, thank you very much.

Operator

Our next question comes from Mark Liinamaa from Morgan Stanley. Please proceed with your question.

Mark Liinamaa - Morgan Stanley & Co.

Hello. You mentioned earlier in the call about selling forward most of your coal for this year before the collapse in prices that we saw at the end of the year and you're perceived as a company that is opportunistic sometimes southerly (ph), can you comment on what's you strategy will be in the current market with 20 million or so tons you have left for 2010? Thanks.

Kurt Kost

It's going to be tougher Mark obviously. We're going to try an attempt at this point to not make reverse course of what we did last year and that is keep our contract short-term, and get the highest price we can. I think we like other companies will be tested with tough decisions by the end of the year. As to whether we commit a higher percentage of our tons in the 2010. I certainly don't want to broadcast that at this point what we're going to do but it's going to be a little tougher trying to figure out the market in the future but we're certainly not willing at this time to make multiyear contracts at the levels that the markets are right now.

Mark Liinamaa - Morgan Stanley & Co.

Thanks very much, good luck.

James Roberts

Thank you.

Operator

Our next question comes from Luther Lu with FBR Capital Markets. Please proceed with your question.

Luther Lu - FBR Capital Market

Good morning.

James Roberts

Good morning Luther.

Luther Lu - FBR Capital Market

Jim, I know you can't comment on the law suit, but can you comment on the shipments after the law suit... have they been normal?

James Roberts

I am not sure I understand the question, Luther comment on the shipments from the customer?

Luther Lu - FBR Capital Market

Yes, to the customer.

James Roberts

I really don't want to make any comment on this issue at all Luther. I think what we stated in our opening remarks is all I can say on it.

Luther Lu - FBR Capital Market

Okay, great. And then Frank, can you give us some color on cost issues like diesel hedging, employee labor turnover...

Frank Wood

I'll try to do that Luther. On diesel hedging for 2009, I think if you look across the entire company we are roughly 74% hedged and we did that back in the late summer, early fall. So, we're hedged it considerably higher prices than what the current spot market diesel prices are. So we'll be able to average it about 25% of our purchases this year against those higher priced hedges.

So we've build that into our cost expectations for this year. Our explosives have some of the same characteristics, although I don't think the movement there has been quite as extreme as what we've seen in diesel fuel.

With regard to employee turnover and employee labor rates, yeah we've seen a moderation of that. Our employee turnover did drop fairly markedly in the fourth quarter so more to what some others have reported and while we're trying to be very judicious about how we price labor and not do things that are going to harm us long-term. We do see some of the incentives that we put in place last year gradually expiring over time.

So we think labor definitely is moderating from what we experienced last year when it was pretty clear that Central App was really leap frog like situation for quite a while. And then the other things we're seeing on petrochemical type products and some of the non-ferrous metal type products we are seeing price reductions on those and we think as the year unfold we'll see that broadening across the broader spectrum of products probably to include most of steel related stuff. Though, not much of that has manifested itself quite yet.

Luther Lu - FBR Capital Market

Okay. Got it, and finally just around the question going back to the acquisition, Jim are seeing that there are opportunities out there that you can buy as the cheaper price than your organic development?

James Roberts

I think we're seeing, I first have to describe this as not a highly active arena right now. Two, one would expect that the opportunities this year would unlike last year be priced more closely at organic opportunities, but what we were looking at in 2008, where the acquisitions were for much higher costs than what we could develop with our organic assets. We are seeing a little bit of that turn around but again not a lot of activities.

Luther Lu - FBR Capital Market

Okay, great, thank you.

Operator

Our next question comes from Jugson Tui with Tui Brothers Investment (ph). Please proceed with your question.

Unidentified Analyst

Good morning guys.

James Roberts

Hi, good morning James.

Unidentified Analyst

Jim, you've been very consistent with your approach to contracts throughout, that's most evidenced with the pending litigation right now. On some of the other calls we've heard so far this earnings quarter, there has been a lot commentary from other producers, sort of talking about being more flexible and renegotiating, and I think even on one call, we heard someone raised the question of, we need to redefine perhaps the definition of a contract and what a contract even means in this environment.

So, I was just ... certainly some of that commentary isn't really helping near hand. And I was wondering if you sort maybe had some thoughts on some what are the other guys are saying?

James Roberts

I think each company has to determine for themselves, what is best for their company and what's best for their shareholders. We at Foundation have consistently year-after-year on all of that contracts we had ever had with all of our customers complied 100% with every contract. And yes, there have been deals in the past where we have renegotiated deals because we wanted to ... we attempted to do that or whether the customer came to us. But overall, the package that was negotiated was a mutual based on a mutual agreement.

I can't speak for the others. I can only speak for Foundation. We worked very, very hard to put ourselves in a position that we are in today. Last year, we sold a lot of coal at some market prices significantly below market. We shipped a 100% of it. We're only asking our customers to fulfill their contracts like we did last year. I can't speak for the others.

Unidentified Analyst

Fair enough. Thank you.

Operator

Our next question comes from Garrett Nelson with Davenport & Company. Please proceed with your question.

Garrett Nelson - Davenport & Company

Yeah. Just wondering if you could comment on your decision to not trim your planned PRB shipments as soon your peers in the have done, given the 65 to 70 days of your inventory that you referenced earlier. Obviously, this year is fully committed in price, but for 2010 or 11?

James Roberts

Well, we have a significant amount of 10, 11 unsold, uncommitted un-priced, with the guidance we're giving is the productive capacity that we have in 10 and 11. And the decision whether we produce all of that and ship all of that will be made as the year goes out.

With respect to 2009, your comments correct, we sold it all, we're going to comply with our contracts and ship to coal. So, what you're seeing in guidance for 10, 11 is what our capabilities are.

Garrett Nelson - Davenport & Company

Okay, great. Thanks.

Operator

There are no further questions in queue at this time. I would like to turn the floor back over to management for closings comments.

James Roberts

Again, as always, we appreciate everyone's interest in Foundation. We believe we are ideally positioned today to handle the uncertainties and the economic uncertainties that face us today. We look forward to having as we said it earlier, record earnings and record EBITDA generation this year, and we look forward to talking to everybody at the end of our first quarter. Thank you.

Operator

This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.

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Source: Foundation Coal Holdings Q4 2008 Earnings Call Transcript
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