Walter Energy Management Discusses Q4 2012 Results - Earnings Call Transcript

Feb.21.13 | About: Walter Energy, (WLT)

Walter Energy (NYSE:WLT)

Q4 2012 Earnings Call

February 21, 2013 9:00 am ET

Executives

Paul Blalock - Vice President of Investor Relations

Walter J. Scheller - Chief Executive Officer, Director and Member of Executive Committee

William G. Harvey - Chief Financial Officer

Daniel Paul Cartwright - President of Canadian Operations

Michael T. Madden - Chief Commercial Officer and Senior Vice President

Charles C. Stewart - Senior Vice President of Project Development

Analysts

James M. Rollyson - Raymond James & Associates, Inc., Research Division

Andre Benjamin - Goldman Sachs Group Inc., Research Division

Shneur Z. Gershuni - UBS Investment Bank, Research Division

Brian Yu - Citigroup Inc, Research Division

Michael S. Dudas - Sterne Agee & Leach Inc., Research Division

Caleb M.J. Dorfman - Simmons & Company International, Research Division

Lucas Pipes - Brean Capital LLC, Research Division

J. Christopher Haberlin - Davenport & Company, LLC, Research Division

Paul S. Forward - Stifel, Nicolaus & Co., Inc., Research Division

Operator

Welcome to Walter Energy's Fourth Quarter 2012 Earnings Call. [Operator Instructions] I would now like to turn the meeting over to Mr. Paul Blalock, Vice President of Investor Relations. Sir, please begin.

Paul Blalock

Thank you, Gwen. Good morning, all, and thanks for joining us today. Today's call is being webcast and a recording will be available and archived on our website for at least 30 days. On this call, we may refer to forward-looking statements made in yesterday's press release, and we may make those and other forward-looking statements during this call. For more information regarding the risks associated with forward-looking statements, please refer to the company's SEC filings.

Joining me on today's call are Walter Energy's CEO, Walt Scheller; and CFO, Bill Harvey, as well as other members of the management team, who will be available for Q&A. Thank you for your attention this morning, and I would now like to turn the call over to Walt Scheller.

Walter J. Scheller

Thanks, Paul. Good morning, everyone, and thank you for joining us. As we always do, I'd like to begin today with a brief but important update on our ongoing safety initiatives. Across all Walter Energy operations, reportable injury rates have improved 26% in 2012 from 2011. I'm proud of this accomplishment and want to remind everyone that safety awareness and prevention is always a top priority.

Turning now to our full year results and achievements. 2012 was a challenging year for our industry. Throughout 2012, Walter Energy responded to these challenging market conditions by curtailing certain operations and projects, reducing costs and enhancing productivity. In order to understand how we executed well on this strategy, it's helpful to look back at how the year began.

In January, Rich Donnelly and Dan Cartwright were appointed to lead our U.S. and Canadian operations. And later in the year, we completed our senior leadership team based out of our headquarters in Birmingham. With a new senior leadership team in place, we aggressively managed production as a key strategic priority.

In total, in 2012, we reduced met output by over 1 million tons with the majority of the reductions coming from our lower margin mines in Maple underground, Gauley surface and from slowing the growth from Brule and Willow. In the right market conditions, our high-quality met operations can increase production and fuel our growth.

Despite the curtailment of some production, Walter Energy made solid progress in our operations in 2012. In fact, we safely increased our met coal production to a record 11.7 million metric tons, which is an increase of 35% over 2011 and within our targeted range. On the cost front, we also made significant progress in reducing production costs in 2012. However, I believe we still have significant room for improvement.

To properly reflect the impact of our cost reduction initiatives, we are introducing a new financial metric externally, which measures the total cost of production per metric ton. We reduced our cost of met coal production by 6% on average in 2012 and we reached a low of $90 per ton in production cost in the third quarter. I am also pleased to note that we made progress in reducing production costs for every category of met coal.

For low vol, our largest and most profitable product, the cost of production decreased 5% from the fourth quarter 2011 to the fourth quarter 2012. For our mid vol products, production cost decreased 10%. And for our PCI, production costs declined 39%. On average, across our met coal operations, production costs decreased 20% from the fourth quarter of 2011. Unfortunately, we also experienced a 39% reduction in the average selling price for our met coal in 2012 from an average of $242 per ton in the fourth quarter of 2011 to $149 per ton in the fourth quarter of 2012.

I'd also want to mention our work at Mine No. 7, our largest and most profitable operation. We've reorganized this operation into 2 separate management teams. And in 2012, we saw enhanced performance and improved safety record as a result. In the first quarter, we transitioned the Willow Creek project in Canada from a contractor to owner-operated coal mine. Later in the year, we moved Brule to owner-operated status and reconfigured operations to respond to lower pricing. Throughout 2012, our operations performed well with strong met production as we implemented productivity enhancements.

In summary, even in the face of market challenges, 2012 was a year of progress as we continue to optimize our operations by controlling the controllables and execute on our strategy, both with the objective to build shareholder value.

Before I leave the highlights of 2012, I should mention that in addition to improving our safety record, Walter Energy also received significant recognition in Canada, West Virginia and Alabama, including the Sentinels of Safety Award, the Edward Prior Safety Award and the Surface Mine Reclamation Award.

Turning now to the fourth quarter. In the fourth quarter of 2012, Walter produced 2.5 million metric tons of met coal in the lowest pricing and softest demand environment from met coal in the last few years. We executed this strategy of a reduced operating schedule across our operations in response to soft global demand and strong inventory levels. Our met production consisted of 2 million tons of hard coking coal and about 0.5 million tons of low vol PCI production.

In the U.S., we've produced 1.5 million metric tons of met coal in the quarter, down from 1.7 million metric tons in the third quarter. Of our 2 large underground mines in the U.S, Mine 4 loss in production in December due to animal [ph] panel productivity declines, while Mine 7 performed well throughout the quarter, completing its E3 panel in the last few days of the year.

In Canada, met production was 924,000 metric tons, down from micro [ph] production in the third quarter. As we indicated on our last call, our plans for the fourth quarter were to reduce production at Brule and destock excess inventory. As I said in our third quarter call, we said we'd be reducing production at Brule and Willow in the fourth quarter in order to destock. We intended to run Brule at 60%, which it did. We expected to idle Willow for 2 weeks, which we did. Brule transitioned from contractor operated to owner operated in that quarter as well. Unfortunately, we experienced port and rail availability issues in Canada in the fourth quarter. The port were shut down unscheduled for 10 days in December and weather-related issues impacted rail haulage. These issues minimize our ability to destock to 100,000 tons. Indeed, we had 3 vessels waiting to be loaded at year end.

Additionally, this outage affected our Wolverine mine, which lost about 20% of its production for the quarter. These transportation issues have continued into the first quarter but have improved greatly in the last several weeks.

In total, fourth quarter sales were 2.5 million metric tons, with just over 200,000 tons of contracted shipments delayed in the 2013 due to the issues with rail import availability, primarily in Canada.

I will now hand it over to Bill Harvey, our CFO, to discuss financial results.

William G. Harvey

Thanks, Walt. On a full year basis, 2012 revenues were $2.4 billion, 7% lower than 2011 revenues with 2011 revenues, including the results of Western Coal only from April 1. In the fourth quarter of 2012, revenues were $479 million, a reduction of 22% from the $612 million of revenues in the third quarter of 2012.

Our average met coal selling price for the fourth quarter of 2012 was $149 per ton as compared to $191 per ton in the third quarter, a decline of $42 per ton. Our sales of met coal in the fourth quarter of 2012 totaled 2.5 million tons as compared to 2.6 million tons in the third quarter.

Our net loss for 2012 was $1.1 billion or $16.96 per share -- per diluted share, including $1.1 billion of impairment and restructuring charges, most of which were recorded in the third quarter. Excluding these charges, our 2012 adjusted net income was $31 million and full year adjusted EBITDA was $412 million.

In the fourth quarter, as Walt highlighted, our operating results were negatively impacted because of the temporary idlings, reconfiguration of our Canadian mines and the large reduction in selling price. In the quarter, our net loss were $71 million or $1.13 per share, which includes asset impairment and restructuring charge of $7 million. Without this charge, the fourth quarter adjusted net loss was $66 million and adjusted EBITDA was $7 million. Cost of sales was about $430 million in the fourth quarter of 2012, down 4% from the third quarter, primarily due to a decrease of 77,000 met coal sales in the fourth quarter.

SG&A was $29 million in the fourth quarter, an improvement compared to the $32 million of SG&A in the third quarter and a significant improvement from the $36 million per quarter run rate in the first half of the year. The SG&A total for the year was $133 million compared to $166 million in 2011. The 2011 number was inflated by acquisition costs related to Western Coal. Prospectively, we anticipate trending down on SG&A and we have targeted to move down to the $120 million range by the end of the year.

Depreciation of $92 million increased by $10 million over the third quarter due to taking an accelerated depletion charge as a result of an LCM charge at the end of the year. This charge will lower our depletion as we drop down our inventory. We expect for depreciation [ph] and depletion to track at the roughly $80 million to $85 million a quarter.

Interest expense of $49 million includes approximately $6 million in accelerated amortization of debt issuance costs due to the earlier payment of debt, as well as a one-time $3 million expense. We recorded a tax benefit during the quarter of $71 million, which reflected about a 50% tax rate. In the quarter, we realized the one-time benefit of $15 million as a result, and that occurred in the quarter. Going forward, we continue to expect a long-term tax rate of 40%.

We ended the quarter with liquidity of $445 million consisting of cash and cash equivalents of $117 million plus $328 million of availability under the company's revolving credit facility.

During the quarter, we issued $500 million of senior notes to mature in 2020, which improved our liquidity an extended our debt maturities. We reduced capital spending to $60 million in the fourth quarter and $392 million for the year. For 2013, we continue to expect capital spending of $220 million.

Our inventory level decreased about 100,000 tons in the fourth quarter as we implemented an operating plan to reduce production and lower inventory. However, rail and port issues limited our progress. We ended the quarter with approximately 1.8 million tons of inventory. We will be managing working capital levels aggressively in order to improve our cash flow. We expect sales tons to materially exceed production in 2013.

Lastly, as Walt mentioned, we added cash cost of production figures to our reporting this quarter and believe that they enhance transparency. This metric takes the cost at each mine before transportation and in the inventory accounting, our tax adjustments on a per ton basis. We believe we also have improved the presentation of the stat sheet to better detail the breakdown by product.

I'll now turn it back to Walt.

Walter J. Scheller

Thanks, Bill. Turning now to 2013 and starting with operations. At Mine No. 7, both longwalls have moved to new panels and are operating normally. We expect production at Mine No. 7 to be more consistent this year and project it to increase from 2012 production of about 4.3 million tons to a range of 4.5 million to 4.7 million metric tons in 2013. Both longwalls at Mine 7 moved in the first quarter and the longwalls continue on those panels until the fourth quarter of this year. We expect the cash cost of sales at Mine No. 7 to average around $100 per ton in 2013 and be slightly higher in the fourth -- first quarter and fourth quarter due to longwall moves.

Mine No. 4 have short panels throughout 2012 and have mined about 1.7 million tons. In 2013, Mine 4 begins transitioning into longer panels and should move up to 2.2 million to 2.4 million tons. We expect 2 longwall moves in 2013 at Mine 4, one at the end of the first quarter and one near the beginning of the third quarter. We expect the cash cost of sales at Mine 4 to average a little over $110 per ton in 2013 and be higher in the first and third quarters due to the longwall moves.

Next, the Wolverine mine in Canada has consistently produced 1.8 million to 1.9 million tons over the last few years and we expect it will do the same in 2013. We expect that the cash cost of sales should average around $120 per ton in 2013.

At Brule, we currently expect production of 1 million tons of PCI depending on market conditions. Our target for average cash cost of sales at Brule is around $130 a ton.

Willow Creek is more difficult to estimate, but we are targeting around 1 million to 1.2 million tons in 2013, with approximately half its production of high-quality low vol hard coking coal on par with No. 7. Our target for Willow cash cost of sales is around $150 per ton.

Turning to our high vol products in the U.S., we expect to mine around 1 million tons of high vol products in 2013, producing 200,000 to 250,000 tons per quarter. We will run these operations at reduced levels for the near term and expect them to be cash positive.

I'd also like to briefly mention our thermal coal business. The majority of our thermal is from the North River operation, which was purchased in order to develop the new Blue Creek Energy project. Our thermal production is contracted to utility customers and operations are EBITDA positive. We expect that 2013 will be the last full year for our thermal business as the mine is expected to complete its mining plan and exhaust its resource over the next 18 months.

In addition to North River, we have some thermal coal as a byproduct of the mining for met coal in certain properties. Some of these coals are classified as industrial coal and used by our customers in their operations. Our coking coal operation in Birmingham is also operating well but in a tough market. As many of you know, on a global basis, coke has been on an oversupply situation as ovens must keep running even when steel demand softens. We have adjusted our production as much as we can and our operations remain EBITDA positive. We've also seen no impact on supplier price from the recent removal from the Chinese export tariff. We also operate 2 gas companies. Its primary objective is to degas fire underground mines. These businesses are expected to produce -- expect production remaining at 2012 levels as they produced in 2013.

Turning now to our met coal outlook for 2013. So far in 2013, while we see improvements in the global supply and demand for met coal, we remain cautious in our outlook. First and on a positive note, excess supply of met coal readily available in recent quarters is diminishing. Demand is stabilizing and the spot pricing has recovered to equal or exceed benchmark levels. As such, it appears that met pricing has bottomed in the fourth quarter of 2012 and that the wide price spreads on mid vol and PCI coals experienced over the last few quarters had decreased in the first quarter. Further, recent reports suggest that second quarter benchmark pricing discussions are likely to begin at levels higher than first quarter levels.

It's positive that some of these data points seen were cautious and expect our production of met coal in 2013 to be in the same range as we targeted in 2012. Specifically, we are targeting 2013 production of 11.5 million to 13 million metric tons and met coal sales should be even greater as we target significant destocking in the coming quarters. I should also mention that Walter Energy now has a clear ability to increase production as market conditions warrant up to a total met production capacity of 15 million metric tons.

Overall, we expect first quarter 2013 met production to be slightly greater than fourth quarter 2012 with somewhat better realization on fresh tons. However, due to almost 700,000 tons of carryover from the fourth quarter in 2012, the pricing list in the first quarter 2013 will be limited. We believe the first quarter 2013 will likely be a low point in both pricing and production for the year.

On the cost front, while we made significant progress in reducing production costs in 2012, we still have significant room for improvement. In 2013, we will continue to drive for operational progress at our mines, keep capital spending tight and at the same time, remain well prepared to seize opportunities and enhance met production and cash flow when opportunities materialize.

Turning now to the macro environment. I'd like to take a few minutes to explain why I'm bullish on the long-term business model of met coal. First, global steel production is stabilizing with price increases for steel products on the rise. Next, global steel consumption is projected to increase 3% in 2013, which is a slight increase from 2012, driven largely by the China market, which accounts for 40% to 50% of global steel demand. In late 2012, China had record monthly imports of met coal, hitting over 7 million tons in 2012, Dearborn [ph] met coal imports grew 46% year-over-year, and this excludes overland shipment from Mongolia, which have recently become less certain.

Next, global steel inventories are finally declining and are generally at normal levels of 2 to 2.5 months worldwide. Steel pricing is beginning to recover around the world and is now about $600 for hot rolled coils, which should enable mills to absorb higher raw material prices. In fact, iron ore pricing, which some view as a leading indicator for met coal, has had impressive positive upward swings in recent months and remained strong.

Several Atlantic basin blast furnace restarts had been announced over the past few months, adding potential coal demand primarily to the struggling European markets. In Europe, steel production decreased 3% in 2012 and is forecast to be flat to down 1% in 2013. So Europe is finally stabilizing and has less downside in 2013 than it's had in the recent past. However, steel production in Germany has nudged higher in the last 4 months. And so far in 2013, it looks like light recovery is underway.

In Asia, Japanese steel production declined in the last few months of 2012 but is likely to receive a boost following the $225 billion stimulus package approved by the government, which includes spending on reconstruction project in areas heavily hit by the massive earthquake and tsunami of March 2011. In Korea, mills are still running high utilization rates and we continue to see customers taking all contracted tons.

In South America, steel production has been soft in the second half of 2012 due in part to currency issues. In Brazil, however, forecast continued to call for significant met coal demand increases for the upcoming infrastructure projects for the World Cup and Olympics.

On the supply side, Australia, the biggest supplier by far in the seaborne coke and coal market, has moved to the middle of the global cost curve and production cutbacks when the producers are having a positive impact on met pricing. Essentially, the reduction in high-cost met coal production over the last year was driven by low demand and ample supply, creating poor pricing.

Finally, the significant production cuts, totaling about 15 million tons in the U.S. alone with additional cuts so far in 2013, are working their way into the marketplace in the form of less available supply. When the met coal supply cuts meet the long way to return of steel demand, which looks like it's beginning to happen, pricing will start to rise. So net-net, we expect the environment for met coal will improve in 2013 and we are cautiously optimistic on the future. In either case, Walter Energy will be ready to increase our met production as market conditions warrant.

In summary, during 2012, we improved our operating performance, enhanced our production profile and reduced our costs. We responded to the decline in the world met pricing by reconfiguring our operations and we stand ready for better days.

I am particularly pleased that both the Canadian and U.S. operations are now capable of maintaining solid production levels and are on a path to improve cost structures. So while we remain bullish in the long-term outlook for met coal, we are cautious in our near-term outlook for pricing. The actions we implemented in 2012 to tighten our belts on spending and reduced production until demand and pricing improve were prudent and we look forward to a stronger 2013.

Before we open the floor to questions, I'd like to briefly address Audley Capital's announcement earlier this week that they intend to nominate 5 directors to our board. To date, we have had no dialogue with Audley with respect to their nomination and we have no insight into their plans or objectives. We're always willing to have constructive conversation with our owners regarding ways that the board and the management team can enhance shareholder value. So it's unfortunate that Audley has chosen to take a course that may prove disruptive to our company. The board and management team remain fully committed to creating value for all shareholders due to successful execution of the company's strategy.

As I've often said, no other coal company has a met coal focus like Walter Energy. In my view, the assets we have, along with the strategy we are executing, will help us secure our position as a leading pure-play metallurgical coal producer in North America. We will -- dealt [ph] -- address Audley's assertions in the days ahead.

Having said that, our Q&A session this morning will be focused on our full year and fourth quarter earnings, as well as our outlook for 2013. Thank you for listening. The team and I will now be happy to take your questions. Operator, please begin the Q&A session.

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from Jim Rollyson, Raymond James.

James M. Rollyson - Raymond James & Associates, Inc., Research Division

Walt, you talked a bunch about cost and obviously, you spent the last year plus trying to focus on costs, especially in Canada, bringing them down a fair amount from where you started. And it seems like you've gone through the owner-operator conversion from contractor-operated, and you mentioned just the need to keep focusing on cost. Kind of curious kind of what you think about what other levers you can pull to try and bring costs down. Because it seems like at the end of the day, when all the Western acquisition happened, one of the issues was just maturity of some of the newer mines and getting volumes ramped up was one of the things that would normalize cost and we're kind of in this market that doesn't allow for that just yet. But what other things can you do to keep focusing on costs to help bring those down so you can get to profitability on a couple of those operations?

Walter J. Scheller

All right, thanks for the question, Jim. I'll turn than over to Dan Cartwright to answer for Canada. But before I do that, I do want to mention also, in the Alabama operations, our Mine 4, we anticipate it being a little over $110 a ton in 2013 is also still higher than what we anticipated. But there's a clear path forward that allows its cost to come in line and that is the longer panels. And we're simply dividing higher -- the cost over a higher volume. So we anticipate that mine over the next year or 1.5 years to start to get much closer to the Mine 7 cost, which we anticipate be around $100 a ton. That's -- to Canada, I'm going to let Dan answer that.

Daniel Paul Cartwright

All right, Jim, this is Dan. The things that accomplished we're -- that we've accomplished so far in '12 have had a lot to do with dealing with contractor cost on our operation, not just moving from a company to -- or a contractor-run on to a company-run operation, which is a big part, but there's others as well. But while we've been doing that, we've been working on what I've been calling block and tackling over the past year in this, as the things that will drive the cost down and keep them down and those are in our mine planning. We're working at our mines for opportunities to shorten our haul distances and work on our shovel productivities, which are the driver -- the very heart of all 3 of our operations. We've made great progress and we have that in operation at Wolverine, where we're putting in realtime scorecards that get at the process measures that drive the KPIs that we need to do and we're putting in the technology that allows our supervisors and other people to see on a realtime basis where we are so we can make adjustments, even during the course in the shift and we're making excellent progress on that. We're putting in maintenance systems that allows us to plan and schedule, not just do better repairs, but on a proactive basis, to look on a condition-based situation where we're able to look and address our issues. We're looking at better cost management tools to allow us to see on a close-to-realtime basis so we can make adjustments where possible to -- for those decision makers making our costs all the way from our first-line supervisor all the way up through our high-level managers in the organization. And then we're working on our supply chain and we've made strides in that too in terms of dealing with our key vendors and levering our size and support. So I'm really optimistic that a lot of those things that, really, we laid the foundation for but really didn't get a lot of benefit in '12, are going to come to bear in '13.

James M. Rollyson - Raymond James & Associates, Inc., Research Division

And I presume, just as my follow-up, that a lot of this is -- progress you're going to make is somewhat reflected in the guidance? And I guess just maybe kind of further following up is the -- if prices stay soft like they have been of late and obviously, there's reason to think that things are booked a little bit better, hopefully they get better, how long do you kind of keep running that? You're obviously losing money in the PCI business. Like at what point do you either continue to get costs down or slow down operations there? Just like how long do you kind of keep go with the negative number for where we are today?

Walter J. Scheller

Well, Jim, first of all, Wolverine, as we anticipate the cost of being $120 range in selling a mid vol product, we expect it to remain to be profitable. At Brule, as we've said, we expect our cost to be in the $130s. And with where we see the market going, even though the Q4 benchmark or -- and Q1 benchmark were a little below that, we anticipate it quickly getting up close to $140 or so. So we think that our anticipation is that the Brule mine will be positive throughout the year. The mine that's been more problematic and more difficult is the Willow mine. And when we -- when you look at the total PCI price, a lot of tons that includes the Willow price as well. So again, I want to say that the -- all of the Brule coal in the Brule mine we believe will be profitable. Willow will produce about a 60-40 blend between PCI and hard-coking coal in 2013. So that's the mine where we are most sensitive to a soft market with our cost structure where it currently is and the one that we are monitoring constantly in terms of what our projections are and what the future for Willow is.

Operator

Your next question comes from Andre Benjamin, Goldman Sachs.

Andre Benjamin - Goldman Sachs Group Inc., Research Division

First question, do you consider the Canadian operations now that a lot of the owner-operation conversion was done fully, I'd say ramped in terms of development? Instead of [ph] distinctive pickup, we should be able to see quickly ramp to full capacity? And then what we should think about unit cost being if the capacity was running all out?

Walter J. Scheller

Well, the Brule mine is currently going to be running this year at about 50% of its capacity, maybe a little closer to 60%. If the market for PCI ramped way back up where it was 1.5 years ago, which was closer to $200 a ton, it would take us a little bit of time to ramp back up. We've cut the workforce basically to half of what it was when it was contractor-operated. So it would take us a little time to get the additional folks. We have the equipment that we need to run at full production. We also know that by ramping it to full production at least currently, given the haulage capacity of the Falling Creek Connector Road, it would require us to go back to some -- over the main highway trucking potentially, which has a little -- higher costs associated with it, so it would take a significant price increase for us to ramp that back up to its full capacity. At Willow, Willow, we could -- we have all the equipment that we need to run at full capacity. It's really -- while it's -- this year, it's expected to run at 1 million to 1.2 million tons. Its full capacity will be probably accomplished through the year where it will get to about 1.8 million tons of capacity. So it -- we couldn't respond in a quarter or 2 with Willow, but with the others, I think, we could do so pretty quickly.

Andre Benjamin - Goldman Sachs Group Inc., Research Division

And then regarding debt maturities, I know you don't have any in the next year or 2, but you do need to plan a bit in advance. Based on your view of demand and pricing, do you think that you're going to be able to repay those with cash flow? Or are you thinking you'll have to partially refinance or use some other means of raising capital to repay? And would you consider to potentially, say selling U.K. or West Virginia some non-core assets to do that?

William G. Harvey

It's Bill Harvey. We would -- our plans are a combination of cash flow and a refinancing. As you know, our capital structure has Term A and Term B, and both of those are secured and what we'd like to do is, over the next year, move towards a more normal capital structure and with both cash flow and refinancing be the primarily vehicles.

Walter J. Scheller

In regard to the disposition of assets, as we've said in the past, we constantly look at the assets we own and consider whether or not they are strategic. We find ourselves right now at the bottom of the market and it's a very difficult time to go out and move properties.

Operator

Your our next question comes from Shneur Gershuni, UBS.

Shneur Z. Gershuni - UBS Investment Bank, Research Division

My first question I guess is somewhat a bit of a follow-up to Jim's question, just specifically about the cost in Canada. I was wondering if you can elaborate a little bit about how much more capital you plan to spend on the operation? And then also, if the cost targets that you gave us today kind of where you expect it to be longer term, do you expect it to go lower from there? And I guess the point though really is it worth it to invest any more capital in that operation given that it doesn't seem to generate cash flow at the bottom of the cycle and generally you would prefer a company -- an operation to at a bare minimum to breakeven in -- at the bottom of the cycle. I was wondering if you can sort of elaborate on how much is left to be spent and kind of your view on it on a go-forward basis.

Walter J. Scheller

Well, they are -- all of the operations are substantially capitalized. There's -- the only capital in 2013 was really a little bit of carryover capital for a couple of trucks, I believe. So they are already completely capitalized. From there, the only capital going into those operations right now is some maintenance capital, and that's really pretty minimal at least for the next few years because most of that capital that's been employed has been employed over the last couple of years, so it's -- those -- that equipment is all fairly new. Longer term, we think that Willow operating in -- at around $120 range is a pretty good expectation for -- I'm sorry, Wolverine in $120 range is a pretty good expectation for that operation. I would expect that Brule probably has a little bit of room left. I would hope that we could get it even below the $130 marker longer term. And with Willow, Willow again is the one that I'm most cautious about, but I would expect that there's no reason longer term why it couldn't get a heck of a lot closer to the Willow and Brule cost structure than it is to the -- than where it is currently.

Shneur Z. Gershuni - UBS Investment Bank, Research Division

So if we think about a market where, let's say, it's a weak market, weak pricing and you're forced to take back tons which causes your fixed operating leverage to go up. Is what you're saying is that we should expect it at the kind of on a go-forward basis that the cost targets that you've established for this year is kind of what you think about in a bad -- in a bad market and it could be better in it, in a higher volume market? Is that the way to think about it?

Walter J. Scheller

Yes. Yes, the additional volumes would help drive the cost down.

Shneur Z. Gershuni - UBS Investment Bank, Research Division

Okay, great. And then I was wondering if you can comment on your SG&A a little bit as well, too. I understand that you said that you want to get to that $120 million run rate towards the end of the year. That still seems relatively high to where SG&A was, going back a couple of years, and I realize you do have a bigger operation at this point right now. But relatively speaking, it would seem that you can probably take another $20 million, maybe even $30 million out of that number. Is that possible over time? Is that something that you're targeting? I was wondering if you can sort of elaborate on that a little bit as well, too.

William G. Harvey

It's Bill Harvey. No, I mean, everything is possible. There's nothing -- the way we look at SG&A, there's nothing off the table. Again, a couple of years ago, although I wasn't here, I think the Walter Company alone had SG&A once $117 million. So our $120 million gets us back to where we were before the acquisition. I think we also have to be -- SG&A is highly dependent on where the costs are. We, of course, keep all SG&A that are at the mines. We treat that as SG&A and roll it up that way. Since I've been here, I've looked -- we've looked at SG&A from the bottom up and we're going to be aggressive. I think the only way to manage a company is to be aggressive and reduce costs and we're going to keep doing that over the next year. We try to put in front of us something tangible and that's where the $120 million comes from and something that we know we can get done. There's still a lot of work to do it, but that doesn't mean that's the endpoint. That's -- you should think about it as one of the first steps.

Walter J. Scheller

And I want to reiterate the point that pre-acquisition, if you combine the 2 SG&A numbers, it totaled $190 million. In 2012, it was around $133 million. So from the date of acquisition to the end of 2012, that number came down $57 million. Is that right? $47 million. And we anticipate getting that down even further as we move through 2013.

Operator

Your next question comes from Brian Yu, Citi.

Brian Yu - Citigroup Inc, Research Division

Walt, I believe I heard in your answer to a prior question about capacity at Brule that if you would ramp it up, you'd have to rely on the highway rather than the Connector Road. Can you comment on what the capacity is, with the Connector Road right now? And what would be the amount of CapEx to -- get it to build the service to full 2 million tons out of Brule?

Walter J. Scheller

Well, right now, the Connector Road is running at about 4,000 tons a day. If we are running at 2 million tons a year, that has to be increased to closer to 6,000 tons a day. And that's just a matter of some further capital the truck hauler has to employ in order to get it up to that 6,000-ton range. They can't do that overnight and if -- with our production levels scheduled to be lower than that rate, the need for them to be at 6,000 tons a day is not as great as it would be if we were running at the 6,000-ton a day or at the 2 million ton a year pace. But we would still have the capability. As I said, it's a little higher in cost per ton, but we can temporary run some additional tons across the highway.

Brian Yu - Citigroup Inc, Research Division

Okay. And then my second question is at Willow Creek. I thought I heard you mentioned a 50-50 mix but then there's also a 60-40 mix. I was hoping you'd clarify that for me. And then while on the same lines, what would you think is the longer-term hard-coking PCI mix at Willow?

Daniel Paul Cartwright

This is Dan. We're probably -- we're looking at 40% to 50% this year is really what we are expecting there in our hard-coking coal. In the way that our mine plan is laid out, we're looking at, probably longer term, the same kind of mix of 40-60, 50-50 hard-coking coal to PCI mix in Willow. But we're still working our mine plan to determine the way at which that's uncovered and would be produced.

Operator

Your next question comes from Mike Dudas, Sterne Agee Capital.

Michael S. Dudas - Sterne Agee & Leach Inc., Research Division

Well, you did a good job taking us around the world relative to steel production and several [ph], maybe you or Mike can -- maybe a little more detail on how much -- or how long the lag might be from European or Brazilian customers to start to see their inventories of their coke needs improve relative to what we are witnessing in the Pacific basin and how quickly you might see that flow through to impact margins for Walter this year?

Michael T. Madden

This is Mike. I guess, I think Walt said in his prepared remarks that we're seeing a definite improvement in Germany, which is a big customer of Walter. In fact, just for January alone, their production was up 5%. I think we saw a lot of destocking going on in Q4, which is normal course for steel mills to get their cash out of their inventories and we are starting to see some pickup. But it's very segmented, particularly in Europe. And unfortunately, Brazil has still been a bit of a disappointment for us. We really had felt that Brazil would do better by this stage, but their real is still hurting them. But we're confident that in '13, they're going to have to force the issue to pick up the pace because they've got some big construction items out there. So overall, I think Europe will be as -- maybe a slight increase over '12 and then I think Brazil I think will have a better picture for '13.

Michael S. Dudas - Sterne Agee & Leach Inc., Research Division

So you're getting indications from your Brazilian customers -- or you haven't really received them yet about the fact they may have to force the issue as you move into second half of the year?

Michael T. Madden

I haven't seen it in Q1, but we haven't gotten our Q2 schedules yet. But Q1 schedules were relatively normal, but we're still anticipating that there should be a pickup, particularly in the second half.

Michael S. Dudas - Sterne Agee & Leach Inc., Research Division

And my follow-up would be -- and Walt, you talked about one of the drivers of the market being the Australian mines falling into the middle of the cost curve or moving up into the middle of the cost curve. Or maybe you can characterize that relative to where you might see some of the high-cost mines. How much is Canada and U.S. kind of moved in that spectrum? And do you think the market is well supported at $165 given where the cost curve is today?

Walter J. Scheller

What -- I think that when we look globally, I think that the cost curve has moved up kind of across the board. I don't think there's any -- there's not a lot of low-cost operations left out there once you factor in transportation cost along with the mining cost. At the $165 mark, I think that's where -- we started to see a lot of these tons come off the market actually when the price was closer to $200 a ton. So I think we've seen tons that are going to struggle to come back into the market. And a lot of that is -- the Central App tons, that's where those tons started coming out of the market. I think the number that really supports the production levels that even we're seeing today is probably above the $180 mark.

Operator

Your next question comes from Caleb Dorfman, Simmons & Company.

Caleb M.J. Dorfman - Simmons & Company International, Research Division

I guess, first off, it seems like the low vol PCI pricing has been pretty strong as of late. When do you think you're going to start to realize this uptick and how much more of an uptick do you see coming in the next 2 to 3 quarters?

Michael T. Madden

Well, to answer your first part, yes, we have seen an uptick for sure, not only on the pricing, but in the demand sector as well. We've had 2 customers, traditional customers in Asia who will have already asked for increases in their contract tons for 2013, so demand is running well. I think Walt said earlier, the $140 looks like a definite or a pretty definite number for the next quarter. Even though we've seen spot, actually we're selling above that in some instances.

Caleb M.J. Dorfman - Simmons & Company International, Research Division

Great, that's very helpful. And then I guess next, what are you seeing on the demand side for the mid vol products versus your low vol product? It looks like during the quarter, you had production of low vol outpacing mid vol. Is that more of a demand for the mid vol products or there's some other issues to think about?

Michael T. Madden

No. The low vol, I guess you're referring to the Alabama operations, but the low vol in Alabama is always going to outpace the mid vol because there's 2 longwalls operating in that mine versus 1 longwall at the mid vol. But we're starting to see the delta on pricing between the low and the mid narrowed, which is a good sign.

Caleb M.J. Dorfman - Simmons & Company International, Research Division

How large of a delta are you seeing right now? I know that before, you talked about it blowing out to $15 a [indiscernible], then I think it sort of like narrowed more to the $5 to $10 range. What are you seeing now?

Michael T. Madden

I think, well, the Q1 benchmark, it narrowed down to about $4, so -- and that's what -- I think in Q4, it was about $8. It's moved up 50%.

Caleb M.J. Dorfman - Simmons & Company International, Research Division

Do you see that continue?

Michael T. Madden

The indications are out there that, yes, that delta that we seeing right now could narrow a little a more or stay the same.

Operator

Your next question comes from Lucas Pipes, Brean Capital.

Lucas Pipes - Brean Capital LLC, Research Division

I'm trying to understand what is driving down the costs in Canada and the future considering you don't plan to spend additional capital there. Is the geology improving? I know that has caused some volatility on the cost side in the past, so is really geology the driver or it's more of the technology and equipment changes that you mentioned earlier?

Walter J. Scheller

I'll let Dan answer that, but I guess I'll start with just saying I don't think we've see the fruits of everything we did in 2012 yet, so I think that the employment of capital, the changes from contractor-operated to owner-operated, the continued training and enhancement of skill sets of the employees have been brought over from the contractors and have been hired. But from there, I'll let Dan answer that as well.

Daniel Paul Cartwright

Well, I guess probably the biggest thing that -- if you compare '12 to '13 is the fact -- is Willow's cost. And if you remember, those were highly affected by the developmental activities that were going on that wound down probably the latter part of October. The other thing longer term at Willow that we've talked about is that the nature of these operations, which are essentially open pit means you're mining in a bowl, it may be -- might be the best way to say that. And early in the life of a mine, even when it comes out of development, you're -- if you can just imagine a bowl, if you manage across the top -- if you manage from the top of it down to the bottom in horizontal slices, you're going to be taking more waste than coal as you work your way down into that. Now Willow is in that situation and will be in that as it works through this year and to next year. But our other mines have all gone through that same process, so that's -- it's the Willow costs that have them at the higher level where they are and it's those costs that will improve due to ratio as we mine toward the bottom.

Lucas Pipes - Brean Capital LLC, Research Division

That's helpful. And just in terms of your coke business, how do you think about that strategically?

Walter J. Scheller

Well, I think strategically, it's a huge asset to us in that Since we ship some of our Mine 7 or Mine 4 coal to our coke plant, any issues and anything we have going on with our coals, we know about well before it goes to any of our customers. So I think it gives us an advantage there. We're also able to approach the customer from a far greater knowledge base in terms of what we think the products we're presenting are capable of doing. So I think it has a lot of strategic value to us in terms of our customer base.

Operator

Your next question comes from Chris Haberlin, Davenport.

J. Christopher Haberlin - Davenport & Company, LLC, Research Division

Kind of focusing on Q1. I believe, Walt, you said that Q1 would be the low point for sales price and production. And just thinking about costs given that, that production is going to be at the low point, should we expect costs to be the high point for the year in general? And then how should we think about it relative to Q4?

Walter J. Scheller

I think, first of all, we had 2 longwall moves in Mine 7 in the first quarter. So that's naturally -- as I said before, that's going to drive their cost structure higher on a per ton basis. So I think when we look at it, Q1 production will probably be higher than Q4. Costs will, across all the operations, be close to down a little, but it's going to be pretty close because again, we have -- where in Q4 we had reduced production in Canada intentionally, some intentionally, some unintentionally in Q1, the reduced production levels will be at -- in the Alabama operations.

J. Christopher Haberlin - Davenport & Company, LLC, Research Division

Okay. And then, there's been a lot of commentary out there about pricing spreads for hard coking coal being pretty wide in the Atlantic basin versus the Pacific basin. And given that you all produced premium products, are you seeing those wide spreads and the -- kind of what's the trend you've been seeing there?

Michael T. Madden

Yes, this is Mike. In Q4, we did see a spread in the Atlantic versus the Pacific when the benchmark was at $170. When it moved to $165 in Q1, we've seen pretty much an equalization on the realization on the top-tiered pricing.

J. Christopher Haberlin - Davenport & Company, LLC, Research Division

Okay. And then just last question for me. You mentioned the $120 million in SG&A. In Q4, it looks -- if you annualize that, it kind of ran below that. What's the difference there for the year?

William G. Harvey

I guess that one is on -- I think we -- the way we look at it, you really have to look at SG&A on an annual basis. And so we've set our budget on a annual basis and that's how we're managing it. There's always, in any given quarter, some noise up or down, but we think $120 million for a year is a good aggressive target. And again, it's a starting point, we're not going to end there.

Operator

Your last question comes from Paul Forward, Stifel.

Paul S. Forward - Stifel, Nicolaus & Co., Inc., Research Division

I wanted to ask about the Blue Creek project. On the $220 million of capital spending planned for 2013, how much of that is kind of early development work on Blue Creek? And maybe as a follow-up to that, as you look at that project, how important are the tax credits to the economics of the project? And maybe since you're splitting out the costs on No. 4 and No. 7 here, I was just wondering if you could talk a little bit about -- as you look at that project, how does it -- does it look a lot more like No. 4, does it look like No. 7 on cash cost and quality?

Walter J. Scheller

I'll let Chuck Stewart answer that question.

Charles C. Stewart

Yes. This year, I think the CapEx for this year is about $40 million. It's getting into the main development of the shafts and slopes for this year. The second part of your question was -- I'm relating back to the quality. Yes, quality-wise, it's going to be more like a No. 4 product. Cost structures wise, it's very -- at this point, it looks very attractive. It looks like that's going to be like any Blue Creek mine's geology, when you get down there, it can change a little bit but right now, I'd say it's going to be on the line with potentially the 4 and 7 mines and that there...

Walter J. Scheller

I would anticipate, we've said in the past that we expected Mine 4 to get closer to Mine 7's cost structure. And I'll anticipate this mine to be running in that same general area in terms of cost structure overall. In terms of the impact to the tax credits, we are able -- those tax credits are -- they're not critical to the return on that investment. They just greatly enhance the return on that investment and those tax credits really start to become important after the mine is in full production and is very profitable.

J. Christopher Haberlin - Davenport & Company, LLC, Research Division

And just a follow-up to that, I think earlier in the call, there was a talk about the long-term tax rate being 40%. Is that -- how does that relate to the -- how could the tax credits impact that? And is that something we can anticipate beyond 2013? Is that a pretty good number to use or is that more specific to 2013?

William G. Harvey

No. That was more specific to 2013. It will go down past 2013 more to the low-30s. The tax credits on Blue Creek will lower further, but not significantly until Blue Creek is in operation.

Operator

I will now turn it back to you for closing comments.

Walter J. Scheller

Thanks, everyone, for listening today. We're available to take questions. Have a good day.

Operator

This does conclude today's conference. Thank you for attending. You may disconnect at this time. Once again, thank you for attending. This does conclude today's conference. Thank you for attending.

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Walter Energy (WLT): Q4 EPS of -$1.13 misses by $0.23. Revenue of $479M misses by $32.31M. (PR)