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Executives

Vic Svec - SVP, IR and Corporate Communications

Greg Boyce -Chairman and CEO

Mike Crews - EVP and CFO

Rick Navarre - President and CCO

Analysts

James Rollyson - Raymond James

Michael Dudas - Jefferies & Co.

Brian Gamble - Simmons & Company International

Paul Forward - Stifel Nicolaus & Company, Inc.

Jeremy Sussman - Natixis Bleichroeder

John Bridges - J.P. Morgan

Lawrence Jones - Barclays Capital

Brian Singer - Goldman Sachs

Meredith Bandy - BMO Capital Markets

Michael Goldenberg - Luminus Management

Brian Yu - Citigroup

Mark Liinamaa - Morgan Stanley

David Gagliano - Credit Suisse

Luther Lu - FBR Capital Markets

Peabody Energy Corp. (BTU) Q1 2009 Earnings Call April 15, 2009 11:00 AM ET

Operator

Ladies and gentlemen, thank you for standing by and welcome to the Peabody Energy quarterly earnings conference call. (Operator Instructions)

With that being said, I'll turn the conference now to the Senior Vice President, Investor Relations and Corporate Communications, Vic Svec. Please go ahead, sir.

Vic Svec

Well, thank you, [John], and good morning, everyone. Thanks for taking part in the conference call for BTU.

Today our Chairman and CEO, Greg Boyce, will provide an overview of Peabody's position in the current macro environment, our EVP and Chief Financial Officer, Mike Crews, will review our positive first quarter, and President and Chief Commercial Officer Rick Navarre will discuss the market fundamentals.

Our forward-looking statements should be noted with the MD&A section of our filed documents as well as the language at the end of our release, and we also refer you to PeabodyEnergy.com for additional information.

And with that I'll turn the call over to Greg.

Greg Boyce

Thanks, Vic, and good morning, everyone. While Mike will review the financials and Rick will cover the current market [break in audio] increases in our major financial metrics through the toughest economic conditions any of us have seen. We believe that's what you've come to expect and why you should invest in a bellwether company.

I'll start by noting that the global economic downturn is leading to effects that are unprecedented. In the metallurgical coal markets, we are selling to an industry that is 23% down globally. China remains the only bright spot, up 3% year to date on production, while steel production is down 25% to 40% across the rest of Asia, 45% in Europe.

But no market has been hit harder than the U.S. steelmakers, who are down 50% year to date. Steel mill capacity utilization will improve as orders pick up and the year-over-year comps likely become easier in the back half, but it is difficult to find a period in history with such disruptive production cuts.

Global generation is stronger in the Pacific market than the U.S. and Europe. U.S. electricity generation is down over 4% this year, which would mark the first time in the 60 years of government data that U.S. generation declined for two successive years. This has a strong impact on coal markets when you combine it with lower exports, high stockpiles and inexpensive natural gas.

There are potential early signs of stabilization, however. Steel destocking appears to have largely concluded. The steel mills are running at a higher capacity than their lows of December, although still at very low levels. The benefits of stimulus packages have yet to work through the system, and we're now just a month away from the beginning of the summer burn season and a typically sustained draw on stockpiles.

So clearly this year is proving out as we expected - quite challenging for the world's economies and, more specifically, energy producers. I'd like to review several steps we've taken to mitigate the impacts to Peabody from this economic turmoil, while capitalizing on opportunities that may only come along during these unique times.

First, we continue to position Peabody within high-growth, high-margin markets. The Pacific seaboard markets will grow at multiples of the Atlantic market over time. And during the current recession this translates into moderate growth versus decline for our Atlantic customers. This clearly benefits Peabody over our other U.S. peers.

Second, within the U.S. our decision to go into 2009 with a fully contracted position has been sound. The markets, however, remain soft and oversupplied. As Rick will detail, we have reduced our 2009 production targets once again, so we're 100% sold out for 2009 and some 90% committed for 2010.

Third, we continue to conduct stem-to-stern reviews of all operations to ensure they are the low cost and/or high margin producers in each market.

Fourth, we're continuing to work with our customers regarding their long-term coal supplies and, where appropriate, signing up baseload contracts that enable resource development. Our recently announced Bear Run mine, for instance, will access 90 million tons of reserves to serve long-term coal supply agreements that represent nearly $6 billion in future revenues. These contracts are made possible by Peabody's reputation for reliability and our extensive reserve position, and they allow us to unlock the true value of our coal. Clearly, our strategy of only developing new capacity for baseload contracts separates us from those who build to supply the spot markets.

And fifth, we are more active than ever on identifying opportunity opportunistic acquisitions around the world as a priority use of cash. Both assets and equities are at very attractive levels, and our balance sheet and liquidity are in a very healthy position to create long-term additions to our portfolio. Our recent investments in coal is just [coal] is just but one small example in this category.

The other area that's received significant attention in recent months has been clean coal and within the U.S. carbon management policies. Our view is that the first is an important prerequisite to the second, and clean coal technologies received major support through the $3.5 billion for fossil fuel research and development in the U.S. stimulus package, much of which will be focused on carbon capture and store advancement. CCS has also received a $20 per ton of CO2 tax credit for deep storage and a $10 per ton for enhanced oil recovery tax credit.

In the U.S., we look forward to greater regulatory clarity to permit carbon capture and storage as we continue to advance the position that technology must be in place before hard carbon dioxide goals make sense.

Globally, Europe has been returning to coal generation. China and India are leading dozens of countries around the world building new coal plants, and Australia, China, Japan and Europe all have major carbon capture and storage initiatives under way.

Long term, we are strongly of the view that coal will carbon capture and storage will be the low-cost, low-carbon alternative, and we remain active, advancing nearly a dozen low carbon projects around the world.

Now as you know, Peabody has a strong track record of sharing insight into the markets and our prospects. We advised last quarter that we would defer establishment of financial targets. We did indicate that we would have three long wall moves in Australia and that we did not expect to ship the metallurgical coal deferments from the fourth quarter of last year until later this year. And all of those that follow the steel sector know that it continued to slide during the first quarter of this year. So given all of that, we believe that this quarter was a very solid quarter for the operational team.

But as Rick will discuss in more detail, we have most of our Australian coal contracts left to settle. We also have uncertainty regarding ultimate volumes and carryover treatment in Australia as well as what U.S. full year demand will be. The effect of this variability is measured in the hundreds of millions of dollars and doesn't provide enough clarity to offer meaningful guidance. We expect that once we have final settlements we will have greater visibility into full year results.

So in summary, Peabody has the portfolio depth to navigate the current storms, position the company even better for long-term success, and advance the projects and enhance coal's prospects longer term.

I appreciate your interest today and I'll now turn the call over to Mike Crews. Mike?

Mike Crews

Thank you, Greg, and good morning, everyone.

As Greg mentioned, we previously identified reduced customer demand and three planned long wall moves in Australia as factors that would impact our first quarter results. Despite those issues and the ongoing market downturn, Peabody delivered higher revenues, EBITDA and earnings per share than the year ago period. Our operating cash flows grew to $220 million, cash rose to more than $0.5 billion, and we continued our conservative approach to capital spending. Let me begin today's review with the income statement highlights.

Revenues were 15% higher than last year as improved unit prices more than offset a slowdown in volumes. The addition of higher-priced contracts drove a 13% improvement in the U.S. and in Australia higher term pricing delivered revenues that were $71 million above last year.

First quarter EBITDA totaled $325 million, with the U.S. and Australia mining operations increasing a combined $137 million or 68% over last year. This increase was in spite of the deferral of just over 1 million tons of high-margin Australian metallurgical coal shipments by customers that would have increased EBITDA by approximately $135 million along with a $35 million unfavorable cost impact from the long wall moves in Australia.

Trading and brokerage contributed $66 million of EBITDA, ahead of expectations though lower than last year. Our visibility into multiple markets around the world allowed us to identify value-added transactions even as the markets continued to contract.

Resource management results declined $55 million versus last year as the market softened and we did not pursue any sales of non-core properties.

First quarter income tax expense was $30 million, about one-third less than what we incurred in the first quarter of 2008 despite higher pre-tax income. Last year, tax expense was unfavorably impacted by the dramatic rise in the Australian dollar. This quarter the exchange rate ended about where it began.

Finally, income from continuing operations increased 80% to $141 million, with related earnings of $0.50 per share.

Now let me take you through the supplemental schedule beginning with the U.S., where volumes were lower and prices per ton were higher than both last year and last quarter.

In the West, our improved average price per ton reflects the roll off of lower price contracts, new contracts that were signed during last year's favorable markets, and increased contributions from the El Segundo mine in the Southwest. On the cost side, absent the effect of sales-related taxes, our Western cost per ton increased 6% over the prior year. The higher costs were largely the result of suboptimal production levels in the PRB due to acceleration of planned production cuts and winter storms.

Turning to the Midwest, we began to benefit from the rise in Illinois Basin prices which more than overcame increases in unit costs that were largely due to higher sales-related taxes and the timing of maintenance and repair costs. But compared to the fourth quarter, costs were more than 4% lower, with three-fourths of our operations turning in better results. Finally, per ton margins expanded 67% over the prior year.

In Australia, first quarter volumes were 4.5 million tons. By comparison, last year's run rate was 6 million tons per quarter and you can expect the rest of this year to be between 5 and 6 million tons per quarter. And our met coal volumes were less than half of fourth quarter volumes as customers continued to destock inventories. Our Australian revenues per ton were $81, an increase of $27 per ton over last year, but could have risen another $27 had we shipped the additional 1 million tons of met coal during the quarter. Cost increased $10 per ton over the first quarter of 2008; however, nearly $8 of the increase was due to the three long wall moves. Excluding this impact, our cost increased 4%, largely due to $3 per ton of higher royalty expense. All told, our Australian margin came in at $18 per ton, the net result of higher average realized prices and the temporary cost impacts.

Turning to our balance sheet, our strong first quarter operating cash flow drove cash to $527 million, an increase of $77 million, and our liquidity remains at just over $2 billion. We are continuing to exercise capital discipline. First quarter CapEx was $48 million and our capital spending for 2009 is expected to be up to $450 million. Sustaining capital will comprise more than half our needs, averaging $1 to $1.50 per produced ton. We'll also have about $100 million associated with the new Bear Run mine under development to serve long-term customer contracts and $60 million to fund our investment in Prairie State.

With the continued weakness in the markets, our focus remains the same - tight management of costs, capital and liquidity.

And now I'll turn the call over to Rick.

Rick Navarre

Thanks, Mike. As Greg earlier mentioned, I will provide an overview of the major industry drivers and discuss the industry fundamentals in a bit more detail and explain how Peabody's actions have positioned us in the short term to continue to be successful even in these difficult market conditions and in the future for what we expect will be a solid rebound.

The market challenges we outlined during our last conference call are playing out much as expected, and in fact, they're tilting toward the higher end of our estimates as the economic situation drags on. Our earlier forecast at seaborne metallurgical coal demand might be off some 20% this year still appears to be a good estimate. The good news is that we've also seen a swift supply response that had resulted in met price settlements that were above most of the earlier estimates and in fact the second-highest level ever. Global thermal coal markets are seeing some declines as electricity demand is dipping. In the United States, the supply/demand picture remains out of balance due to several factors that I'll discuss in more detail.

Let me take a moment to review each of these conditions.

First, Greg mentioned the significant decrease in global steel production, which has clearly had an impact on met coal pricing and settlements. I'll give you a bit of color on what's happened thus far. The benchmark price for high quality hard coking coal was recently set at $128 per metric ton. So where does that leave Peabody? We have 3 to 3.5 million short tons of met coking coal that we expect to price off of this benchmark; however, we have concluded only a small number of these contracts to date and expect to settle most of those in the next several weeks.

With regard to carryover tons, we have also been holding the line on performance regarding pricing and volumes for the approximate 1.7 million tons of met coal carryovers from the prior fiscal year. We will continue to push for the full value of these contracts.

Of our unpriced met coal, up to 500,000 tons of this is the lower quality PCI-type coal. Some of the other producers have already capitulated on carryover performance for lower qualities in a bid to maintain additional volume. We have about 500,000 tons of carryover volumes related to lower quality met coal and we're uncertain how this will play out, but we'll tell you that we will contend that we will try to continue to get carryover pricing for those volumes as well.

Regarding global seaborne thermal coal, we expect demand to be off 5% or 30 million tons from 2008 levels. Most of the reduced global seaborne thermal coal demand will impact the Atlantic markets and more specifically reduce U.S. exports that are currently not competitive into the European market. On a positive note, the seaborne markets are showing some signs of stabilization, with the benchmark API 2 European prices up $13 to $15 per ton in just the past several weeks on the forward markets, a very good sign.

This year in the Pacific, demand should remain relatively flat thanks to China and India. China has increased its imports of both met and thermal coal from Australia and other countries, and it has decreased its exports. We expect that China could be a net importer of as much as 10 to 20 million tons in 2009, which would be very positive for Peabody's global production and trading platform.

And India continues to grow its coal imports. Many plants are still below 7 days of supply and rapid increases in generation are occurring. India is projected by many in the country to increase coal imports by more than 25 million tons per year over the next several years, once again, another very positive factor.

We expect the benchmark thermal coal settlements in the seaborne markets to be roughly $70 per metric ton. Peabody has 5 million short tons available for pricing through the remainder of the calendar year.

While settlements are below last year, we expect our average thermal coal export pricing for calendar '09 to remain in the mid-$60s, consistent with 2008. Why? As you may recall, last year Peabody had 2.5 million tons of thermal export coal out of Australia. It was priced at legacy prices largely from the Excel acquisition at ranges of $35 to $55 per ton that are now starting to roll off.

Now let's turn to the U.S. markets. Demand for U.S. coal is likely to be down 70 to 90 million tons below 2008 levels based upon negative U.S. electricity generation, lower exports, and cheap gas. In addition, we'll need a good strong summer burn or additional reductions over time to bring customer stockpiles back into line. We've seen announced producer cutbacks of approximately [45] to [50] million tons to date. We expect the Eastern coal regions are likely to be hardest hit as the U.S. steel demand is down some 50% and the East will also bear the brunt of the declining export markets and lower gas prices. Of course, lower generation and stockpiles will impact all coal regions.

As noted in our release, Peabody is adding to its previously announced production cuts. We are reducing targets another 5 million tons in the United States and 1 to 2 million tons in Australia, bringing our total cuts to 18 million tons to better match production with demand and attempt to avoid a supply overhang beyond 2009.

We told you on our last call that we were essentially sold out and in fact we are, and we have strong contractual commitments. We could have moved this coal. But we think reductions need to occur and as we look at it, we have certain customers where we are the sole supplier under requirements contracts. In those cases, we will see a slight decline in demand and in other cases we are going to choose to work with our customers to reach commercial solutions such as cash buyouts or other consideration. We think it's smarter to create win-win situations for our customers and for Peabody and create greater value in the future than build stockpiles higher at this point in time.

Furthermore, we have positioned the company very well for this environment, with only 10% of 2010 U.S. production remaining to be sold, allowing us to be very selective in our contracting strategy going forward.

We also stated last quarter that the underinvestment in energy is likely to lead to a much sharper rebound once the economies improve. We believe that now more than ever. Within the industry we are seeing reduced investments, cancellation of major projects, and a financing environment that is available or affordable to just a few companies. Coal is a capital-intensive business with needs for bonding, replacement equipment and reserves. All of this paints an interesting picture for pricing when the long-term secular demand resumes.

And this is evidenced by the sharp contango that we're seeing in pricing for nearly every energy product, including coal. In natural gas, for instance, where rig counts have been cut nearly in half, we see a two-year contango of up 75%. And in coal, the trade market prices for 2011 delivery are up nearly 45% for API 2 and 60% for Powder River Basin coal over the prompt levels of today. And they're even higher still for 2012.

For Peabody, all of this suggests near-term challenges but also greater opportunity for a company that is well positioned as we work through these unique conditions.

That's a review of our first quarter, the international and domestic markets and Peabody's actions to create value and improve our long-term position. Thank you again for your interest and Operator, we are now ready to take questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from James Rollyson - Raymond James.

James Rollyson - Raymond James

Maybe this one for Rick. With all the details you gave kind of on Australia, obviously you've got some coal that's booked and you're hoping to still fulfill those contracts over the course of the rest of the year. And you gave us some maybe price thoughts on what's open and how prices generally look for the thermal and the met that is open. Can you give us some maybe ballpark average of what's booked already, maybe what the blended price is assuming that you get performance on those contracts just to kind of get us in the ballpark overall? I know you don't like to get too granular but maybe overall?

Rick Navarre

It maybe tough to get into too much detail, Jim, because we've only settled a few contracts. I'll give you the higher points. Certainly, the contracts that we have settled to date on the high [quality] hard coking coal have been in that benchmark range of $128, which translates to about $125 for Peabody on its high quality Goonyella-type coals, so we've been able to settle those out with carryover performance.

So that's where we stand, but it's only a few contracts. We have a lot of negotiations still to do over the next couple of weeks, but we think those numbers will stay in line with that and then, of course, based on different qualities we'll see different pricing all the way down to the PCI qualities, which we haven't settled any of the PCI qualities at this stage of the game but they're beginning to come in and we'll have some discussions around that.

And on the thermal side, as I said, we're looking at a $70 benchmark number and that starts at, you know, there's ranges of thermal coal as low as 7% ash all the 25% ash and you'll see different prices for that.

On the carryover side, as we said from the very beginning, we have strong contracts and we honor our side of the carryover business when the price moves the other direction and we would expect that our customers do the same. And so far the settlements that we have had on the hard coking coal we've seen that. We've seen some others, as I said earlier, that puts a little bit of value at risk with respect to some of the lower-quality coals, but we'll continue to push for that.

James Rollyson - Raymond James

And then as a follow up on the domestic side, Greg, you guys are cutting 5 more million tons versus what you had said before. Kind of a two-part question - one, do you suspect that that's generally coming out of the West or is it blended and do you kind of see this as a gradually lower production level as you go throughout the year or is it kind of a stair-step drop and then maintenance at a lower level?

Greg Boyce

Yes, I would say it's predominantly coming out of the West. There's a few tons in the Midwest, but almost all of it's coming out of the Powder River Basin; that's where the stockpiles have gotten to be the highest. So when you add up the 5 that we're talking about here with what we've done before, we've taken 15 million tons out of the U.S. platform in terms of our forecast for the year since the first of the year.

Rick Navarre

We have a few tons in other regions that might relate to requirements contracts, as I said earlier, such as the Southwest, where we may be the sole provider of coal to a particular plant. And in those cases obviously if they burn more, we ship it to them; if they burn a bit less obviously we have to cut back a little bit.

James Rollyson - Raymond James

And do you suspect that will be kind of an immediate drop or is that kind of a gradual rolling off over the course of the rest of the year?

Greg Boyce

Well, if it continued to have snow storms in the West, it may be more immediate than we thought, but we would look most of it to be somewhat ratable through the three quarters of the year.

Operator

Your next question comes from Michael Dudas - Jefferies & Co.

Michael Dudas - Jefferies & Co.

Greg, maybe you can share some thoughts. I think you're pretty realistic in your expectation on U.S. demand destruction, but how do you see the industry playing out? Do you see a lot more involuntary production coming off line? And, given the timing of utility contracts or met contracts, is that going to happen, again, on a gradual basis or are we going to see in a month or two some pretty steep declines? Because it seems like the industry really needs to catch up and accelerate some of the production discipline to balance this market a little more quickly than maybe people anticipated.

Greg Boyce

Well, I guess it's our view that we're going to have to start to see more significant and steeper declines now, whether those are imposed because of issues related to permitting, whether those are related to individual production problems. But you take the whole high end of the cost curve and those guys are under pressure today to the extent that maybe they were shipping under higher price contracts. Based on what we're seeing out in the marketplace the shipping volumes are starting to come down very, very rapidly. We've already started to see a couple of announcements of cutbacks just in the last week. It's our anticipation that we're going to see more of that and it probably will accelerate in the near term rather than extend until later in the year.

Rick Navarre

And I guess I'd add, Michael, that when we look at the cost curves, where we see a lot of folks have not announced production cuts yet, they will ultimately have to based upon where the prices are today for spot pricing. And I could say very positively on the coal that we've cut back in the United States, none of that coal was out of the money; all of that coal was on the lower end of the cost curve. So clearly there are going to be others [inaudible] pressure.

Greg Boyce

As we talk with the utility sector out there, as I indicated, generation is down over 4% across the country year to date; coal-based generation is down almost 6% within the context of the overall generation mix. And we've got customers that are still trying to understand what the floor is in terms of their generation load loss given the real economy has not shown any signs of recovery at all.

Michael Dudas - Jefferies & Co.

My follow up is relative to your comments on potential opportunities for investment and acquisition. I guess I'm going to assume that implies that given you're looking at a fast-growing region versus one that's much more mature, would the marginal dollars that you would spend on mine or asset acquisitions be in the Pacific Basin as opposed to the Atlantic Basin - and I would include in that the U.S. market - or would valuations make a big difference to you where you could possibly expand some of your U.S. operations though it may not be the type of longer term fast-growth market that maybe you would have thought in the past?

Greg Boyce

Well, first of all, when we look at and we talk about growth markets, we take a 10-year or longer view, particularly for the kind of acquisitions that we're talking about, so we still see some of the U.S. basins having what we would call high growth or higher growth, potentially not quite as high as the Pacific Rim and that's an area we continue to look. But given the values that we're seeing out in the marketplace today, I would not preclude anything in the higher growth U.S. markets, but clearly we would look across the global platform and our existing platform, which we believe we've structured to be in the high-growth markets.

Michael Dudas - Jefferies & Co.

How does share repurchase fit into the equation?

Greg Boyce

I think, as I indicated in my remarks, our highest priority right now for the cash that we're generating and accumulating is to look at very value accretive acquisitions during this period of reasonable to lower than long-term average value for assets.

Operator

Your next question comes from Brian Gamble - Simmons & Company International.

Brian Gamble - Simmons & Company International

I want to focus on the U.S. and on the stockpile situation specifically. Utilities, we're all seen the data that the stockpile numbers are big. In your perspective, just how big are they and what is the possibility that they become so large that utilities physically can't put coal anywhere else and start to push back tons to you guys just out of a sheer space issue at their facilities?

Greg Boyce

Well, clearly, we all can see the stockpile numbers. They have gotten large. There is a differential based on regions as to how much over average that they are. The PRB stockpiles are probably in the higher range today.

Our view is there's a number of utilities that still have substantial room for additional coal. They may not want to carry it in terms of having that much in inventory, but physically there is room for more coal in the stockpiles.

The other point I would say is, as we talk with our customers, for a customer that says that they want to burn some very inexpensive spot-priced gas right now, that isn't a rationale to not meet their contractual commitments to lift coal. They can take care of those opportunities if they're taking all of their coal commitments.

So when Rick says we're having individual discussions with all of our customers, we're very cognizant of what their burn requirements are, what their sources of fuel supply are, and where our contracts fit within their overall obligations to produce electricity. So we are being opportunistic in terms of capturing and maintaining value, but we are also being sympathetic that it's not in our interest nor others to have these levels of stockpiles go for a number of years.

Brian Gamble - Simmons & Company International

And then maybe a follow up question on the Australian market. You mentioned during Q4 you had deferrals, I believe, correct me if I'm wrong, but of roughly 1 million tons and then saying that Q1 was roughly the same, it'd be up slightly, so you're at 2 million tons of deferrals that you expect to try to get out the door Q2 through Q4 of this year. Can you just give us some clarity on how you feel that is going to develop with China essentially being the only steel producer that has held up in this down economy?

Rick Navarre

Well, if you give it exact numbers, I think we're roughly at about 1.7 million tons of carryover business. And not all of that's met coal, but it's predominantly metallurgical coal with a small amount of coal involved in that, a couple hundred thousand tons.

As we look forward, it'll all get to the negotiations as it relates to the volumes that they lift under their contracts going forward under the new contracts. So they'll know what their carryover commitments are and they'll know the pricing for that business and then they'll have to make a decision as to how much coal they need going forward. So we expect the first coal that goes or at least a blended component - we will work with folks to blend it throughout the year - will be the deferred coal. It's still under contract and needs to be taken.

Greg Boyce

And I think what's important to remember is we're not talking about that 1.7 million tons in terms of volumes to be additive to our normal run rates. That was demand destruction that we don't see coming back. What we're talking about is what percentage of that coal can we take that higher price and ship through the course of this year for the volumes that Mike indicated you can expect out of Australia.

Mike Crews

Exactly.

Operator

Your next question comes from Paul Forward - Stifel Nicolaus & Company, Inc.

Paul Forward - Stifel Nicolaus & Company, Inc.

On the second quarter, there's no earnings guidance that you've set for us, but when we compare the $0.50 that you posted in the first quarter, what kind of changes can we expect in the second? I'm looking at the list here. I'd say a little bit stronger Australian volumes after no long wall moves or not the same level of long wall moves as you had in the first quarter; possibly when you normalize it a lower contribution from trading and brokerage; a little lower U.S. volumes. What can we think about how this will all impact, what the major impacts will be when you compare quarter to quarter first to second quarter?

Greg Boyce

Well, I think you've outlined a number of those, Paul. We would expect Australian volumes to be higher. We would expect not having three long wall moves that our Australian costs would be more in line with the averages. As you look at the U.S. platform, there will be lower volumes in the U.S. platform. And because there's going to be lower volumes in the U.S. platform, we're going to work as hard as we can to keep our costs under control, but with a lower divisor and fixed costs there is going to be cost pressure on the U.S. platform.

And then you've got, as you indicated, the trading and the resource management. Resource management has always been a spotty part of the business and probably don't see significant changes in the trading platform.

Paul Forward - Stifel Nicolaus & Company, Inc.

So a lot of moving parts and hard to set a range, I guess. Just as a follow up, you had a pretty steep miss relative to where Street expectations were in the first quarter. Why not provide a little more either, if you're tracking lower, why not warn when you know that the expectations are too high for the quarter, and also why try to give us a little bit more quarter to quarter, maybe when you see numbers are too high, why not set guidance or at least give us a little bit more information to rein in some of the numbers that are too high?

Greg Boyce

Paul, I obviously appreciate the concern. We spend a lot of time reviewing all of those things internally.

As we went back and looked at our conference call in the first quarter at the beginning of the year, we talked about the Australian volumes, particularly in light of the three long wall moves that we had there in Australia. Rick specifically indicated that we were not going to be shipping any of the fourth quarter deferred tons in the first quarter of this year. At the time we indicated we didn't know to the extent that there would continue to be deferrals out of the first quarter met volumes. As it turned out, the steel sector continued to slide in the first quarter of this year, which I think was known to everybody. So there was a logical continuation of deferrals. And in the U.S. platform, our volumes were pretty close to where we thought they were going to be through most of the quarter. We had a couple of snow storms in the last two weeks of March.

So I guess as we look at it - and it's always a judgment call - we thought the physical evidence and the market evidence was pretty much in line with what we had indicated at our last call. Now, we didn't provide numbers. And you're correct, there was this gap between what the consensus numbers were. But to be honest with you, those numbers didn't reflect what we indicated in our last call.

So, I guess, is that something we should warn? That's kind of an academic discussion that we can have, but we felt that we had provided all of the parts that would have led people to look at our quarter and look at our results that we announced today and said that was a solid quarter given what was happening both in the platform as well as what was happening in the marketplace.

Operator

Your next question comes from Jeremy Sussman - Natixis Bleichroeder.

Jeremy Sussman - Natixis Bleichroeder

Greg, you mentioned that the benchmark quality that you recently signed at $125 does include full carryover performance, so of the 1.7 million carryover tons that you still have left on the books, how much of that is benchmark quality? Just to be clear, I think you said you have 500,000 of that 1.7 that's PCI and then about another 200,000 that's thermal, so would the rest of that 1 million tonnage basically be kind of benchmark quality?

Rick Navarre

Well, it's the benchmark quality. It's hard coking coal. Either high quality or just hard coking coal would be about 1 million tons of the 1.7 million.

Jeremy Sussman - Natixis Bleichroeder

And then in terms of the PCI contracts you have, can you give us a sense of who or at least what countries you have those with?

Rick Navarre

Well, it ranges. They're across the full gamut. You're going to have PCI contracts that are going to be with customers in Japan and customers in Taiwan and Korea and India, you know, really across the board. So it's spread out. But it's mostly Asia, for the most part. It's probably 80% Asian.

Jeremy Sussman - Natixis Bleichroeder

And then lastly on the cost side, obviously you mentioned $8 per ton were associated with the long wall moves and given that you expect higher volumes or [inaudible] next few quarters, is it safe to say that maybe Q3/Q4 '08 is more of a reasonable run rate for the cost per ton side of things than we saw this quarter?

Mike Crews

Yes. Ultimately it comes down to the volumes that we end up with, but we should see a more normalized cost approach versus where we were in the first quarter. I mean, it's unusual that we would have three long wall moves because, you know, like a North Goonyella may be an 18month timeframe, so these aren't turning over rapidly. So it was a huge impact in the first quarter. But having said that, we'll continue at these higher prices to continue to have higher royalty costs.

Rick Navarre

Jeremy, I'll clarify on the carryover business, we're at 1.2 million tons on the hard coking coal and 500,000 on the semi-soft and PCI. The additional 200,000 thermal is over and above the 1.7.

Operator

Your next question comes from John Bridges - J.P. Morgan.

John Bridges - J.P. Morgan

Just going back to the utility pushback, we've heard some stories about rail service as well. Have you seen any of that? Has that interfered with deliveries?

Greg Boyce

Other than the snow storms in the West, we've not had any rail delivery impacts at all.

John Bridges - J.P. Morgan

And then the planned reductions in deliveries, any sort of profile as to how that's going to develop over the year?

Rick Navarre

Well, we strive to have all of our volumes prorated through the course of the year because that allows us to operate the mines more efficiently and manage our cost structure more effectively, so right now we're anticipating that they'll be fairly smooth through the last three quarters.

John Bridges - J.P. Morgan

And then the impact of the carryover tons in Australia, any idea as to when those will be delivered?

Mike Crews

Well, our view, John, is that obviously we'll continue to negotiate and get the final resolution on the new contract pricing as well as the settlement of the carryover tons over the course of the next three to four weeks with the customers and I think there's a lot going on right now to get that done. And we'll have a lot more clarity going forward after that point in time. But I suspect it'll be through the year to get all of that delivered for sure.

Operator

Your next question comes from Lawrence Jones - Barclays Capital.

Lawrence Jones - Barclays Capital

I just wanted to see if you could provide some clarification on the convert, that balance? I guess the numbers were restated relative to December 31. I'm just looking for some color there.

Mike Crews

Yes, you're correct. There's a new accounting rule which is probably one of the longest on record  FSP APB 14-1 - that required us to adjust the convertible. And what you do is you fair value that. Because the stated rate is at 4.75%, you fair value that at what the straight debt rate would have been at the time of that deal. And once you get the fair value of the debt, the other component goes to equity. So that adjustment was in the $350 million range. And we've rolled that back; it was effective 1/1/09, we rolled it back into the December '08 number so you can see it for comparative purposes.

Lawrence Jones - Barclays Capital

Is that adjusted on an annual basis - I apologize for the basic question - or is that just once?

Mike Crews

You do it one time and then you just accrete it up.

Lawrence Jones - Barclays Capital

And then my follow up question is just on pension and OPEB funding. I think on your last call you had said pension and OPEB cash contributions in excess of expense in '09 would probably be about $100 million.

Mike Crews

Well, at the time I said it would be, I think, less than $100 million.

What we've done at this point is we have made the minimum contributions, which are approximately $23 million. We'll continue to evaluate that relative to the other cash needs of the business, where we come out on our earnings profile and the cash outlook. But even if we do make some additional payments in September, it's a manageable number and it's much lower than that original estimate.

Operator

Your next question comes from Brian Singer - Goldman Sachs.

Brian Singer - Goldman Sachs

In Australia, how much demand do you see if you wanted to sell your hard coking coal at, say, slightly lower prices relative to the benchmark price? And is that something that you consider for that or are you really going to sell to the benchmark price or hold those lines?

Rick Navarre

Well, I think we're going to settle at the benchmark price. That's traditionally how we've focused on this. And, of course, we could always break ranks and do something differently, but it isn't going to create the most value doing that at the end of the day. So we're going to stick to the benchmark settlements and move forward with that. Then we'll get our volumes from that, and then we'll evaluate the market, of course, after that.

If there's additional needs in the market - we think there may be after the settlements because we think the Chinese may begin to import more coal, as I said earlier - we may have some opportunities to sell some coal into China over and above the contract settlements and those could be at prices at or above, frankly, the contract settlements depending upon where supply and demand goes in the later part of the year.

Greg Boyce

As Rick indicated, there's no surprise that China is the one market where steel production is starting to come back up. They've got a massive stimulus program and when they announce a stimulus program, a week later the cash is actually flowing into activity on the ground. So the orders for steel for railroads, bridges, all the infrastructure that they're putting their stimulus package into has already started to flow through that economy, and we expect that that will continue to accelerate through the last three quarters of the year and into next year.

And then I think it's everybody's estimate or guess as to when the U.S. stimulus dollars will actually flow into physical activity here in the U.S.

Brian Singer - Goldman Sachs

And my follow up is in the U.S., what specifics are you seeing in terms of coal-to-gas substitution and are you seeing any impacts to plants that are either taking or blending Western coal?

Rick Navarre

Specifically, I think what we're seeing is a couple of regions that are probably being harder hit. And, once again, when you see prompt gas prices that are in the $3 range against Eastern coals, a bit of that in Colorado, where we're seeing gas very cheap in Colorado. For most of the other regions, particularly the ones that are competing with Western coals, we're not seeing any gas switching at all when it's competing with PRB coal, so on the margin.

And even the regions where there are opportunities where gas is lower, it's not necessarily a given that gas has taken the place of coal because of contractual commitments and dispatch priorities. But nevertheless, the Western coals are running full out.

Brian Singer - Goldman Sachs

And any changes to your overall expectations for the amount of [inaudible] lost to coal-to-gas switching?

Rick Navarre

You know, we started out, in the beginning of the year, we said about 10 to 15 million tons. I think we were on the high end of that list when we gave that number. I guess I'd still stick with 10 to 15 million at this point in time for this year.

We'll get into the summer; things will change. And as we get towards the year, we'll see a lot of these rigs coming off. It'll take three or four months for the price to start to bounce around on the gas side. But I think we're going to stick with 10 to 15 now. Maybe it's on the higher end, but it's somewhere in that range.

Operator

Your next question comes from Meredith Bandy - BMO Capital Markets.

Meredith Bandy - BMO Capital Markets

I wanted to follow up on a comment that Mike made, you know, in Australia, talking about the 5 to 6 million tons per quarter going forward you're going to see. Could you give us some more color on the breakdown of the met versus thermal on that?

Mike Crews

I think what we're looking at on a run rate is the metallurgical tons would be in about a 2 million ton per quarter range. The thermal's a little higher at 2.8. And then we've got some domestic thermal that's going to run in the 1.5 to just under 2 range.

Meredith Bandy - BMO Capital Markets

So the thermal basically stays the same. You don't see met coming down to B thermal?

Rick Navarre

Oh, from a composition - oh, moving down the product scale? No.

Meredith Bandy - BMO Capital Markets

No. No, you [just sell it as that] or you leave it in the ground?

Rick Navarre

Correct.

Meredith Bandy - BMO Capital Markets

And then so the cuts are really coming also just from met and from met across the board on your met qualities?

Greg Boyce

The lower quality probably take a disproportionate hit on the reductions in our view across the entire Australian platform, not just ours.

Meredith Bandy - BMO Capital Markets

Right.

Greg Boyce

That's traditionally what has occurred in the past and it's our sense that may go forward.

The only caveat to that comment in terms of history is obviously the steel mills are still looking to manage their cash flows as well. Over time they have been increasing the amount of PCI coal they've been burning in their mix. But right now, if you look at the volumes that have been shipping, the higher quality met coals have been the quality of coals that are still in short supply globally and have been shipping.

Operator

Your next question comes from Michael Goldenberg - Luminus Management.

Michael Goldenberg - Luminus Management

I wanted to just get the absolutely crystallized details on the met contract situation for 2009. So there's 1.7 million carryover tons, 500 and 1.2. And then on top of that there's 3 to 5 million that are completely unpriced? Because you used the word repriced in your release, I just want to make sure that none of it includes the 1.7.

Mike Crews

It does not include the - it's 3 to 3.5 million tons that need to be repriced.

Michael Goldenberg - Luminus Management

Repriced meaning priced?

Mike Crews

Priced, yes, priced. It's rolling over into the new contract year. You're right on.

Michael Goldenberg - Luminus Management

3 to 3.5 are '09?

Mike Crews

That's correct.

Michael Goldenberg - Luminus Management

And then how much is already priced for '09?

Rick Navarre

What we've sold in the first quarter, which would be I guess about 1.5 million tons.

Greg Boyce

1.5 million tons for calendar '09's been priced.

Michael Goldenberg - Luminus Management

So 1.5 was priced for calendar '09. There's 1.7 carryover. That's on top of the 1.5?

Mike Crews

That's right.

Michael Goldenberg - Luminus Management

And then 3 to 3.5 that's completely unpriced?

Mike Crews

Yes.

Greg Boyce

So that gets you to a range of about 6 million tons of met coal per year.

Michael Goldenberg - Luminus Management

Okay, 6 million not counting the 0.8 in Q1? So 0.8 in Q1, then, plus 2 plus 2 plus 2?

Rick Navarre

0.8 plus 6 million tons of met coal 2009. So that range that Mike gave you maybe toward the high end of that range, the 2, 2 and 2 for the ratable quarters moving forward.

Michael Goldenberg - Luminus Management

Okay, so 2 is somewhat high? So it's about 1.5?

Rick Navarre

Well, Mike's given you a number. I'm giving you a midpoint in the range.

Michael Goldenberg - Luminus Management

Okay.

Rick Navarre

Yes, because it could be 6.5 million tons as well.

Michael Goldenberg - Luminus Management

Okay. And then secondly, on the overall 2009 guidance, I understand that you're still trying to tie down the volumes. As you think about providing guidance, is that something we will have to wait until Q2 or should you sign contracts two, three weeks from now, you would be willing to provide guidance prior to the next earnings call?

Greg Boyce

I think that depending on where we're at in the quarter and the level of comfort that we have that we can give a meaningful range, we would consider giving guidance earlier. But I wouldn't at this point, you know, to assume that we can get enough clarity within a couple of weeks is a bit optimistic. But it really depends on how far into the quarter we are before we have substantive settlements in the Australian platform.

Those that have followed the Australian platform for a long period of time know that sometimes these negotiations can go on for months.

Rick Navarre

And understand when we're giving you ranges and other issues and we're trying to be as tight as we can on those ranges right now, please understand that we are in the process of negotiating with our customers right now as we speak, so we basically don't want to negotiate on conference calls with our customers.

Michael Goldenberg - Luminus Management

Understood. But there's no reason to believe that guidance will not be given at Q2 at the latest?

Greg Boyce

Well, you have to give us a better sense as to where you think the real economies are going to be by the time we get through the end of the second quarter and what's happening in terms of the global platform, but it would be our hope that we would be in a position to provide guidance at that point in time.

Operator

Your next question comes from Brian Yu - Citigroup.

Brian Yu - Citigroup

My question relates to the U.S. thermal coal contracts. Earlier you had talked about trying to reach commercial solutions with some of your customers. Can you discuss what percentage your U.S. thermal coal contracts are a duty to commercial solutions cover? And also is the present value of the contract that was originally intended being preserved?

Greg Boyce

Well, I think I'll take the last part of that question first and say we have lots of customers and lots of contracts, and clearly we are working with the ones where we can preserve the value of the contract. As I said earlier, we are fully sold out. We are voluntarily cutting production by 5 million tons in the U.S. And we haven't decided which customers that 5 million tons relates to at this point in time, but it'll be on contracts where we can work together to create a win-win situation where we get and preserve the value that we have in those contracts.

So as a percentage, when you look at the total, 5 million tons across our platform in the U.S. is about 2.5% to 3% of production, so it's not a big number by any means. So it's certainly not we're going out wholesale offering up reductions in volumes across our customers.

Brian Yu - Citigroup

And a follow up question on Australia. If we look at your Q1 realizations of about $81 per ton and as we look out, you're going to get greater contributions from met coal entering into the mix and also some of these carryover tons at a higher price. Is it fair to assume that Q1 could be the low water mark for your Australian price realization for the year?

Greg Boyce

I think it's too early to say at this point in time. I think we'd be getting too far out on the guidance limb at that point in time, giving you a number exactly for that, until we really get all the settlements and get the mix taken care of.

If it's really a mix issue, that's what drove the number down in the first quarter was mix. We had a lot more thermal coal in the first quarter than what we would normally ship compared to the met mix, so we need to get the mix before we can give you a good answer to that.

Operator

Your next question comes from Mark Liinamaa - Morgan Stanley.

Mark Liinamaa - Morgan Stanley

There's a fair amount of concern out there in the investment community that inventories at the utilities are going to get away from you before enough is cut back, up to, say, a 200-million ton level. What do you think the risks are of waiting for the high cost guys to shut down? It seems like that's a story that's been going for awhile. And what would it take to get the broader industry to take more aggressive action in your view?

Greg Boyce

Well, I think a large part of those questions probably ought to be asked on future conference calls. Suffice it to say that to the extent that people are continuing to operate today, high cost non-profitable operations or operations that they're only living off of legacy contracts, when the day comes that they have to make those decisions, they're going to be fairly swift and I think they're going to mount in terms of volumes unless we start to see additional demand come through in terms of economic development and the real economy.

So I guess I would leave it to say those are discussions you need to have with all the other folks in the sector.

Mark Liinamaa - Morgan Stanley

Is there anything you're seeing that people are considering those? It seems to me there is a risk that if we wait it is going to get away.

Greg Boyce

Well, we only see what you see in terms of what's publicly announced. You know, there were some that were announced the end of last week. And it's our sense that we will probably see more and will likely see more, but we have no more visibility at this point than you would.

Rick Navarre

And from our standpoint, we've evaluated what's happening in every market. We look at cost curves. We know that in certain markets there are a number of producers that are clearly going to be below cash cost based upon current spot pricing when they have to reprice business and we know that financing's not available. So we think some of these decisions will take care of themselves. It's not our job to take care of the entire industry. We've got low-cost mines and we're going to balance out what we need to do, we think, for the long term of the company, not run the company for a quarter at a time, but we're trying to run it for the long term.

And you also saw this week, Mark, other people that had already walked through the production cut line go back for seconds, and so you're going to see more of that.

Mark Liinamaa - Morgan Stanley

Any comments quickly on CO2 and the long term competitive balance with CO2, cheaper gas on regional coal-on-coal competition.

Greg Boyce

Well, as I indicated in my opening remarks, we firmly believe that coal with carbon capture and sequestration is the low cost, low carbon, long-term alternative for the energy supply in this country, whether that's for electricity, whether it's for coal-to-synthetic gas or whether it's for eventually coal-to-liquids.

We are in a global recession, arguably in some areas a depression, and so demand has been coming off faster than people could have anticipated. But there's no question that when you look at the lack of investment in the energy infrastructure along all commodities that when economic activity returns, we are going to have a significant shortage of supply of energy. And in that context, coal has to absolutely remain part of the mix. Coal with carbon capture is a low-carbon solution. And so for the long term we feel as strong if not stronger about the coal story as we have in the past, and it's a matter of getting through this uncharted territory of this lack of economic activity to come out the other side.

Operator

Your next question comes from David Gagliano - Credit Suisse.

David Gagliano - Credit Suisse

Just to come back to the contract renegotiation issue, just to clarify, how much of your revised 2009 U.S. production target of 185 to 190 million tons is currently under renegotiation with your utility customers?

Greg Boyce

Well, all we've said is we have now taken 5 million tons out of our forecast in the U.S. in anticipation of a number of customers where we are the requirements supplier and their burn is down, and also a number of customers who we anticipate that we will reach favorable value retaining renegotiation of contracts to reduce their off take for the year. And our estimate at this point is that will involve around 5 million tons total in the platform.

Rick Navarre

Yes, to be clear, Dave, we don't have a bucket of contracts that are out there that we're saying have to be renegotiated and we have to do something about that.

We are making an estimate for the long term that says roughly 5 million tons. Some of that - probably half of that - relates to requirements contracts, as we look at their burn, we think that it's likely that that's going to go away for this year.

And then there's other customers that have approached us and said look, we'd like to buy out of a few million tons or a couple hundred thousand tons or those types of discussions and we said we'll consider it, we'll look into it.

That's all that's happened. This is not a wide-scale renegotiation across our platform by any means.

David Gagliano - Credit Suisse

So when you add all those up - customers approaching you and things like that - you think the impact will total 5 million tons. There's not more behind this or is the 5 million something that already has -

Greg Boyce

Yes. I mean, our view today is it's around 5 million tons. But Dave, if electricity generation continues to fall through the rest of the year, it's hard to say it will never get any worse than 5 million tons. That's our current view as we see the market unfolding. Obviously, it's based on economic activity in the U.S., what generation burn we think through the back half of the year will be. And so right now our estimate is about 5 million tons.

Rick Navarre

And that's, again, that we've already cut. So I think at the end of the day it's a meaningful 15 million tons.

David Gagliano - Credit Suisse

And then just so I understand, when you have these renegotiations, do you typically renegotiate just volume? Do you talk about volume and price?

Rick Navarre

Dave, we're not having renegotiations. We're saying that it's likely that we will talk to our customers having issues, okay? I want to make this clear - we're not in active renegotiations of our contracts.

Greg Boyce

But Dave, when we have those discussions and we look to retain the value in the contract, it can take all forms of shifting tons around, changing the price horizon for different volumes, changing the timing of deliveries within the context of a contract. So we've got the ability to be flexible, but as Rick indicated earlier, right now it's all about retaining value in those contracts just looking at timing of volumes.

Operator

Your next question comes from Luther Lu - FBR Capital Markets.

Luther Lu - FBR Capital Markets

I want to ask a few cleanup questions. When you guys mention in the press release that 90% of the 2010 volume is committed in the U.S., could you give me a range of that volume?

Rick Navarre

Such as where the location of - it's proportionate to our portfolio, Luther. Other than that, we probably can't get much more specific than that.

Luther Lu - FBR Capital Markets

But are you talking about 185 to 190 million tons or are you talking about a higher volume?

Greg Boyce

At this point, we're not indicating what our production [times] are for 2010, but suffice it to say the number of 90% represents what's been committed.

Mike Crews

If we produce more, then we'd have a larger denominator and the change in the numerator, so it's still going to be roughly 10%.

Luther Lu - FBR Capital Markets

And then in your Australia met coal business, the first quarter you sent out 0.8 million tons. Any of that was done on a spot basis or all contracted?

Rick Navarre

A little bit was on a spot basis on some of the - we sold a number of different tons, both through third-party brokers and traded as well as some out of our asset base to China that were outside of the original, last year contracts. And, frankly, those tons were sold in some cases higher than the benchmark settlements.

Luther Lu - FBR Capital Markets

And then on your projections, what do you expect the U.S. export to be this year?

Rick Navarre

I'd say probably 50 to 55 million tons, Luther, which is down from 82 million tons. We probably started the year with an estimate that we'd be cutting exports 15 to 20-ish. Now you've seen us raise our expectations a little bit higher because I think that we thought that some of the legacy contracts that had been signed would keep some of the producers in business a bit longer.

But we're seeing exports dropping significantly. In fact, if you look at the month of March, exports out of the East Coast dropped 52% for the month of March. As we look at the forward months and see what the volumes looked like last year compared to what we just did in March, it's likely to be in the 50s for sure for the export business.

Luther Lu - FBR Capital Markets

And then what about import?

Rick Navarre

Well, import's always been roughly in the low to mid-30s and it'll be plus or minus 2 to 4 million tons in that range. I can't give you an exact number on that. It depends on the strength of the dollar and what their other opportunities are in Europe.

Greg Boyce

And how many continued strikes they have in Colombia.

Rick Navarre

It was down a little bit in the first quarter because of strikes in Colombia. And the Venezuelan tons aren't coming out like they have in the past, either.

Operator

And, ladies and gentlemen, we are past the top of the hour. I'll turn the conference over to Greg Boyce for closing comments.

Greg Boyce

Well, I want to thank everybody for participating on the call this morning. I would just reiterate a couple of things.

Obviously, the times that we're in are unprecedented in terms of not only the volatility but the uncertainty in terms of both the steel and the utility sector markets. As I said earlier, we believe this company's performed extremely well in the first quarter given all of the challenges that we faced.

And we look to continue to provide as much information that is meaningful going forward in a timely manner but we also try and have a good, open discussion about where we see things going, about the uncertainties that are around what we see in the future marketplace.

So thank you very much for your interest in BTU and we appreciate your support.

Operator

Ladies and gentlemen, that does conclude your conference for today. Thank you for your participation. You may now disconnect.

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Source: Peabody Energy Corp. Q1 2009 Earnings Call Transcript
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