James River Coal Co. Q2 2009 Earnings Call Transcript

James River Coal Co. (JRCC)Q2 2009 Earnings CallAugust 3, 2009; 11:00 am ETExecutivesPeter Socha - Chairman & Chief Executive OfficerC.K. Lane - Senior Vice President & Chief Operating OfficerSam Hopkins - Vice President & Chief Accounting Officer.Jim Ketron - Vice President & General CounselBeth Cook - Director of Investor RelationsAnalystsJim Rollyson - Raymond James

Michael Dudas - Jefferies

Justine Fisher - Goldman Sachs

Jeremy Sussman - Brean Murray

Jeff Kramer - UBS

Mark Caruso - Millennium Partners

Brett Levy - Jefferies & Company

Warren Chang - Macquarie

PresentationOperatorGood day and welcome everyone to the James River Coal Company second quarter 2009 earnings conference call. This call is being recorded. At this time for opening remarks and introductions, I would like to turn the call over to the Director of Investor Relations, Ms. Beth Cook, please go ahead.Beth CookThank you and good morning. Welcome to James River Coal Company’s second quarter earnings call. We released our earnings today and our current release is posted on our website and was furnished to the SEC on the Form 8-K. As we noted in our press release we’ll be using an updated slide presentation, these have been posted to the website and furnished to the SEC on an 8-K.With me today on the call are Peter Socha, Chairman and Chief Executive Officer; C.K. Lane, Senior Vice President and Chief Operating Officer, Sam Hopkins, Vice President and Chief Accounting Officer and Jim Ketron, Vice President and General Counsel.Before we begin this morning, I need to remind you that this call will contain forward-looking statements. These forward-looking statements should be considered along with the risk factors that we note in our press release as well as in our filing with SEC.I’ll now turn the call over to Peter Socha.Peter SochaThank Beth, good morning everyone. I had meant to mention before the last call that we actually send out the press release and the slides in the morning by e-mail. So, if you would like to get on that list, either give Beth a call or send her an e-mail, [e-mail] and she will be happy to get them to you and that way you don’t have to go looking.Just in summary, this was a good quarter. We were very happy with this quarter, operations had a good quarter. We continue to demonstrate the mines are flexible and we can ramp up and ramp down depending on the market. Sales, we had a strong quarter on the sales side and contracting side very happy with that.On shipping, I know that that’s been a little bit of an issue this year and this quarter with some other companies. We have not had any issues at all and just by way of two metrics there, I can tell you neither C.K. nor I have had any conversations with customers about shipping issues.Even further than that, C.K. and I have not had a conversation between the two of us about any type of a shipping issue. So, we’ve been very pleased with our customer relationships and with our ability to ship the contracts that we have, on the financial front, we are generating free cash flow and we are paying down debt and we are reducing the leverage of the company.We put it here that our total liabilities to equity, which is how we are defining leverage for this metric, has gone from 6.1 to 3.4 just this year. So, we’re very, very happy with that and then lastly, as I said last time, we are really, really getting well positioned for the next cycle, I just love the management team that we have down to the superintendent foreman level.I told them that the week before last, it’s just an unbelievable team of the 150 some odd people that we have in that group, I can only count three or four that we’ve lost in the last several years. So, that is a group that is together, that is staying together and that as we move through the next cycle, we will see the benefit of that.The mines are running well we’re bringing new equipment into the mines. We’re actually I think I mentioned it last time we’re actually pleasantly surprised by just how productive the new equipment is and how much the men appreciate having the new equipment there. So, I think we will see the benefit of that and then lastly, I think we will have some better market insight as we go through the next cycle.So, I think that we are really setting up well, great customer relationships, flexible mines, a strengthening balance sheet and contracts that will see us through the current weakness both in the economy and in the coal markets so that we will be strong going into the next cycle.With that, I will turn it over to C.K. C.K. LaneThanks Peter. Just following up on Peter’s comments, I agree we’re a much better position going forward with we have strength in our employees through the hourly ranks and the salary ranks and the way we configured our mines with trying to adjust to all the new safety and regulations that are out there, so I agree, I think we’re in a good position to move forward.Moving over to the safety performance side, I just want to point out that our NFDL rate for the quarter was 1.76 that is the nonfatal days lost rate. We have cut that in half in the last six quarters and if you go back even farther, it was probably cut in half to the 3.51 level. With improved safety, there’s a lot of benefits to the company, it becomes a place where people want to work.You keep your experienced workers on the job. It improves your productivity and your production. You have lower workers comp costs. So there’s just a lot of things that go hand-in-hand with a strong safety performance. Also I wanted to point out that on our mine rescue teams. We maintain two teams in two stations, mine rescue stations. One of our teams won first place last week in the Kentucky State mine rescue contest. So we were very pleased with their performance.Moving on over to some of the regulations that we’re seeing. On update on mine rescue chambers, we are on schedule to have all our chambers in place and installed underground with all our training completed by year end. The communication and tracking system, we have submitted our ERP plans to AMSHA. We have chosen a system that we will go with. It is a quote wireless system and we hope to start installing that sometime in the first half of 2010.On mine rescue teams, there are a new rule out there that has been changing quite a bit. Training has increased from 48 to 96 hours. Each mine rescue team has to have two underground visits per mine that they cover per year and you have to have mine rescue stations located within one hour of the mines. So there’s a lot of new teams out there. Mine rescue is growing a lot, I think there was 45 teams that competed in the state meet. This year the national meet will be in September. I’m sure there will be a lot of teams competing in that.The carbon monoxide monitoring systems, those systems have to be in place by December 31 of this year on all belt lines. We’re moving forward to complete that project. We were in pretty good shape. Most of our mines already had the system, but a lot of changes there that you have to change and upgrade. So we’re working on that.The fire-resistant belt starting in 2010, you have to purchase the new style belt. It will be more expensive. As far as inspections, we’re seeing more state inspections, that was increased from four inspections to six per year. So what we’re seeing across the coal fields are that the new safety incentives will impact production in the future.I think when the market does pickup. You will see everybody going back to working more overtime and working Saturdays. So you will see some increase in production, but the times that we’re losing now, I don’t think we’ll get them all back due to all the new safety regulations and the issues with permits.As far as permitting, we’re seeing that there’s a longer lead time across all the agencies. Many of you know about the memorandum of understanding that was done between the EPA, OSM, and the Core. Basically, the EPA will review all 404 permits. There’s a question right now on the nationwide 21 permit that was used to permit surface mines and valley fields.

If that’s going to be allowed going forward, that will cause everyone to go to, what’s called an individual permit, which is much more detailed and requires a cumulative impact study on the total drainage area, not just the mine area.So just longer lead times on getting that done. We’re also seeing changes in the state permits. The water discharge permit process is going through a change right now for an example. So we’re already seeing some lower production on the surface mines across Central App, just due to the permitting situation.Moving over to our mine performance for Central App, we continue to see the labor market improved. There’s a lot more availability of skilled labor as production cutbacks occur, we’re seeing a lot more applications than we had in those applications are with people with more experience.In the quarter, we tried to manage our inventories. We’ve reduced our production approximately 300,000 tons from the first quarter. We did that by taking two unplanned days off during the quarter. Those were both for the mines and the office. We tried to be flexible, when we let the operations choose those. Most of the time, we did that around an existing holiday, but also met some local needs, when there were some festivals going on in the local area. We eliminated most of our overtime and our Saturday production. We cutout third shift production. We eliminated contract and purchase coal and the way we managed our inventory so far, our workforce seems to really appreciate it because we’ve had a very few layoffs. We have had a few, but trying to manage the inventories and keep everybody working when the market does come back.As Peter mentioned, we have received several new pieces of new and rebuilt equipment at our mines and it’s starting to make a good impact there. In the quarter, there was a lot of rainfall especially across East Kentucky, a lot of flooding and it did impact our surface operations.We had one underground mine, mine out in the quarter at Bell County and we had faced up and started a replacement mine and that mine is in production today replacing the mine that finished.At Triad, they had a good quarter both on costs and production. They were impacted by the rain, especially at the underground mine, due to some heavy rain and flooding at the pit area there. We did begin production at our Log Creek surface mine, which was a replacement mine for one of our surface mines that mined out.For Triad overall, they are in a very good position. I think Triad may if you look at our guidance, we will probably reduce our production a little bit at Triad, but due to what we’ve been able to do on the contracting side, I think Triad will mine less tons going forward, but make more money.So with that, I will turn it back over to Peter. Peter SochaThanks C.K. Turning to contracting, in CAPP, in Central App, we did a little bit more on stoker and I think that, we’ve been a little bit surprised. There has been some stoker demand here recently. We’re starting to ship to some paper companies, which is a really good sign to make and so we are seeing order activity and order inquiries pick up.In the Midwest, we completed some transactions with longtime customers and they are happy and we are happy and you can see that it will have a material impact on us next year.Turning to slide 14, which is the sequence, just as an opening comment here; I would have bet $100 that we would not see the international market impact, the U.S. market this year. I really saw the international market as being last years story and that we needed to find what was going to be this year’s story, a lot of that changed in April and May.The elections in India were a big deal, the stimulus plan in China is a big deal and so that has really changed the world, as far as coal is concerned. I don’t think it’s readily apparent yet, but it’s becoming more so and I think we will see it over the rest of this year and into next year.Right now I’m thinking met will lead steam. Asia will lead Africa. Africa will lead Europe and Europe will lead the U.S. We see the U.S. coal market recovering sometime next year. I think it will be the middle of the year. It could be earlier. It could be a little later, but there’s a lot of coal in inventories that need to be burned down and so I think that that’s an overhang.Europe has high stockpiles, but they are high relative to the fact that they normally keep lower stockpiles. So I think Europe will probably recover faster, particularly Northern Europe.News and notes, we always seem to put something like this in here. News and notes or headlines, it is really, really amazing what is going on with the trade that used to go to Europe and is now going to Asia. I highlighted two things here; South Africa was switching about 20 million tons this year.South Africa typically exports about 60 million. Last year, it was 50/10, 50 million going to the Atlantic, 10 million going to the Pacific. This year, it will be more like 30/30 and actually if you look at more recent numbers, it could even tilt the other way, but for the year as a whole it will probably end up being 30/30.Then also Russia, Mr. Putin has made a declaration that he wants to increase trade with the Asian markets and coal is certainly part of that. Last year they exported about 20 some odd million to the Asian markets. In July, if the railroads carried all they were supposed to carry, which is a big if in Russia, but if they carried all they were supposed to carry it was about 44 million. So Russia would be a reduction to Europe of about 20 million and South Africa would be a reduction of about 20 million.So, it starts to add up and we will see that as we move through the slides. The things that we’re watching, we do watch every single week the railcar loadings from CSX and NS. We look at the rate of change, which is something we have talked about before, the second derivative of inventories, the natural gas, for obvious reasons, that’s an overhang on toll this year. Europe, import/export in China, and then term structure and I’ll cover each of these individually.Rail loadings, you can see what they’ve done. These are primarily Central App tons and you can see they’ve come down throughout the year. The rail service for us is good. As I mentioned, we have not had any problems with shipping. The thing that has been interesting looking at the railcar loadings has not been so much coal recently, it’s been the other things. CSX and NS are both seeing improvements in things other than coal within the last two or three weeks, so that’s something that we are paying attention to.The next slide, slide 18 I guess is the second derivative slide we’ve used before. It is not nominal inventories. It is the annual rate of change year-over-year, so if it’s black that means we’re adding to inventories. If it’s red, that means inventories year-over-year are lower. You could see fairly clearly here throughout ‘07, why we kept the open times that we kept because year-over-year they were just plunging.You could also see sort of a hedge fake there in April or May of ‘08, where they’ve started to turn back up. That was actually enough to get us to start contracting. So thank goodness for the head fake, because we did lock up some tons. It’s not, just this graph isn’t saying a whole lot this year, but I think if we look at it 12 months from now, it will actually be very interesting, because I don’t expect that May 31, 2010 we will continue to have record inventories.So that would mean that we would probably be on a year-over-year basis negative. So between now and next May, you would see that curve roll over almost in a mirror image and come back down into negative territory, but we’ll see. We’ll continue to show this periodically. The natural gas market, it looks as though it has rolled over. Production is down, appears to be down one or two be a day gas demand because as we’re seeing on the industrial stoker side, gas demand is starting to pick up a little bit.Chemicals, I know I’ve mentioned that before. The petrochemicals and the chemicals are something that we look at very closely. I saw a note last week and I wish I could find it on a silicate company that was seeing a real increase in their order book and their particular silicate was the feedstock for chemical plants.

I need to go back and see if I can find that. LNG right now was sort of flat, not doing a whole lot. It’s holding in there between one and one and half. There is a lot of liquefaction capacity coming on later this year and we’ll see if many of that, if much of that gas ends up in the U.S.The next slide, slide 20 on Nuclear Refueling, we talked about this at Coaltrans in January of ‘08. There is a definite cycle to nuclear refueling and to the extent that more of the fleet is being refueled, than we would expect to see coal burn pick up. The next time that we would see that cyclical peak would be the fall of this year. So we’ll see what happens there.The PMIs, the Purchasing Managers Index in Europe is something we pay a lot of attention to. Germany is clearly improving, Southern Europe less so, but we tend to look at the whole euro zone. I think if I had my druthers, I’d look at new orders in Germany alone, but you have to pay for that. We didn’t want to pay for it, but German trade with China on capital equipment is moving up nicely and so that’s a good thing.The next slide on China, I thought was interesting. I happened to be in Europe when the April numbers came out at 9 million tons for the month of April. Last year, China imported about 48 million tons, so doing 9 million in one month was a shocker and I was in a room with 200 or 300 people from the coal industry and it was the buzz of the room while we were there.So I started following that a little bit more closely and you can that the run rate of imports into China right now is running about 130 compared to 48 last year. This is just thermal. This is not met and thermal, thermal and anthracite, but you can also see that exports have gone down dramatically. So if you total the two, you’re looking at a swing here of about 140 million tons.Now taking it one step further, what we looked at is, if exports are down, where did they export the coal to and where will those people get the coal was different out their largest are South Korea, Taiwan, and Japan. They total about 90% of the exports from China, so what’s going on in the Pacific market I think it bears watching.

Which brings us to the term structure slide; I really went back and forth on whether or not to include the slide. It’s a busy slide it has a lot of information on it. It can be hard to understand, but it has so much information on there that we are looking at and that we are following that at the end of the day I decided to go ahead and include it.

You can see Newcastle, which is primarily Asia. That is out of Australia as well as Richards Bay, the API-4. You can see that they have moved up nominally, particularly Asia, particularly Newcastle has moved up nominally. What we’re looking at is the line is flattening, so the Contango is narrowing again particularly with Newcastle, but also with South Africa.

In looking at these type of slides, they’re used in every commodity in the world, whether it’s corn, soybeans, tin, lead, zinc, every single commodity look at this. When it’s flattening, that’s a good thing, when it’s positively slow to flattening, that’s a good thing. So, that’s the first thing that we noticed about it.

The second thing and this is not on the slide, but I will do a voiceover on it. That is Asia has tightened and Japan and Taiwan have really not been in the market. Japan is down roughly 15%, 16%, 18% year-over-year, Taiwan, a similar number. Those two have not been in the market yet.

So, we have seen significant improvement in the Asian market and two of the largest players, Japan is the largest importer of coal in the world, have not been in the market. So we think and they are improving as you look at the steel production coming out of Japan this quarter and next quarter, it is clearly improving. So, as they reenter the market, we think you’ll see Newcastle move up again.

We also think you will see South Africa move up and the last comment I have on this slide is the arbitrage and that is if you look at the current prices, at least current as of July 24, you will see that Newcastle was at $75 and Richard’s Bay or South Africa was at $65. The difference in freight to Japan between these two markets is only about $2, the last numbers I saw one was 20, Newcastle was 18 and Richards Bay was 20. So, a buyer in Japan could save $8.

Now there are some differences in Specs, Newcastle is a little bit higher BTU, but you can save money by going to Richards Bay. So, we think you’ll see that arbitrage narrow as we move closer into the fall and we will actually see the API-4 or the South Africa prices moving up.

So, our summary view of the world that the global seaborne market is about 600 million tons, right now there is a lot going on underneath the surface, and I think that it is being covered up by high inventories in the U.S., high inventories in Europe, and high inventories in Japan.

When that situation reverses itself, I think we will see an adjustment in worldwide price as well as in U.S., prices. So that will be something that we will be following and we will certainly be reporting back to you. On guidance, as we usually do midyear, we issue guidance. I’m going to skip EBITDA and cover that on the next slide.

SG&A we nudged up a little bit stock-based comp as well as the cost of our senior secured facility that is on my agenda for the fall, so we will be working on that. DD&A, we nudged down with production coming down. The tax rate, we really studied the NOLs much more, so we are more comfortable with going in with a lower tax rate.

CapEx we have trimmed a little CAPP tons were going down to just the level of our contracts. We’re not going to produce any more than that we don’t need to build inventory and we don’t need to enter into new contracts at a loss making position. With that, we did nudge up CAPP cash costs.

That’s an absorption issue primarily and we expect that that will come down as we ramp production back up later on. Midwest, we adjusted productions to the mine plan. We will have carryover tons and I know Shneur is out there just waiting to ask the question. We will have carryover tons and we will know what they are later in the year.

On the bridge, the amendment that we did, that we announced is a great amendment. Over a three or four year span, it is a great amendment. I thought that we had done a better job of discussing it on the last call and in the last press release, but this is a bad on me. In the financial impact on us was $27 million this year. If you look at it over a three or four years span, it’s a good amendment, but this year it’s $27 million, which to me is roughly $1 buck of share spread over three quarters.

So it would be $0.33 a share. If you back out sales related or you tax effect it and you do all the things that analysts do, then the effect is less than that, but not materially so. I noticed when we went back and we looked at where some of the estimates had been adjusted, they were not adjusted by as much as that.

So to the extent that we missed consensus, I think that’s a big place where we missed it. As I mentioned, we did trim production back and so we will carry those higher costs. We closed our higher cost mines several years ago. So we don’t have a lot that we’d consider for additional closure.

With that, I know we went long, but with that we’ll go and open it up.

Question-and-Answer Session

Operator

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

Jim Rollyson - Raymond James

I had a few questions actually, since I’ll let Shneur ask you about the carryover tons, but regarding the pricing, your year-to-date prices as you mentioned in your slides are about $32.19 for the Midwest tons and your full year kind of committed is a little over $34 bucks, which obviously would imply second half is much better. When you kind of sort out, what’s tons get shipped in the second half versus what carries over into next year? What kind of pricing are we looking on average for those tons, do you think?

Peter Socha

I don’t know, but quite honestly, remember in the Midwest we’ve got diesel adjustments and we’ve got things like that, but what gets carried over and what doesn’t. I’m going to leave that to the guys in the Midwest. Obviously, we’ll have a conversation about it. Those typically Jim, those conversations are had in late September through October. At least if last year is any guide and maybe the year before.

The real issue with the Midwest in carryover tons is we had horrible weather there last year and where we might have had an opportunity to have a conversation with the customers about those tones, we just didn’t. I mean we did, but by the time we did, it was too far past and we just didn’t. So they are carryover tons, we have had these relationships for a very long time. We’re comfortable with it, but what next year’s average price will be, I don’t know right now.

Jim Rollyson - Raymond James

Okay, maybe same question on the cost side. Your year-to-date costs in the 28s, your full year guidance 31 also implies a big step up in cost second half. What do you expect and would drive that or what are you thinking?

Peter Socha

I’ll let C.K. address it in a second, but I think that they have had outstanding production and outstanding costs this year. I think that we just really elected to keep the guidance number where it is. Thus far fortunately, the weather has been on our side and they have had a great first half of the year.

C.K. Lane

If we just our production back from the 3.5 to the 3.2 level that we’ve talked about for the year, we’ll see that in the second half, which will again just be some cost absorption going forward there.

Jim Rollyson - Raymond James

Peter, on the pricing side you guys added some contracts with a foreign front, which is pretty good. A little bit better it looks like in 2011, than what you booked in 2010. If you see prices around $40, $41 bucks, where do you suspect your volumes are next year relative to this year?

Peter Socha

I don’t know. C.K. has got to go over all the mine plans. As he said, I think that we will probably be down from the 3.5 next year just based on the current mine plans, but we’ll make a lot more money. Financially, Triad will have a very good year.

Jim Rollyson - Raymond James

Last question for me, and I’ll turn it over. Just on CAPP shipments, you are obviously tracking below your full year guidance. I think you’re probably running more like 6.9 run rate. Do you feel comfortable you will get to the 7 to 7.1 at this point? Maybe seasonally, do you expect 3Q to be a little lower and 4Q to be a little higher like it normally would?

C.K. Lane

I think we’ll be at that pretty much our guidance level. We have some coal that we sold to a third-party out of our Bell County operation that we were shipping through our contracts. They will go on some of their contracts. So, we should be in pretty good shape there going forward. We’ve had a pretty good July. It looks like August will be a pretty good month also.

Peter Socha

Jim, we are running the mines dialed back right now.

Jim Rollyson - Raymond James

Right, but do you think…?

Peter Socha

I would describe it as a hot item.

Jim Rollyson - Raymond James

With inventories, your own inventory given that you’ve built some inventory this year. Do shipments look a little more stable over the next two quarters? Do you have this normal vacation dip in 3Q?

Peter Socha

No, they are pretty stable. Normally the vacation dip, we usually over ship a little bit heading into it and then over ship a little bit in August. So, they are pretty stable.

Operator

Your next question comes from Michael Dudas - Jefferies.

Michael Dudas - Jefferies

Peter first question. In your discussion with your major customers, maybe more intermediate term, are they concerned about possibly a much slower recovery in burn and electricity sales primarily to their industrial commercial customers? When they are thinking about things getting back to normal, will there be just much more natural gas available for them to buy? Are they thinking that given the fact of the export potential, met coal potential, that Central App could tighten up much more quickly than maybe the market is thinking?

Peter Socha

I don’t think that they see the export side at all. I don’t know which is not surprising; not a lot of people do and I don’t for a while.

Michael Dudas - Jefferies

They never do, Peter.

Peter Socha

They never do. Even I don’t see it for a while, I just kind of see on the far horizon. I think they are very concerned about the production coming down in Central App. I think they’re very concerned about when things do get back to a normal environment, will the coal that I need be there?

On the other hand, the way the market is right now, the market is in steep Contango. So, I’m buying in coal, I’m storing as much as I can to try to mitigate any possible problem later on.

As far as, will the gas be there? I continue to believe that the industrial load on gas will change things; that is such a big component. It’s a half, basically a third of a third, of the demand for market. When you’ve got that down by a lot and so I think that will soak up a lot of excess supply on the gas, if LNG stays where it is.

Raleigh and I had this conversation last week. If LNG stays where it is, I think, we will be okay on gas. Where they see industrial load, I think that’s probably a question better answered by them, but it’s encouraging to me that we are seeing things like a paper company taking stoker coal. That’s a big deal. I was out in Kentucky out at one of our offices, and Darrell told me that and my eyes lit up. Because we are shipping to paper companies that we haven’t shipped to in a long, long time. So, that was a good sign.

What it means longer term, I don’t know. I just think we’re in the drink for the next 18 months or so. There’s so much overhang of inventory. I love my contracts, I love my customer relationships. We are shipping everything we need to ship, but I think there’s just a lot of pressure, downward pressure. When it gets relieved, I think we will be in a much better position, but right now there’s just so much downward pressure.

Michael Dudas - Jefferies

My final question is Peter, when you think about the pressure on inventory levels at mines and looking at the production levels that they come off, when do you can start to see the real distress in the Central App market from a production and a financial side? Is that later?

Peter Socha

That’s a great question, Mike. We’ve already seen massive shut-ins by smaller players. It just being out at the mine, the mines the week before last with C.K., talking to the superintendents and all, they are seeing it. They are seeing the applications come in. They don’t think it can come back. These guys who have been mining coal for 25, 30 years, they don’t think that a lot of these smaller players can come back.

Now what’s interesting on the inventory side in the field, and I may end up making a little news here, when C.K. and I were driving around obviously, we see our own stockpiles, but we also see a lot of other stockpiles. They were lower than we expected and there was one stockpile we had to drive by two or three times that we’re starting to see the stockpiles in the coal fields come down. C.K., would you agree with that?

C.K. Lane

Yes, I think especially with coming off vacations and stuff there in July that people had cut back and we’re starting to see that.

Michael Dudas - Jefferies

Do you think some vacations were extended a little bit in July around fields?

C.K. Lane

I don’t know around, I mean we did have pretty much our normal vacation plan. So I’m not sure what all happened, but I know that there’s been a lot of people cut back and not running Saturdays and cutting back to a 40-hour week and watching their overtime.

Michael Dudas - Jefferies

Thank you, gentlemen.

Peter Socha

Mike, we were definitely surprised by stockpiles a little lower than we expected, driving around coal field.

Operator

Your next question comes from Justine Fisher - Goldman Sachs.

Justine Fisher - Goldman Sachs

Just one first clarification that the new coal that you booked at a little over $70 a ton. Was that stoker coal or steam coal?

Peter Socha

Yes, that was…

Justine Fisher - Goldman Sachs

That was all starker coal, okay and then another question on CapEx. You guys have clearly turned the budget for this year and I guess if the market remains subdued next year, it sounds maybe it will be the same level. I mean, how much lower can it go? Then how long can you sustain these levels? I know this is a question everyone’s asking all these coal companies, but at some point, the spending must have to increase, know?

Peter Socha

Well, keep in mind every coal company is different and we lived on nothing for two or three years. So I’m not looking to see how low we can go on CapEx. I’m actually looking the opposite. I’m looking in how much more new equipment can we put in the mines and still be responsible about it and still be credible about it and take our time.

We are not looking to cut CapEx, because we’re in a recession or because of anything like that. We were $50 million to $55 million for at least two years, Justine. Other folks had big growth programs and opening big new mines and things like that. That’s a totally different situation from what we had.

Justine Fisher - Goldman Sachs

Then I wanted to just dig a little bit deeper into the statement you just made about a lot of the small mine tonnage not being able to come back into the market. I guess the estimates run the gamut from 80 million tons to over 100 million tons of production that’s been taken out this year.

Peter Socha

Yes.

Justine Fisher - Goldman Sachs

So first of all, that also includes PRBs, but what do you guys think is the number? Then if we’re talking about a percentage that can’t come back, what percentage is that? If prices were higher, does that change? If prices were higher, does it mean that some of the small mines might come back?

Peter Socha

Yes, I will throw some numbers out there and then I’ll be interested to hear C.K. My gut tells me right now Central App is probably in the $180 million annualized rate. Last year it was $236 million, so we’re down 50 or thereabouts and that’s up a little bit. That may be up a little bit. Of the $50 million that’s lost, maybe $35 million is capable of coming back and $15 million or $20 million will not be capable, C.K.?

C.K. Lane

I think it’s a good ballpark estimate. I mean, what you will see is that the smaller mines with the cost of doing your mine rescue chambers and the cost of the communication system that were contracting and selling independently, those will be hard to come back because that’s a pretty big cost to absorb, some of the larger companies that have contract mines that will pay for that for their contractor, they will probably be able to come back.

We had two contract mines, one surface and one underground, that we can bring back and would plan to bring back when the market improves. So I think that’s more the direction you will see.

The other thing is just the longer lead times on permitting. People will start things back on the permits they have on the shelf, but once those are used up depending on how quickly all this issue between the EPA and the core gets worked out, you’ll starting to see longer lead times and delays that will affect mines as we mine through the existing permits that we have now.

Justine Fisher - Goldman Sachs

Then the last question is a tough one for me to phrase, but you guys as costs are now in the mid-60s per ton at current production levels. I know that when people look at CAPP generally, they’re saying that there are small companies that have high costs that would not be profitable at today’s prices, but because of legacy priced tons, legacy liquidity that they got during better years, these companies can survive.

It seems like that you guys are sort of in that boat. So, the question is if you’re not able to sign prices at higher tons, does that put you guys in the camps having to cut more production? Because yours would be unprofitable and then is the notion just that you guys would be able to outlast other smaller companies?

Peter Socha

No, well, first of all, I wouldn’t phrase it that way. I wouldn’t put us in that category. We are choosing to idle back production. We are choosing to do it by not closing additional mines; partially that is a market call. That is we are looking at what is really happening in the market. I don’t see that it that way, Justine.

You know, if you look at what we have available to sell next year to get us up to what we consider sort of the minimum level, it’s not a whole lot. It is truthfully not a whole lot and then if you look at what we sold this year on stoker and you say, we’ll probably do the same, maybe plus 5% next year, it’s even less.

So, we have the positive cash flow, which is one reason why we did the amendment the way we did, to take us well into ‘11. I am not sure how many companies that you look at can make that statement.

Justine Fisher - Goldman Sachs

No, I believe that you guys do have the cash flow, but just from an industry perspective, the argument that tonnage will come out of the market…

Peter Socha

Well, tonnage is coming out of the market. We’re taking on a percentage basis; we have taken quite a bit of tonnage out of the market. Certainly again on a percentage basis, certainly much greater than some others have done, but, and so we will continue to do that. I just don’t want to go out and sell additional tons at $48 or at $54 or $52. We don’t have to do it.

Now in the $20 million or whatever it is of cost, maybe $18 million or $19 million of that is absorption and the rest is cost that I’m choosing to incur to keep everybody on board. Because the way I’m looking at the market, I want to make sure that we are full of steam and the gas tank is full when I call C.K. up and I basically tell him okay, crank it up. That is very important to me.

Operator

Your next question comes from Jeremy Sussman - Brean Murray.

Jeremy Sussman - Brean Murray

Anyway, certainly glad to hear, good to hear that you guys had no shipping issues. I would imagine that that is in part due to the relationships you have with your customers, but maybe can you expand upon that a little bit and also kind of what are your customers in general doing, maybe not necessarily with you guys, but how are they managing their inventory levels?

Peter Socha

I will say this and this is what a friend of mine at one of the utilities told me. People that have not been reliable suppliers to them in the past are getting killed, just killed. Because they ask me this was a senior guy I saw him a few weeks ago, and his question was, are we okay with you and I said, yes, you are fine.

We’re in good shape. He said, well, I’ll tell you the people, given our coal burn and given stockpiles, the people that we’ve had problems with in the past we are being a problem to right now and I mean all I can tell you is what I said earlier in my opening comments, which is C.K. hasn’t had a conversation with a customer about shipments.

I have not had a conversation except for the anecdotal one, the small one with a customer about shipments and C.K. and I haven’t had a conversation between us about he hasn’t called me up and said, Peter, this may be a problem next month. We may be short some trains to this customer. We haven’t had that conversation.

As far as the nature of our relationships, we’ve said for years that they are very strong relationships. I think if you look at our contract book that we did last year that indicates some strength of that relationship. The fact that we are shipping all of those contracts now really with a minimal amount of issues between us, I think is also indicative of how strong the relationship is.

We do not miss shipments. We’re a good supplier and they are a good customer and this is from the most senior levels of these customers down to the guys that run the plants and work in the plants and in at least two of the cases, I know all the people in between. I know the top and I know the guys running the plant.

Jeremy Sussman - Brean Murray

So it’s safe to say they’re being selective and you guys are benefiting from that?

Peter Socha

Yes, I think so.

Jeremy Sussman - Brean Murray

Then just moving on, you obviously talked about moving some of your high priced contracts into 2011 and 2012 and it’s great that you have that flexibility. I guess, where exactly does that show up in the guidance? Because I don’t see any change in your…?

Peter Socha

No, that’s because it was in the Q1 table. It was in the May 1 table. It was the amendment that we announced. Quite frankly, I did a bad job of explaining the impact on ‘09, but that’s all I can say is I did a bad job of explaining it. That we were in fact taking tons at 1/08, taking tons away at 1/08, inserting new tons 70. 700,000 tons times $38, this is how you get to $26 million, divided over three quarters.

What I noticed, when I was looking some of the models a few weeks ago, some of the sell side models was people had adjusted their guidance, but they had adjusted it more like $0.15 for the year to $0.20 for the year. That’s when I realized that consensus and actual were going to be different.

Jeremy Sussman - Brean Murray

I thought that’s what you were trying to say earlier, but I wasn’t sure.

Peter Socha

I just trying to say I blew it.

Jeremy Sussman - Brean Murray

Last question, obviously you gave us the cost bridge, which was helpful as always. You have now given us full year guidance for in Central App, I guess $63 per ton for your cash costs, so two things. One, why did your labor costs increase this quarter to that level? Two, you expect costs to go down when you ramp production backup. So maybe can you put that in context versus the $63 number that you have out there? For this year, were obviously you’re not at kind of full blown production mode?

C.K. Lane

Labor cost, if you look at that’s composed of a couple things. Our hourly labor, when we’ve cutbacks our overtime and cut out Saturdays. So our total dollar spend on hourly labor has went down on the dollars we spent. If you look at it salary labor, it’s pretty much a fixed number. So if you don’t work Saturdays or cutback on your overtime, your salary rates do not change that much and then medical benefits is lumped into the labor cost.

Actually our benefits/medical costs did go up in the second quarter compared to the first quarter. So when you run less tons and medical goes up, salary stays the same, that’s the big costs on where your production, which makes sense because folks get more time off. They get more time to go to the doctor there. So that’s how we see the labor trending. Hourly dollars went down, but salary dollars stayed about the same and medical dollars went up.

Jeremy Sussman - Brean Murray

Then maybe just any idea, where you see costs shaping up next year, I mean up or down?

Peter Socha

If production is up, costs will be down. There’s a fair element of cost absorption there, that plus the newer equipment.

Operator

Your next question comes from Jeff Kramer - UBS.

Jeff Kramer - UBS

Am I supposed to read shipments, as far as commentary on shipments haven’t had any conversations, that equals any conversations around customer deferrals as well?

Peter Socha

That’s correct. We have not had a conversation about a customer deferral cancellation, termination, amendment, is there anything I’m leaving off? If it’s not, whatever I leave off, consider that included as well.

Jeff Kramer - UBS

For your customers that have switched from coal to gas, I mean at some point they’re going to want to use up some of their inventories, if they’re sitting on the coal side. I mean for your customers, do you think there’s a gas price in your conversations with them where that may happen?

Peter Socha

They’re just so different. I mean you’ve got so many different efficiencies of power plants and the coal units. We have some customers that have very little on the gas side. So it doesn’t affect their coal burn very much. We have other customers that have a larger fleet gas fired generation.

So, I don’t know where the breakpoint is for them and I suspect that it’s very different for each plan; as a matter of fact I know that. So I can’t come out and say there’s a number where they will turn back to gas and turn on to coal, because that number if they have 10 gas plants that’s 10 different numbers.

Jeff Kramer – UBS

Then on the export front, have you kind of thought about a ballpark number where you think, U.S. exports are going to be for this year? When they may turn around?

Peter Socha

You know, ‘07 was 50 something, ‘08 was 80 something or low 90s. This year I will say this, the trains have been running very hard, starting in early to mid June. The trains going to the, as you know, I live down near the export terminals, but they’ve been running very hard. I haven’t seen any today, but that could be in nominal.

So, I don’t know where the number ends up for the year. I just think that next year, the international markets could play a role again next year just given what is happening, but I’ve been very surprised by the train activity starting from mid June to today.

Jeff Kramer – UBS

So, that you’ve painted kind of the 18 month picture earlier for recovery, but that could be really dependent on the international side?

Peter Socha

Yes, I’m kind of thinking, if you want to know the truth. I’m kind of thinking that a lot of these exports trains that we are seeing are what is taking down the inventory in the coal field. That in fact, the utilities are ramping down their deliveries or whatever and that we are seeing the inventories come down probably more so, on the met side than on the thermal, but that may be where it’s going.

I haven’t confirmed that. I haven’t been down to the ports. I was going to go down Friday and didn’t make it, but that’s what I’m thinking.

Operator

Your next question comes from Mark Caruso - Millennium Partners.

Mark Caruso - Millennium Partners

Just a quick few clarifications the first was, the business that you did in ‘09 and ‘10 in CAPP, is that all stoker for both year’s or just…?

Peter Socha

I believe this is all stoker. If it’s not all stoker, it’s predominantly stoker.

Mark Caruso - Millennium Partners

Then as you said though, if things starting to see improvement, the number that you did in 2009 you should be, actually let me ask a different way. In a normal year, what’s the typical stoker sale again?

Peter Socha

Typically it’s 600,000 or 800,000 tons and we will do 600 and some odd thousand tons this year in a pretty soft economy.

Mark Caruso - Millennium Partners

I guess going back on Jeremy’s question on costs directionally, if production goes up, your costs should go down. Is the sensitivity that you guys gave this quarter sort of a good run rate of 300,000? Is $2 worth of absorption? Is that --?

Peter Socha

I don’t know. What do you think, C.K.?

C.K. Lane

I don’t know if I would want to clarify. I think that one thing you’ve got to keep in mind, with our sales price there’s about $4, that’s covered due to the higher sale price because of royalties and taxes, severance taxes and things like that. So it’s built into our cost, but generally medical is the kind of unknown one there, how that tracks.

Peter Socha

Mark, probably a good rule of thumb and C.K. and I have talked about this, but if you take the lower end of our production range, which is kind of where we are now. You’re going to see costs in the lower 60s. As C.K. said, if you back out sales-related, you are actually in the upper 50s.

At the upper end of our production range, which is 2 million tons plus from where we are, you’re probably going to see costs in closer to the mid-50s, again, backing out the sales-related.

Mark Caruso - Millennium Partners

So, if you go back to your original guidance or even a more normalized year, no reason not to think that costs could end up back down in the low...

Peter Socha

Yes, that’s true. I would agree with that. We have not come off other than the dialing back of production. We haven’t come off of that cost cut.

Operator

Your next question comes from Brett Levy - Jefferies & Co.

Brett Levy - Jefferies & Co.

Quick question; you guys have given guidance for the full year, any granularity between third quarter and fourth quarter? Should it be more level?

Peter Socha

Typically Brett, fourth quarter is slower. It is a lower quarter. You just have deer season. You have more holidays.

Brett Levy – Jefferies & Co.

So third better, fourth slightly worse.

Peter Socha

Yes.

Brett Levy – Jefferies & Co.

Then it’s the same question I ask every quarter. What are your -- go ahead, answer the question before I ask it.

Peter Socha

No, I’m not putting a bid on the bonds.

Brett Levy – Jefferies & Co.

Thanks so much.

Peter Socha

No, I’m not giving quarterly guidance and no, I’m not putting a bid under the bond.

Operator

Your next question comes from Warren Chang - Macquarie.

Warren Chang - Macquarie

My questions have mostly been answered. I just had a couple follow-ups. First on the new tons that you signed for ‘09 and ‘10 at $70, the stoker tons, is that associated with the contract that was amended or is that more market based?

Peter Socha

No, that’s totally different. The contract that was amended was a utility contract.

Warren Chang - Macquarie

So that’s a brand new contract. Okay, and then not to belabor the cost question too much, but I just wanted one more follow-up on what Jeremy and Mark were talking about. The new equipment that you have, how much production does that impact? Can you maybe give an estimate of the dollar per ton impact?

Peter Socha

Well, on an overall basis, no, but I’ll tell you in the mines that we have put it in the productivity that we look at or feed per shift has gone up by a material amount. Like a lot and we’ve been very pleased with that, but no, we haven’t come out and said, because we don’t, it wouldn’t, no we haven’t done that.

Warren Chang - Macquarie

Then one last thing, I really like the slide that you had in the deck about the international impact from the market. Is there any specific, more company specific anecdotal things that you can, that you’ve seen this quarter maybe that you can talk about or is there…?

Peter Socha

How about inbound calls from Europe?

Warren Chang - Macquarie

Okay.

Peter Socha

That’s the anecdotal I can tell you as we have gotten more than one call inbound looking for coal for next year.

Operator

It appears there are no further questions at this time. I’ll turn the conference over to, Peter Socha for closing remarks.

Peter Socha

Great, Casey, thank you and thank you, everyone, for joining us today. Our next earnings right now I’m looking at Tuesday, November 3, so we look forward to talking to you then. Thank you.

Operator

Thank you. Ladies and gentlemen, this does conclude today’s presentation. We appreciate your participation. You may now disconnect.

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