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Executives

Janine Orf - Director of IR

Rick Whiting - CEO

Mark Schroeder - SVP and CFO

Analysts

Shneur Gershuni - UBS

Kurt Woodworth - Macquarie

Brian Gamble - Simmons & Company

David Khani - FBR

Garrett Nelson - Davenport & Company

Jeremy Sussman - Brean Murray

Brian Singer - Goldman Sachs

Meredith Bandy - BMO Capital Markets

Paul Forward - Stifel Nicolaus

Barry Haimes - Sage Asset Management

Mark Caruso - Millennium Partners

Jacob Mueller - AYM Capital

Patriot Coal Corporation. (PCX) Q3 2009 Earnings Call October 27, 2009 11:00 AM ET

Operator

Welcome to the Patriot Coal third quarter 2009 earnings call. For the conference, all the participants are in a listen-only mode. However, there will be an opportunity for your questions and instructions will be given at that time. (Operator Instructions) As a reminder, today's call is being recorded.

With that being said, I'll turn the conference now to Ms. Janine Orf. Please go ahead.

Janine Orf

Thank you for joining Patriot’s third quarter 2009 earnings call. I am Janine Orf, Director of Investor Relations for Patriot Coal. With me, are Rick Whiting, CEO of Patriot, and Mark Schroeder, our Senior Vice President and CFO.

On this call, we will be discussing our operations, our outlook for coal markets and our results for the 2009 third quarter. As a reminder, forward-looking statements should be considered along with the risk factors that we note at the end of our press release as well as in our Form 10-K and Form 10-Q.

Finally, we will be referring to non-GAAP financial measures which are reconciled in our earnings release available at our website patriotcoal.com.

Now, I would like to turn the call over to Rick Whiting, Patriot's Chief Executive Officer. Rick?

Rick Whiting

I’d like to start this morning, with an overview of the coal markets and the positive trends we are seeing. We believe the markets are at an inflection point poised to see a substantial improvement in demand in 2010 in both metallurgical and thermal coals. This is a significant shift since we last talked at the end of July. I am now more optimistic that the timeline is within our near-term [site].

Let’s look first at the metallurgical coal market. As you know the domestic steel industry began a slow recovery in the second quarter and we have seen a steady improvement each week since then. Utilization at steel mills in the U.S. has actually increased 26-weeks in a row and now stands at 63 plus percent. When we spoke with you last quarter, this figure was 50%.

In international markets, higher fixed asset investments in China have led to higher steel production and increased met coal imports. Our U.S. coal producers have not historically shipped large quantities of met coal to china. There have been a number of U.S. exports to China in recent months. In fact, Patriot recently entered into an agreement that we believe will represent the first meaningful shipments of U.S high volatile met coal to China.

Clearly met coal demand around the world is rebounding as a result of the higher domestic and international steel production, and because of the limited availability of high quality met coal in the world, our forecast show demand outstripping supply and therefore driving up met pricing as we move into and through 2010.

On the thermal side as well, we believe that domestic demand will improve significantly in the next six to nine months. Forward strips are indicating that natural gas pricing in 2010 will be at levels where utilities were returned to normal dispatch of their coal-fueled plants ahead of natural gas generating plants. We’re seeing estimates that this alone couldn’t results in a 20 million ton to 40 million ton increase in thermal coal demand in 2010. A continuation of below normal temperatures into the winter, coupled with the effects of reduced natural gas exploration will drive this coal demand.

Further, improving domestic and world economies will result in higher industrial production and electricity usage, resulting in higher thermal demand, both in the U.S. and overseas. Between increased domestic electricity usage and higher thermal coal exports to satisfy world demand, industry experts expect an additional 20 million ton increase in U.S. thermal coal demand in 2010. These two factors will lead to a 40 million ton to 60 million ton increase in thermal coal demand in 2010. This higher demand will naturally draw down the current higher levels of thermal coal inventory at domestic utilities and as markets rebound, we believe that supply will be hard-pressed to keep up with demand, particularly in Central Appalachia.

In addition to publically announced production cuts, we believe that more than 10 million tons have been taken offline by private producers in Central App. We believe that some of the public and private company production cuts will leave the market permanently.

Additionally further constraining supply the delay and issuance of surface mining permits in Central Appalachia during 2008 and again this year in 2009 is almost certain they have a meaningful negative impact on surface production in 2010.

We see thermal coal demand especially for Central Appalachia extending supply around the end of 2010, and the change from oversupply to undersupply may be abrupt taking place over a very short period of time.

With upward pressure on demand and downward pressure on supply, we believe the impact on pricing will be meaningful. In fact we are seeing an improvement in our customer sentiments on the thermal side even though inventory levels remain high and just the last month, utility and industrial customers who have previously indicated they wanted to discuss delivery deferrals are now indicating these discussions are no longer necessary.

At Patriot, we are in a position as market conditions warrant to essentially double our met coal volumes from the current run rate of approximately 5 million tons to around 9.5 million tons. This ramp up could take place relatively quickly with the fairly modest capital outlay.

Our decisions to increase met production will clearly be based on the pricing and the duration of new sales commitment with our long established customer base.

For thermal we can also increase our production by several million tons annually, even after taking in to account certain production crossing over from steam to met. This increase would largely be the result of adding [chips] and bringing up our new lower cost Hill Fork and Blue Creek facilities to full production.

Despite the improving market outlook, management will continue to focus on the basics, safety, cost control, reliable output and customer interaction to make Patriot successful.

So, now let’s step back and look at our results in the third quarter. Patriot achieved EBITDA an excess of $25 million this quarter, following EBITDA in the 2009 first quarter of $22 million and the second quarter of $31 million. These three consecutive quarters of solid EBITDA validate the steps we have taken in our Management Action Plan during the first nine months of 2009.

As you may recall we begun implementing this plan in the fourth quarter of 2008 in response to the extraordinary economic condition and weaken markets. The plan includes operational, commercial and financial action items.

On the operation side, a number of our mines had higher productivity this quarter including our Wells and Corridor G complexes, and as we managed our production base in order to fulfill contractual obligations, we stepped up brokerage activity and were opportunistic in purchasing third-party coal.

Our diverse portfolio of mining complexes is allows us to dial up or down production in response to market fluctuations and the idling certain properties in concentrating our production in fewer complexes we have been able to keep our per ton cost in line.

We also continue to make in roads on the commercial initiatives in our plan. As we have stated before our approach is to workout mutually beneficial arrangements with customers on their coal requirements.

During the quarter we successfully restructured three thermal coal contracts and received compensation for shortfalls in contracted shipments. Restructuring of coal supply agreements is a normal part of dealing with our customers and we may see opportunities for these types of transactions additionally in the future.

Finally, covering our Management Action Plan initiatives on the financial side, we are seeing positive results from our ongoing emphasis on cash and cost control. We continue to keep our capital expenditures under tight control at $19 million for the quarter.

We have also worked very closely with our supplier to reduce cost and have successfully negotiated price reductions in numbers areas. With diesel fuel we have hedged in place for about two-thirds of our expected 2010 usage, at price points modestly below current prices.

Regarding safety in our mines, maintaining safe operations continues to be a top priority at Patriot. During the first nine months of 2009, Patriot achieved a safety incidence rate of 3.63 per 200,000 hours worked. This compares favorably to the national average for the industry for all coal mines of 3.97 per 200,000 hours worked and to the Patriot’s safety incidence rate last year for the first nine months of 2008 of 3.79.

During the quarter, Patriot was recognized with a number of safety and reclamation awards. Our mine rescue teams received first place awards in the first aid and the pre-shift categories of the National Mine Rescue Contest, as well as third place in the combination, or the overall category.

In the reclamation area, Patriot received the Commissioner's Award of Excellence in Reclamation from the Kentucky Department of Natural Resources for work at the Patriot surface operation. We are very pleased with these awards and command our employees for their dedication and commitment to safety as well as being good stewards of the environment.

Currently surface mining provides almost two-thirds of Central Appalachian thermal coal. So, we look with great concern on the EPA decision to further review all 79 surface mining permits pending with the core of engineers.

If future permits are not granted and important source of low cost fuel for electricity will be eliminated that will mean higher utility cost for many Americans. Unfortunately the EPA’s decision adds further uncertainty for coal producers, our employees, our customers, and our investors. At Patriot, we take our commitment to being a good steward of the environment very seriously, as well as being a good neighbor in the communities where we operate. These are a fundamental part of our company's mission statement.

We will continue to interact with both state and federal regulatory authorities, including the Army Corp of engineers and the USEPA in a constructive and businesslike manner in order to acquire the necessary permits to continue our surface operations. These are low cost sources of fuel for electricity generation that contribute to the quality of life for American citizens and the competitiveness of U.S. companies in global markets.

In concluding my remarks, thermal and met coal markets remain challenging. Although the exact timing of the recovery is not yet clear, we are now much more optimistic that the timing is near term. I do want to take this opportunity to thank our very capable and loyal employees for their continued focus on safety, on productivity, and on customer satisfaction during what has been one of the most challenging and disruptive periods ever experience by our industry over the last 12 months.

On behalf of the entire Patriot team, I want to assure you that we are eager to resume our growth strategies and fully participate in rebounding coal markets in the coming months.

Now let me turn the call over to our Chief Financial Officer, Mark Schroeder, to discuss the third quarter's results. Mark.

Mark Schroeder

Thanks Rick. Let me begin by sharing with you some financial highlights of this quarter. First, as Rick mentioned, this was our third consecutive quarter of EBITDA in the 20 to 30 million range. Second, our EBITDA per ton in the Appalachia segment was more than $10 this quarter, reaching our goal of double digit EBITDA. Next, our met coal volumes were up 50% compared to the second quarter, and met coal cost per ton were down by more than $5 per ton. And finally, our operating cash flow was stable during the quarter with no borrowings against our credit facility, roughly $50 million in cash, and $222 million in liquidity.

Before I get into the details of the quarterly financial results, let me give you an update on the performance of our important Federal and Panther longwalls. As anticipated, the Federal longwall experienced a rock binder or a parting in the coal seam early in the current panel. Additionally, adverse roof conditions were encountered in the parting area, which had not been experienced in previous panels. This lowered production for the quarter to 700,000 tons, following production of almost 1 million tons in both of the first two quarters of 2009.

By quarter end, the longwall was operating in more favorable geology and running near its normalized level, on pace for October to be the best month of production so far in 2009. And the next panel, which will be the final panel over the current mining area, we have further refined the mine plan to avoid this difficult area, bypassing the initial 1,800 feet of the panel. Looking forward, in mid-2010, this Longwall will move to the south area of the mine, where overall geology is expected to be more favorable.

At Panther, as we have previously discussed, the Longwall moved during the quarter, including significant upgrades to components of the longwall mining equipment. Downtime related to longwall move, together with time required to fully integrate the new equipment caused Panther's output to be lower in the quarter. The equipment includes new components from the supplier, and with these new components we experienced unanticipated issues with the electrical systems and software. We also experienced issues with the new stage loader and pan line chains. While these problems were disappointing and caused additional downtime, once the new equipment was fully integrated, the longwall productivity improved as we realized its benefits. By quarter end, the longwall was operating near its normalized run rate, and during October, the longwall has continued to perform well, and has had the most consistent performance of any month in 2009.

Now let me provide a bit more color on the quarter starting with the supplemental financial data portion of our earnings release. In the third quarter 2009, Patriot sold 7.8 million tons compared to 8.3 million tons for the 2009 second quarter. The third quarter sales include 1.5 million tons of metallurgical coal, up 0.5 million tons from last quarter. As a reminder, in the second quarter, net sales were lower as we were working with customers to restructure their contracts in light of the soft economy.

As Rick just mentioned, the met market began to turn in the last few months resulting in significantly higher met sales in the third quarter. With this increase, met made up 19% of total sales in the third quarter, compared to 13% in the second quarter. Thermal coal sales were down about $1 million tons in the quarter. Lower production at Federal and Panther, along with the impact of contract restructurings led to this decrease.

Revenues per ton were $62.95 in the 2009 third quarter compared to 58.66 in the 2009 second quarter. Higher revenues per ton were primarily a result of the increased met tons. Costs per ton were $54.70 in the 2009 third quarter, compared to $52.41 in the prior quarter. The significant increase in met coal in our total sales mix caused our overall cost per ton to increase compared to last quarter. As I mentioned earlier met cost were down by more than $5 per ton in the third quarter compared to the second quarter. With a more normal mix of met and thermal shipments coupled with the improved longwall performance, we expect to see a reduction in overall cost per ton in the fourth quarter.

Segment EBITDA per ton was $8.25 in the 2009 third quarter, 32% increase compared to $6.25 in the 2009 second quarter. The higher EBITDA per ton was primarily a result of the increased higher margin met coal sales. We realized this improvement despite the cost challenges I just mentioned. This is another example of how our management action plan has had positive impact across our entire operating portfolio; resulting a more predictable performance at more of coal mines as we move forward.

Segment EBITDA for Appalachia was $10.54 per ton for the 2009 third quarter compared to $7.36 in the 2009 second quarter. EBITDA per ton for this segment increased primarily due to the higher met coal shipments. As I mentioned earlier, reaching double-digit EBITDA per ton has been a short-term goal. We’re pleased to have reached this level and we will continue to work towards higher per ton EBITDA in the coming quarters.

Illinois Basin segment EBITDA was minimal in the 2009 third quarter compared to $2.19 in the second quarter. Revenues per ton for this segment were lowered by about $1 while operating cost per ton increased $1.21 in the third quarter, primarily as a result of [Campbell] belting issues and additional inspection related production delays at the Highland mine.

Compared to the year ago 2008 third quarter, total ton sold decreased 300,000 to 7.8 million, largely a result of rationalized production related to the lower demand for thermal coal and as a reminder since the third quarter of last year 2008, Patriot has idled or closed the Jupiter, Remington and Samples thermal coal mines and scaled back production at several other operations.

Revenues per ton increased $3.44 compared to the year ago quarter, resulting from higher average selling prices, particularly for metallurgical coal.

Operating cost per ton declined $0.72 in the third quarter of this year, compared to the year ago quarter. Appalachian cost per ton decreased $1.53 compared to a year ago led by declines in materials and supply cost. In particular, diesel fuel, explosives and repair cost were lower in 2009 than in the third quarter of 2008. The decline in Appalachian cost per ton was partially offset by a $1.94 increase in cost per ton in the Illinois Basin due to the issues at the Highland mine I mentioned earlier.

EBITDA per ton in the 2009 third quarter was $8.25, doubled the amount in the prior year. This per ton growth occurred despite the lower tons [although which to] absorb fixed cost. As Rick mentioned earlier, by closing an idling mines to drawdown production, we have kept our operating cost in line.

Past mining obligation expense was $40 million compared to $34.2 million in the second quarter. A higher cost in the third quarter related primarily to wages and benefits from closing the Samples mine during the quarter. Approximately 315 employees were displaced when we shutdown the Samples mine. Expenses associated with these employees severance pay were included in this line item in the third quarter.

Our capital expenditures totaled $19.3 million in the 2009 third quarter. We continue to tightly manage our capital expending as part of our ongoing Management Action Plan. Capital expenditures through the third quarter totaled $54.2 million. Major expenses in 2009 were for continue development of the Hill Fork and the Blue Creek operations as well as upgrade to the Panther and the Federal longwalls.

As a reminder, we have deployed more than $75 million of capital equipment including both underground and surface equipment as well as infrastructure to more productive locations.

Now turning to the income statement portion of the release; on a sequential basis we have recognized EBITDA $25.4 million in the quarter, solid EBITDA in all three quarters was achieved through successful execution of our Management Action Plan, which as Rick mentioned focused on operational, commercial and financial aspects of our business.

EBITDA improved $27.6 million, compared to the year ago quarter, despite the impact of the Panther longwall move and fewer tons sold in 2009, a resulted from an increase in average selling price as well as lower cost.

Accretion related to shipments on below market sales and purchase contracts obtained in the Magnum Coal acquisition totaled $94 million in the third quarter of 2009 compared to $61.7 million in the 2009 second quarter. The higher amount in the third quarter relates primarily to the restructuring of thermal coal contracts and associated reduction in shipments in future periods.

Our DD&A was $50.4 million in the 2009 third quarter, in line with our reported in the second quarter. DD&A was higher this quarter compared to a year ago largely as a result of DD&A associated with the former Magnum properties.

Interest income was $3.7 million in the 2009 third quarter compared to $5.8 million in the second quarter. The second quarter amount included interest related to Black Lung Excise Tax Refunds we received during that quarter. We continue to expect no income taxes in 2009 so we recognized no income tax provision in the third quarter.

Turning to the balance sheet, our cash balance was just under $50 million at September 30th in line with the June 30th balance. We had no borrowings under our credit facility at September 30th with letters of credit of almost $350 million.

Our unused borrowing capacity under the credit facility was $174 million at the end of the third quarter. So, including our cash balance, our available liquidity was $222 million.

We continue to carry very low debt on our balance sheet. At September 30th our debt totaled $205 million and consisted primarily of our 3.25% convertible debt due in 2013.

Once again in the third quarter, we achieved stable operating cash flow. Our operations continue to fund our capital expenditures and I just noted, we did not draw on our credit facility. We expect cash from operations to continue to fund our capital expenditure needs.

In today’s release, we have provided the average price per ton for contracted business for the fourth quarter 2009 and for 2010. You will note that there have been some adjustments in price business since our last disclosure. In particular the price per ton on met business for 2010 is now $86 compared to $92 last quarter.

During the quarter, we restructured a customer contract to blend in lower quality met coal at a lower price in lieu of higher quality tons previous contracted. As a result of this restructuring, we have introduced our met coal to new markets and have locked in solid margins on cross overturns. And as a result of this restructuring, while our price per ton for contracted met business declined, we now have more high quality met to price in 2010 in what we believe will be a tightening market.

And finally, we priced about 600,000 tons of met business that had previously been [committed] but unpriced. We also priced about 300,000 tons of Illinois basin coal at prices substantially higher than our average 2009 contracted price.

Unpriced volumes for 2010 will depend on the finalization of production plans, taking into account demand, pricing, cost structures, and the availability of mining permits and we expect to provide projected sales volumes and other guidance for 2010 in conjunction with our fourth quarter earnings report.

So I closing, our fourth quarter looks to be shaping up nicely with the Federal and Panther Longwalls both running well. Looking forward to 2010, customer demand has stabilized. We have a solid base of 2010 book business, and are comfortable with our unpriced volumes remaining in each of our operating regions. We expect the market recovery to generate solid earnings across our existing operating platform. As Rick mentioned earlier, while we don't expect the market recovery to be in full swing by early 2010, we are optimistic that that timeline for recovery is more within our sight than it seemed just a quarter ago.

We have the flexibility to selectively increase production as conditions warrant by restarting idle properties, adding projects in the pipeline, both brownfield and greenfield, and pursuing bolt-on acquisitions. And as Rick noted, we stand ready to resume our growth strategy once coal markets fully recover.

This concludes our prepared remarks, and Rick and I will be happy to take your questions at this time. With that I'll turn the call over to our operator, John.

Question-and-Answer Session

Operator

(Operator Instructions) The first question is from the line of Shneur Gershuni with UBS.

Shneur Gershuni - UBS

I just wanted to clarify your comments with respect to the met contracts for next year. You'd mentioned that some of the tons was a restructuring of an existing contract. So you have substituted lower quality tons from higher quality tons. I was wondering if you can confirm that and also if you can give us some color with respect to the committed but unpriced tons, kind of where the pricing was on that and as well as with the Chinese contract that you signed?

Rick Whiting

First off, let me just say, if you look at the math it would say that we booked 0.5 million tons of met coal at 66 bucks during the quarter. Let me just confirm that we did not do any of that. We did not book any coal near that price. It's really just related to the mix. There are four or five different parts that occurred during the quarter. We did book some additional business.

You just mentioned Chinese business. We did book some of that. It was at the lower grade of our high volatile met coal. Still a good grade, but the lower of our three different grades that we have out there and it freeze up some of the higher quality coal that we had, so when you take the lower quality, restructure it at a different place, it drives down the overall cost per ton, but this is as we view it very positive and that it gives us more of the coal at the higher grade to offer into the market. I won't give specific as to what prices we did book on the new business, but I'd say we feel its very competitive prices that we did record. It was on an existing business that had been committed, but on price so we knew the customer was just completing that transaction that was already out there. So I won't give real specific on the price, but I will say that it was competitive and don't look at the decrease in the average per ton is anything but positive and that it freeze up some of the higher quality met coal out there as we go into 2010.

Shneur Gershuni - UBS

If I can follow up with two more questions. I was wondering if you can kind of give us a breakdown of your sales number between what was actually produced versus sold out, the inventory versus open market purchases and also if you can comment on your CapEx, if this is kind of the number we should see going forward and tell you're ready to call a turn in production?

Mark Schroeder

First on sales, very little spot business during the quarter, there is a little more interest going on as both Rick and I have mentioned in our comments, but very little spot, almost all of what we sold was already committed business in the third quarter. On the CapEx number, I had mentioned earlier in the year that we were targeting in a number of about 100 million for the full year. I still think that's a target. I expect it will be lower than that as we complete the fourth quarter. As we look into next year; we're still finalizing our budgets. I would expect the number in 2010 to look a lot like 2009.

Shneur Gershuni - UBS

If I can just go back to your breakdown for sales for one second, your sales volume is basically what you produced and your inventory in very little was the open market purchase?

Mark Schroeder

That's correct.

Operator

Next question from Kurt Woodworth with Macquarie.

Kurt Woodworth - Macquarie

Rick, in terms of thinking about the mass production for 2010, right now you're running at almost a 6 million ton run rate in a more normalized environment. And you say in a U.S fuel production, utilization rate close to 80% and the export market is continuing to improve. How much production do you think you could get next year and in terms of the crossover tonnage what level of crossover tonnage could you eke out?

Rick Whiting

The easiest part is to change the gravity on the plant and move some of the steam tons over the crossover, so that generally would take place more from the Panther and Kanawha Eagle. I got to think, we could probably do 1.5 million ton to 2 million ton, so that type of crossover fairly readily. We worked some other commitments but given our portfolio and ability to shift from multiple origins, that shouldn't be much of a problem. If I look at it, where we are today, the run rate as you said, 5.5 kind of a category, may be a little more than that in recent quarter, may be 6 million ton run rate and we said in our release and our comments that we thought we can get up over 9, may be 9.5 million tons. It’s just really about the timing of bringing that production on. We could bring it on by 12 or if the markets were there, certainly by time we got to the latter part of 10, we could up at that run rate for 11, assuming we would get the right type of commitments, not only price but some duration that would want putting out the additional incremental capital to get to those levels. So, it’s pretty realistic. Some of our tons are already moving the across over type tons are already moving as met coal.

So, it would be realistic to move on up through the 7 and 8 million ton range pretty readily and then start brining on more production at the [likes of] Black Oak in our 2 Gas, Washington mine down in Logan County, and ultimately get up to the 9.5 range. So, it’s really about dialing it in, in conjunction with our commitments we can make I guess our traditional customers most likely.

Kurt Woodworth - Macquarie

One question in terms of Federal and Panther operating exclusive normal performance right now, what positive impacts that have on your unit cost on Appalachia in the fourth quarter relative to what you had in the third quarter.

Mark Schroeder

This is Mark. It certainly should be better. I mean just getting the fourth quarter to be meaningfully better than what we did in the third quarter. The quarters not over and actually were only in October here, but what we have seen so far out of Federal and Panther in the month of October make us feel pretty good, and those are mines that when the running well and we are getting the tons out the costs are pretty nice number, and when we went through the third quarter Panther having a move, Federal having a little bit of geology issues. They didn’t produce what we expected them to.

So, just Federal as an example if it goes from 700,000 tons in the third quarter to 1 million tons and your total cost looks the same. You know what that can do? You can do the math and what that does to your overall cost structure. So, the combination of those two mines Federal and Panther should have a meaningful improvement for our cost in the fourth quarter.

Operator

Next question is from Brian Gamble with Simmons & Company. Please go ahead.

Brian Gamble - Simmons & Company

I start with the capital, Rick and you mentioned ramping up. How much capital is modest we are talking 20 million, we are talking 50 million?

Mark Schroeder

Brian, this is Mark. It would come in the increments, but I would say it would be more like total of 50 million to ramp it up. It would come in 10s and 20s a couple of different tranches along the way, but it’s probably a 50 million number.

Brian Gamble - Simmons & Company

Okay and then the 2010 position that you gave price tonnage and price available there, what are your additional committed tons that are not priced yet, that should be associated with 2010.

Rick Whiting

In the range of 1 million to 1.5 million on the met side, on the thermal side it’s really a nonissue. It’s a met side.

Brian Gamble - Simmons & Company

Okay and then my last question and I will hop back in, but as far as the accretion for the contracts that renegotiated during the quarter. I know you mentioned this on the call, I just want to clarify, what part of that flowed in to the quarter itself as far as borne into other income versus what goes into the next quarter? I just wanted to know from a modeling standpoint where we should be on that other revenue on?

Mark Schroeder

I think that number should look more like 65 to 70 million number in the fourth quarter in a normal quarter. Does that helps?

Brian Gamble - Simmons & Company

That does help.

Operator

Next in the line of (inaudible) with FBR, please go ahead

David Khani - FBR

Yes, it’s actually David Khani. Can you talk a little bit about; I mean throughout there that we are starting to see a little bit of the sunshine and daylight here where things are turning. What kind of things are you seeing out there that give you sort of that view that things are going to get better sooner than later, without putting an exact timing on it?

Mark Schroeder

I guess one of the things I'd say, Rick and I spent some time with the sales group here. Normally, as we get closer to the call as well as through the quarter, but as we get closer to the call, one of the big things I point to is, their phones ringing a lot more about things like I don't want to talk about having to defer tonnage, let's talk about what our needs are for 2010. So I point to that one as the biggest thing. Certainly we see things in the met side. Rick mentioned 26 weeks in a row, so that's certainly positive for us. But the positive we're seeing is really on the thermal side. And it's more the inbound phone calls being more about 2010 than about deferrals.

Rick Whiting

The other thing I like on the industrial side, some of these guys that buy stoker coal and also people that buy power for their industrial consumption are more active. They've come back into the market, the guys that were radio silenced for most of the summer have come back in and started talking about industrial purchases. I think that will flow over into the electricity usage side as well.

David Khani - FBR

I guess sort of follow up question, how much met do you think you are going to export this year, and what do you think on a percentage basis, what do you think you will export next year? And then, are you seeing any pickup at all on the steam side for exports?

Rick Whiting

I'll answer the steam coal first. We haven't been particularly active in that -- weren't really that last year, other than some coal (inaudible) Gulf for Midwestern coal. So, that has been relatively quiet, at least on our front but that hasn't been a big part of our portfolio to start with. I think we'll do about 3.3 million of export coal this year, which is almost exclusively met coal, tying back to the first answer. Well, I would think we would be, based on what I'm hearing on global markets and the kind of interaction we're getting as our sales guys travel around Europe and Brazil, I would think that would be a floor for next year.

David Khani - FBR

Possibly higher.

Rick Whiting

Yes. I would think some meaningful amount of our growth, if we are able to dial up their production as I answered a couple of questions back, would go international, so it should grow.

David Khani - FBR

Okay. And then how much inventory do you have on hand for both steam and met?

Mark Schroeder

Very little; we are talking a week and a half to two weeks of total inventory. There is not a whole lot out there in our mines.

Rick Whiting

It varies a little bit by location, but in total if you wrap it all up, you're in somewhere around a week and a half to two weeks range.

David Khani - FBR

That's great. And then last question before I pass it on. I know you didn't buy much third party coal. Did you jump into the financial markets at all and buy some of the NYMEX or TC or something to play the trade-up in coal prices in the quarter?

Mark Schroeder

No, we did not. That is an area we look at. We have a couple of guys that are pretty good at that, but during the quarter, we opted out of that, did not do anything.

Operator

The next from the line of Garrett Nelson with Davenport & Company.

Garrett Nelson - Davenport & Company

Getting back to the met business you booked at China, could you give us a sense of the volumes that are involved, and do you view that as a one time deal, or do you expect China to become a significant met coal customer of Patriot's going forward?

Rick Whiting

We actually did that business through a third party, and there are multiple destinations in Asia. China is one of those, but it's several hundred-thousand tons in total, so that would mean if any meaningful portion which it is to China, we think at least a cargo or two are going to China.

Garrett Nelson - Davenport & Company

When are those scheduled for delivery?

Rick Whiting

Actually, I think some of it probably by the end of this year, and on into 2010. Believe it or not, it's some of our lower grade, all of our coking coals are out, ours' are pretty strong, but it is some of our more of a Panther, Kanawha Eagle-type product that is moved to that, and I do not see it as a flesh in a pan. I think, it is an opportunity for some ongoing business, that's why we took on that business and moved quickly to try to secure that for that type of coal in particular, because it's our highest margin business. If you get into where you have the Panther product selling at a met coal price, that's kind of best of all worlds.

Garrett Nelson - Davenport & Company

Thanks for the detail on that. Now that 2010 is almost here, could you provide some detail on your [2 million] price book of business for 2011?

Mark Schroeder

If you don't mind, why don't you get back direct Janine or I, and we can provide that to you. Now, we didn't do it in the release. We just went through 2010, I think we have shared 2011 in the past. I'll be happy to do that.

Rick Whiting

Obviously order of magnitude, we've got priced about 14.5, 15 million tons of coal in 2011 in total for all products.

Garrett Nelson - Davenport & Company

How much of that?

Rick Whiting

It's very minimal coking. It's almost negligible on the coking, so it's basically all thermal coal in Appalachia and Illinois Basin that is price, but virtually no coking coal.

Operator

Next from the line of Jeremy Sussman with Brean Murray.

Jeremy Sussman - Brean Murray

I appreciate the color on China. In the highball market, in terms of 2010, if in fact the highball market kind of holds up as well as maybe you would hope, and seems to be indicating based on your shipments to China, what type of volumes could we see in 2010? I know you mentioned, we could get to 9.5 million tons ultimately, but kind of thinking next year here?

Rick Whiting

For us?

Jeremy Sussman - Brean Murray

Yes.

Rick Whiting

I think realism in terms of the timing of transactions and the timing of the capital expenditures and they are calling people back and all factors considered, I think it's probably going to be at the high end and in the 7.5 to 8 million ton range for '010, and it will be able to move right on through that number to higher levels by the time we hit '11.

Jeremy Sussman - Brean Murray

Then following up on Brian's question earlier, obviously you restructured some contracts. This quarter did that last quarter as well, and this quarter, your stuff that you are trading in brokerage. Just trying to get a sense of maybe how much of that each float into your EBITDA or maybe what we can expect on a normalized basis going forward, just to help us model this out?

Mark Schroeder

We have a spate line item called other revenue in the income statement, so that's where that sort of stuff would go. There are other items in there as well, but you can see that in total that number was 13 million in the quarter. Now, it's not all 13 million, it's a number less than that, but it's part of that number.

Jeremy Sussman - Brean Murray

Okay, so it's nowhere other than the sales contract accretion that you mentioned, it just flows into the other income?

Mark Schroeder

That's correct.

Jeremy Sussman - Brean Murray

Great, and then just last question before I move it on. In terms of Federal, you mentioned that you are further refining your mine plan in your press release to avoid kind of the adverse geology that we have seen, can you give us a sense of maybe what changed that’s caused you to further refine this? Maybe as we move into 2010, what type of impact can we see in terms of production given your mid-year move? I guess it sounds like you’re comfortable with the $1 million tons in Q4 as well.

Rick Whiting

First of all, I’d say, yeah, I am comfortable with $1 million tons. We are off to a very good start in the month of October. So I like the way the mine is performing. As far as just parting our [boundary area] that we’ve experienced. We knew that was there and we have plan for that. However the roof got a little more challenging coming in and out of that (inaudible) in the middle of the phase this time. So, all factors considered given the fact that [progress] down a bit on our productivity and production. We made the decision to not do that on the final panel that we’re going to mine in the north area before we move to the south. We have enough lead time on our development that we decided to just eliminate that. It’s about 1800 feed in total and we had reasonably good experience on the previous two panels. We did suffer from a standpoint of yield though prep plant, but the roof conditions were lot more tolerable.

Based on our drilling and our core sampling and our actual mining in the development entries, we just felt like we will play more conservatively and work towards higher production next year, given the fact we do have the longwall moves next year and just avoid that area and it was more of a decision based on actual experience in the most recent panel. The roof was more difficult than in the previous two or three panels. So it was one of those things that we had extensive drilling and we had advanced planning when you generally knew what we’re dealing, with but there were some localized circumstances that we experienced that we do not care to experience again in early part of next year.

Jeremy Sussman - Brean Murray

Just the last part of that, kind of annual production for Federal in 2010 or is that too soon to get into that?

Rick Whiting

Little too soon, but I think for walking around numbers, you can still look towards the 4 million number or so is what we’d like to see out of Federal on a regular basis.

Operator

Next question is from the line of Brian Singer with Goldman Sachs.

Brian Singer - Goldman Sachs

Following up on the couple of the earlier questions on cash costs, can you support your cash cost structure in Appalachia to what is met versus thermal. Then a little bit more color, as you bring on some of the longwall improvements at Federal and Panther, how the thermal portion should progress over the next few quarters and maybe the same on the met side, as you increase met production there?

Rick Whiting

For competitive purposes, I’d rather not split the two out. I guess I would say that as I mentioned in the release, the met was down on the third quarter. Thermal was up slightly, not a big number, but up slightly in the quarter. I expect them to both be in pretty good shape as we go into the fourth quarter. When I talk about cost in the fourth quarter relative to the third, and I am anticipating that the fourth will be better, I am really banking on Federal and Panther having pretty good performances to drive down that thermal number. I would expect thermal to again be better in the fourth quarter as it has been in the first couple of quarters of this year and the third quarter of what I call anomaly with thermal going up slightly was more related to Federal Panther.

Keep in mind, as we’ve gone through this year and we’ve closed out idle facilities and cutback at production of five day to a four day or six to a five day. As you know, we talk about the device it just heard from the device side in getting the fewer tons out there I feel really good about how the cost have performed during the year and as I look to the fourth quarter as I mentioned I think with Federal and Panther both running well. I expect both the met and the thermal to improve.

Rick Whiting

The recent samples closed it was higher end of the range. It was not a higher cost amount. It was higher end of our surface mining cost range and it has dropped out of the mix now with the transition out of in the third quarter. So, that should also have a positive impact on our thermal coal average with that higher cost component dropping out versus previous quarter.

Brian Singer - Goldman Sachs

I guess continue that in to 2010 were as you have highlighted you have some longwalls move has been it seems like some of the geology should improve thereafter. Is the fourth quarter good benchmark for 2010 or should there be more volatility in thermal cash costs in 2010/

Mark Schroeder

It looks too early to gaze with the 2010 is going to look like were well in to the budget season, but I guess I’m not in a position yet to talk on that. I have said in the past continue to say, it like a good end product for us would be 2010 cost very similar to how we finish 2009. I don’t anticipate an increase or would be I’m happy with an increase in the overall cost. I think fourth quarter of this year is going to be our best cost quarter.

Brian Singer - Goldman Sachs

Lastly going back to the pickup in thermal sentiment that you’ve noted, are they any regional or is there any specific region or utility type, where you’re seeing some of the versus it is it Appalachia specific Illinois Basin specific. I think you had mentioned in response to previous question potential industrial pickup, but I guess is there anything else that you can add on the thermal sentiment improvement.

Rick Whiting

I think its pretty well uniformed, it’s for the customers for the Northern App for Federal product we’ve had enquires and actually about Central App steam down in the southeast and in the central Corridor there though how markets and also we have had some discussion around Midwest product. We have some possible transactions there. So, think it’s fairly uniform. I don’t know it’s concentrated on any one product versus the other. It has been kind of across the board actually.

Operator

With the line of Meredith Bandy with BMO Capital Markets.

Meredith Bandy - BMO Capital Markets

I just wanted to go back to met coal for a little while if I could. I know you said, you were looking at 3.3 million export tons that for 2010? I was wondering if you could put that in context of what sort of a normal amount of export tons for you guys and also what is your capacity to ship. Do you get to a point, where you have any capacity constraints on next (inaudible).

Mark Schroeder

The 3.3 is about were short about 60% or so of our met volume. So, as Rick mentioned as we see the met volume uptick if that occurs in 10 or 11 or whenever it occurs we do think the export side of that could tick up from 60%. So, as far as how high it will go I think it somewhat dependent on whether the 5.5 to 6 million run rate goes to 7 or 8 or whatever it is next year, but we think the increase that would occur on the met side is probably more export related than domestic related.

Rick Whiting

I think we have additional capacity capability in our arrangement to go through Dominion Terminal to dial that up to some extend of course there are other owners of DTA that we can get additional capacity through it. If that is a problem certainly we have the ability to put meaningful amounts of our CSX coal across a belt line on to the Norfolk Southern, and indeed we do some of that anyway. So we have another outlet to the East Coast to the Norfolk Pier on Norfolk Southern, which gives us a lot of flexibility. So, I don't foresee limitation on port capacity being an issue for us, even if we were to dial up international business, meaningfully back up a million tons.

Meredith Bandy - BMO Capital Markets

Okay, and the price that you have for next year, could we consider what's already priced right now to be sort of more in the first quarter of first half of next year, so later is open or…?

Mark Schroeder

If you're talking specifically about met, we…

Meredith Bandy - BMO Capital Markets

Yeah, met specifically.

Mark Schroeder

As we go through the year, more of the unpriced is later in the year. It is ratably, so I don't want to make it sound like everything's first quarter or first half, but there's more unpriced to later get into the year.

Meredith Bandy - BMO Capital Markets

Okay. And I'm a little bit surprised, was it the customers that wanted to switch the coal tons to the lower quality? A lot of other companies say that the tightness is really in the highest quality, but you guys seem to have restructured to get that lower tons out. I recognize what you're saying that there'll be the higher quality open, but I wondered if you could sort of give us a little more color about who's behind that change, and what's going on there?

Rick Whiting

Well, as kind of a unique circumstance, it was a combination of some business that was pricable higher, and the opportunity to introduce to some new markets. We were looking at our availability a couple of months ago, and knew that we had some tons at our Panther complex that we would likely sell us steam [coal]. We didn't have a met opportunity, and it looked very lucrative for us to work against that particular margin and make met coal out of that. And all the combination, we put it together and shook it up and came out with a more favorable mix and a combination to ship up a little bit lower grade coal. And we are optimistic, and every week and month that goes by, we feel better about what met prices are going to do out in the future. Some of those higher price turns were out in the future, and we think we can do that again and enjoy some very high prices on that product.

So, it was a combination of four, five factors that drove us to make that decision. But the good part was, that some of these customers are willing to take in what I'll call a [minus] highballs right now, perhaps because they are running at lower rates on their coking capacity and at longer coking times, and they can absorb that lower quality highball right now as long as it has some meaningful fluidity, but I think the good news is, as the market picks up and they're making shorter time coke and want a stronger product to ensure that they have a strong coke, then that's when our grade A products will have their day in the sunshine.

Operator

And next from the line of Paul Forward with Stifel Nicolaus.

Paul Forward - Stifel Nicolaus

Good morning. You mentioned a few of your expansion projects in met coal; there was Hill Fork, Blue Creek, Black Oak, and the 2 gas Washington mines. I was just wondering if you might be able to give us a little more detail about how much production you might be able to get out of either all four of those combined or it'd be great if you could give us a little bit more of mine by mine detail if possible.

Rick Whiting

Mark, probably help me out with the terms, but Hill Fork and Blue Creek are thermal. So the Black Oak and what we call Washington or 2 gas are the metallurgical ones that are not currently running.

As you know Black Oak was running previously. We were doing development there and we were just to the point where we could go to two and onto three sections, so that one can come up pretty quickly bringing back equipment and people, and it feeds into our Rocklick complex.

Whereas the two gas Washington mine was a Magnum property that they had permitted in the pipeline, and indeed we did the face up, and most of the civil engineering working and all the drainage and so forth. It's fully permitted, and it's basically just waiting on equipment in mine or two to begin production and in fact they even have a segregation system for separate handling of that at the Loadout Facility and at the Preparation Plant at [Samco]. That gives you a feel that those are a pretty easy projects to bring along. Mark, you want to help me with the terms?

Mark Schroeder

Just in terms, the metallurgical mines are more 1 million tons, maybe a little bit better, but right around that 1 million level, whereas the thermal mines Hill Fork being a surface mines, more like 1 to 1.5, and Blue Creek would be more like 1.5 to 2 million tons, Blue Creek is being an underground mine.

Rick Whiting

I think the Black Oak, probably be a 1 million plus. Been over 1 million by the time you get to three sections, 1.2 million, perhaps, and the two gas would be more like 700,000 or 800,000 tons, so in total 2 million tons between those two sources, and we still have a lot of under utilized washing capacity at our Rocklick plant, and we will continue to look at bringing back additional days or additional source mines that can go through Rocklick or even some more tonnage through our well's preparation plant, which is kind of our flagship operation from a tonnage and quality standpoint as well as is the work (inaudible).

Operator

Our next is from Barry Haimes with Sage Asset Management.

Barry Haimes - Sage Asset Management

I just wanted to circle to the impact of the deferrals. It looks like if I compare that other income number, this year compared to last year that the delta is maybe $9 million to $10 million, which should imply that perhaps the deferrals might be in that range. As long as there is no cost associated with this, so is it fair to say that compared with the 25-point for EBITDA that maybe (inaudible) the deferrals.

Then secondly based on the increased optimism on the part of the customers that you alluded to, is it fair to assume that this impact of the deferrals probably would be non-recurring in 2010?

Mark Schroeder

Thanks, Barry, for your questions. First off, the other revenue line does change by like 9.5 million or so quarter-over-quarter. I guess I would say the deferrals are not at 9.5 million. There are number less than that, greater than 5 million, but less than 9.5. There are other things that go through that line and they do change from quarter-to-quarter, so I guess I'll just leave it at that that it is not the 9.5, it is less than that, but it is a substantial number and it's a little bit over 5 million this quarter.

The second part of that, you said what will happen as we get into 2010 or further quarters where you have that same item? No, we won't, but I guess the flipside of that is to say that we'll sell coal that was otherwise going to go to the customer. I think what Rick has said in the past, what we’ve said in the past is when we do these restructurings or these deferrals, we try to work it such that we keep the margin in the current quarter and that’s what we are attempting to do. Although it does show in the separate line item of other revenues if I look into future quarters, I would say we would expect to sell that same coal to someone else and make a margin on the coal that we sell to someone else.

Operator

And next from the line of [Brian Finkelstein with Catapult]. Please go ahead.

Unidentified Analyst

I just had a quick question. I know you guys have some met growth potential and if you look at the met pricing, it did tick down and I understand you had some lower quality tons, but where are you guys seeing currently the market for a [highball] if you can’t provide any color.

Mark Schroeder

I guess maybe I will first answer it by saying there is a lot of chatter going on. We have not the sold the whole lot of met coal. There is some that we did in the quarter and that was coal, that was already contracted and we just finalized the pricing on it. There’s been a lot of chatter. It is a little bit hard to say exactly where the price is. I will say that we’re optimistic. Rick mentioned the 26 weeks in a row that domestic production has upticked. So that leads us to be optimistic. I won’t go out and say here’s where the pricing is, but I guess I will say that off the chatter, that is occurring out there. We feel pretty good about where things are headed.

Unidentified Analyst

Then I guess it hasn’t been brought up but just on the permitting situation, I know you guys previously spoken about the Hobet Mine, could you comment on any other mines that could have potential issues and your thoughts and colors on what’s going on?

Rick Whiting

I think that anything else that we have in our line up it becomes more of an issue in time you get to mid 2011, of course, we have the Apogee operation its large surface mount on Logan county and at some point we have permits we need to get down there be more in the having to mid to second half of 2011 we were effective there.

Obviously at some point in time we have other opportunities, what was Paint Creek, which is the area, where samples previously operated, we have some other reserves already permitted out there and we have another large block that we would be seeking a permit for sometime in the future probably all those we get done in by 2012 up there we would be a good shape for that fits in to our strategic plan and when we think we would like to bring those terms online.

So, as we get in to 11 and 12 no permit scenario, we can’t run at high from that any more than in the rest of the industry can. I think we are probably a typical profile that if our production drops down over the next three or four years, if we don't get any permits, but I think anything that's going to affect '10 is pretty well the Hobet 45 that has gotten so much fame of light.

Operator

We have a question from Mark Caruso with Millennium Partners. Please go ahead.

Mark Caruso - Millennium Partners

Thanks for squeezing me in. Just quick follow-up questions, to either Mark or Rick, Mark, earlier you had given us some color about bookings some tons in Illinois Basin and you gave us a lot more granularity on the crossover, are those reflected in the table for '10 or are those incremental to the table for 2010.

Mark Schroeder

They are included in the table already for 2010.

Mark Caruso - Millennium Partners

Okay, got you. And then for 2011 you had said there is 14 to 15 million total thermal, and I remembered you saying the Illinois Basin you booked for 10 being meaningfully higher, should we assume that that's the case for both whether it's Appalachia or Illinois Basin, as we look at '11, or should we think about the step up in growth just as you take advantage of the curve opportunities and people getting concerned about permits for '11, going higher?

Mark Schroeder

Yeah, I guess for '11 we haven't booked much new business this quarter for 2011. The number that Rick threw out there for 2011, really most of that was around already, and has been around there. It's these contacts typically that are two or three year legs on them. In a couple of cases, we have contracts that run through 2011, 2012. But most of that business, 14 million or so is stuff that has been out there for most of this year, I guess I would say.

Mark Caruso - Millennium Partners

And then lastly, on the crossover tons were you able to take advantage of Panther for that or is it other mines, and that still leaves the Panther product open for '10?

Rick Whiting

I think Panther and Kanawha Eagle to some degree, but there's still plenty more that we can crossover at both of those properties.

Operator

And we go to the line of (inaudible) with Morgan Stanley. Please go ahead.

Unidentified Analyst

Thanks for taking my questions. Just two quick ones, first, let me try to Brian's question in a different way. With Black Oak and Washington, would you expect your run rate met coal unit cost to be higher or lower, flat going forward?

Mark Schroeder

Early on, I would say it's going to be a little higher. Once we get going in both of those mines and producing closer to the 1 million tons, I think we will be at least as good as what we have in the other mines right now.

Unidentified Analyst

What do you estimate is the total size of the highball crossover met coal market in the US at its full potential?

Rick Whiting

Well, I guess it's probably 5 to 10 million tons in total, just a swag number.

Operator

And we have Brian Gamble with Simmons & Company.

Brian Gamble - Simmons & Company

Rick, I think you (inaudible) crossover at 400, it's probably higher than that 10 million mark, don't you think?

Mark Schroeder

That's clear.

Brian Gamble - Simmons & Company

At a full run rate of steel utilization, or bit higher than that 10.10 range, don't you think?

Mark Schroeder

Yeah, probably.

Brian Gamble - Simmons & Company

On pricing, I could maybe ask you different, the trend on the range between what you are seeing for your lowest highball, the good quality highball, lowball, which way have that been trending? We are getting a wider spread, is the spread narrowing that steel utilization reach creep up, maybe that would give us some inkling of where pricing is going.

Mark Schroeder

I think, there has been more height and price pressure on low-vol and mid-vol. I think high-vol has some catching up to do, candidly. On relative basis, I think there is stronger interest and there is stronger pricing at least so far on the low and mid vols.

It seems to be its tighter based on the queues in Australia and the demand in Asia. I think relatively speaking, maybe we are lagging a little bit, but I think we will follow, so if anything, I don't think we think we've closed the gap.

Brian Gamble - Simmons & Company

Then the [Hobet], is that final? Do you have that in hand, or that, are you still waiting for something from somebody?

Rick Whiting

We do not have it in hand. We continue to provide answers to questions and have meetings with the regulators and in fact I think we are going to make a new submittal, I guess, I'll call it a partial submittal or an adjustment to previous submittal by the end of this week, and we continue to keep the dialogue open and respond to their request, and I believe we are making progress, but we do not have a permit at this point.

Operator

We have a question from the line of Jacob Mueller with AYM Capital.

Jacob Mueller - AYM Capital

Thanks. My question has already been answered.

Operator

To the presenters, there are no further questions in queue.

Janine Orf

In closing, Patriot is a company with the right team and the right growth strategies and plans. We have significant high quality coal reserved, we are well diversified from a production and coal quality perspective and we have a very meaningful high quality in metallurgical coal position to fully serve this important market. We thank you for you interest in Patriot Coal, and we look forward to speaking with you next quarter.

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: Patriot Coal Corporation Q3 2009 Earnings Call Transcript
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