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Executives

Beth Cook - Director, IR

Peter Socha - Chairman and CEO

C.K. Lane - SVP and COO

Analysts

Jim Rollyson - Raymond James

Jeremy Sussman - Brean Murray, Carret & Co.

Michael Dudas - Jefferies & Co.

Justine Fisher - Goldman Sachs

Mark Caruso - Millennium Partners

Shneur Gershuni - UBS

Jeff Kramer - UBS

Garrett Nelson - Davenport & Co.

James River Coal Company (JRCC) Q3 2009 Earnings Call Transcript November 3, 2009 11:00 AM ET

Operator

Good day, everyone. And welcome to the James River Coal Company third quarter earnings conference call. Today's conference is being recorded. At this time, I'd like to turn the conference over to Ms. Beth Cook. Please go ahead, ma'am.

Beth Cook

Thank you and good morning. Welcome to James River Coal Company's third quarter earnings call. We released our earnings today and our current release is posted on our Web site, and was furnished to the SEC on a Form 8-K. As we've noted in our press release, we'll be using an updated slide presentation which has been posted to the company Web site and furnished to the SEC on an 8-K.

With me on the call today are Peter Socha, Chairman and CEO; C.K. Lane, Senior Vice President and Chief Operating Officer; Sam Hopkins, Vice President and Chief Accounting Officer; and Jim Ketron, Chief -- Vice President and General Counsel.

Before we begin this morning, I need to remind 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 at the end of our press release as well as in our annual report and on Form 10-K and other SEC filings.

Now I'll turn the call over to Peter.

Peter Socha

Okay. Good morning, everyone. Thank you for joining us. I know it's a two-hour stretch between us and (inaudible), but we have a short slide deck today, and hopefully we will cover more of your questions.

This quarter has been a quiet quarter. It’s been a -- steady as she goes would be the best way to describe it. We are tweaking our production schedules. We're shifting our contracts. And we're selling a little bit of coal in Central Ap and a little bit more in the Illinois Basin and in our Indiana operations.

But basically, it's been a quiet quarter and we're preparing for the next upturn, which we think will come some time between next year or certainly in early '11. But we are busy getting ready for that and taking this opportunity, both in time and in resources to do that.

You could see that we did sell some coal, as I said, in the CAPP and in the Midwest. So we're happy with that. And we're staying very close to our domestic utilities and we're staying close to what's going on overseas. For which what seems to be where most of the action is right now.

Anyway, that is it for our summary. Our turn it over to C.K. for his operations review.

C.K. Lane

Okay. Thanks Peter. I want to start talking about our operations on safety. We have a pretty strong trend that we're continuing with. Our NFDL rate continues to reduce over 2008. And right now, we're well below the national average. And given the underground mines that we have in East Kentucky, which are a little bit lower conditioned, we're very pleased with that.

McCoy Elkhorn, the complete operation; our Triad underground mine, and our surface mines in James River Coal Service all went through the quarter without a lost time accident. And we're very proud about that. Just recently, last week at the Kentucky Coal Association annual meeting, Mine 16 at McCoy was awarded the safest mine in the Pikeville district by the State of Kentucky, also the Mine License and Safety. And our Beechfork at Bledsoe also received the safest underground mine in the Barboursville district for 2008. So we're very pleased with those operations and with all our operations in general.

Moving over to third quarter for Central Appalachia, we were reduced our cost of about $1.82 a ton from the second quarter, while we reduced production about 81,000 tons. This was done just basically to manage our inventories through some adjustments in our operating schedule. We continue not producing coal on Saturday, have reduced production of coal on our third shift, and have reduced our overtime across the board. We did add that one extra day during the quarter around the Fourth of July holiday to assist in managing our inventories.

Some of the projects that we began, we started the construction of the new impoundment at McCoy. We began production on our new Jellico Mine, which replaces one of our mines at Bell County. We developed a new portal for Mine 75 at our Blue Diamond operation which greatly reduced our travel time and helped lower the overtime.

We continue to deal with the delays in permitting, both on the State and Federal level. I think it's been pretty documented that permits are very slow in coming. We are in good shape through 2009 and 2010. We're right on permits right now.

Talking about cash cost -- cash costs just a little bit, if we go back to the third quarter 2008, we were $58.59. Just as a bridge to get you to the $63.11, raw materials have decreased just over $1. We have seen labor and benefits go up about $0.46. This is due -- as you reduce the production, you still have the same amount of -- on the salary side on the labor. The absorption and others is about $1.90, which really -- due to the reduced production and just the changes that we've seen in the regulatory environment allowing a lot more commitment and time devoted to that.

The sales related, which is royalties and taxes, went up $3.17, which is a good problem because it was basically due to the higher realization. And that's how we get to the $63.11 from last year.

In the Illinois basin, again we continue to try to manage our production just matching our shipping schedules. We did decrease our surface production from the second quarter and increased our underground production a little bit.

We continue to develop our Freelandville West Mine. This mine is scheduled to start in early 2010 as a second underground mine. Cash cost did increase about a $1.34 mainly due to some reduced production and some increased repairs. While we had the opportunity, we spent a little bit more money on repairing our surface mining equipment, some preparation plant projects that will help us going forward. And by changing our shipping schedules around we didn't pick up some extra trucking cost.

Overall, I agree with Peter. It was a pretty quiet quarter. We're pretty well positioned going into the fourth quarter. And with that, I'll turn back over to you, Peter.

Peter Socha

Okay. All right. As usual we start out with just a few headlines here. I'm not going to read them all. In the international markets, what we think is most important right now as far as '11 and '12, is what we're really focused on is Russia. I know that India, South Africa trade gets a lot of attention. The China, Australia trade gets a lot of attention. But I think as we move in to '11 and '12, I think we'll see Russia play a more prominent role in what happens in European prices and then a derivative of that is what will happen with US prices. So that's where we're focused on internationally.

Domestically we're focused obviously on natural gas prices and on inventories at our utilities -- at our utility customers, and what will cause the market to correct sometime in the next 12 or 18 months to get back to a more normal balance. You see signs of it today, but we're not there yet. It's still early. As we said in the press release, it's still early.

The next slide, which is the Net CAPP to South Atlantic -- what we do is we take the Genscape data every week. Genscape is a data service provider that most of you are familiar with. And we take South Atlantic deliveries and we back out exports. And that tells us how much coal is actually going to the utilities in the South Atlantic. To me that's the replacement rate.

And it's pretty clear that it's coming down dramatically with exports picking up. Certainly since about July exports have picked up. So what's available to the South Atlantic utilities was clearly coming down.

The stock piles are high, but we think that the combination of the burn -- going in the winter, the combination of the burn and what's getting delivered is pretty much in balance today. And we'll see where it goes over the next several months.

On the new sales commitments, you could see that we did sell some in CAPP. We sold about 400,000 tons in CAPP for next year, which was a welcome sight. And Midwest, we -- these are long term customers in the Midwest. And we reached agreements there. We are clearly seeing a pick up in industrial stoker demand and we are clearly seeing the pick up in flex coal going into the Met Market.

I was talking to our sales guys on Friday. And what we're seeing on the industrial stoker side is now people are looking for longer term contracts. Whereas either in June or July, they might have been looking for a quarter at a time, now they're looking for a six to 12 months at a time. And that is a discernable change that we have noticed.

On natural gas, you can see that the forward strip -- I got an email from our lawyer last night that this was a confusing slide. But I don’t know in any way to make it clear. The forward strip on natural gas, you could see where when it's below say $4.00 or $4.50 -- if there is a fair amount of switching, we think it was about 30 million tons. That's the number we've been at since January when we went out and sold all of our Central App customers. Between $4.50 and the low $5.00, there's some switching going on and above $5.00 there's virtually -- I mean above $5.00 or $5.50 there's virtually no switching. And you could see where gas -- natural gas prices are forecast to be -- where the market is forecast to be over the next 12 months.

Where are we today? Just slipping over to our sum review, we think that supply has fallen hard. We notice it everyday. I personally think that we'll be another leg down in supply in the first quarter or the first half of next year at some of the contracts if you recall, going back into late '07. Early '08 there were -- a lot of people, they were doing '08 and '09 contracts and we know of several of them where they will roll off either this quarter or next quarter. So we think there maybe another leg down in supply. Met may offset that, people producing that there. There are some economic prices out there on the Met side today.

Some review with the world, the Eastern -- we still think that the Eastern market needs about 30 million tons coming out of that. We think it will be a combination of things. If you ask me to weight them, I don’t know that I could really do that. We think it will be a little bit of lower production. We think there will be some less fuel switching. We are seeing a little pick up in industrial stokers, so that tells me that industrial electric generation is probably picking up. And if you listen to AP or a Southern company, I think we heard similar comments there. And we are seeing some more flex tons move across into the Met market.

So we see the market in the US improving in late '10 to early '11. I break it down into six month increments. I think we're in -- by pricing, I think we're in a period right now where pricing is basically unacceptable. It's below cost. I think in the first half of next year, we'll see pricing that will migrate from unacceptable into acceptable. And then going into the fourth quarter next year and in the first half of '11, I think we'll see a better then acceptable pricing.

Just a couple of miscellaneous comment at the very end and then we’ll go to Q&A. We did change the poison pill [ph] from 20% to 4.9%. The reason we do that is that the NOLs, of which you can see the amount, we have 240 of regular and 150 of AMP, if you had a cumulative change of 50% over a rolling three year period, you have what’s called a change of control. And your use of the NOLs is severely restricted. Today we’re right around 40%, probably about 50%. But we just think out of an abundance of caution, we need to go ahead and lower the threshold.

On December the 5th of 2010, 18% of that will roll off. If you recall, we did our first block trade or our first equity deal back in late November of 2007. So that will roll office the calculation, will be down to a 20% or 22% out of the 50%. And we think that that’s a very safe level to be at.

So that’s why we did this. They are large assets to the company and we certainly want to protect them for all of our shareholders. Particularly as we look forward to the next several years where we will be in a net income generation mode.

We just grouped all of our -- slipping over we just grouped all of our upcoming investor conferences and meetings into one slide. Davenport will be Thursday. We got Ray Jay [ph] on Tuesday, and then Macquarie, UBS, and BofA at the end of the month. We are spreading it out a little bit. C.K. will be handling Davenport. Mark and I are out with a customer all afternoon. And Sam’s got some family things. Ray Jay, I’ll be handling that. I’ll handle Macquarie, and the C.K. and Sam will handle UBS and BofA.

Right now we’re targeting February 26th -- Friday, February 26, we will issue our initial 2010 guidance and our fourth quarter earnings. If you remember, historically we did guidance in December right around Mike’s conference in New York. This year we did later in January -- February. And I think that actually worked out better because it gives us a chance to go out and see all of our customers in the middle of winter. I’ll be making at least one trip to Europe prior to that time, so I'll have a good handle on the European market and we'll know where we are at the end of the year. So we’ll issue the guidance that time. And with that Robby, we will do Q&A.

Question-and-Answer Session

Operator

Thank you. The question-and-answer session will be conducted electronically. (Operator instructions) And we’ll go first to Jim Rollyson with Raymond James.

Jim Rollyson - Raymond James

Good morning, Peter.

Peter Socha

Good morning, Rolly.

Jim Rollyson - Raymond James

Pretty decent prices you guys are booking coal for, specifically in the Midwest which implies mid -- low to mid teens when you get out to 11 and 12 and start realizing that on average.

Peter Socha

Yes.

Jim Rollyson - Raymond James

Anything you can point to on the cost side that should dramatically change, outside of the royalties, related to higher cost or higher pricing that changed that outlook?

Peter Socha

C.K., why don't you take that one?

C.K. Lane

We're going to be -- over the next few years, we’ll be shifting more to underground production with some of the reserves that we require. The good thing in the Midwest, there’s not a lot of different between the surface and the underground cost. So I think cost should stay close to where they’re at now in the near future.

Jim Rollyson -Raymond James

Okay. So that obviously becomes a--

Peter Socha

The Midwest will be good solid EBITDA generator from the next several years, Rolly.

Jim Rollyson - Raymond James

That’s a big difference from what you’ve seen the last two or three years.

Peter Socha

Yes. Right.

Jim Rollyson - Raymond James

So that’s a good thing. Nice work generally all around on cost this quarter especially given the volumes. Any kind of indication on what you’re looking at for 4Q? And just how you’d see that trending going forward? Any opportunities to continue the cost saving issues or efficiency projects or stuff you’ve been doing?

Peter Socha

Well I’ll tell you, if you ever want to watch C.K. pucker, ask him about the $0.12 that missed [ph]. He was determined to get cost below $63 this quarter. And he’s upset with Sam and Steve that he couldn't get there.

No. I asked Sam yesterday, “Is there any thing material that we need to update on guidance?” And his answer was, “No. We’re trending right where we are. We’re shipping our contracts." We’re really just shipping our contracts right now. As far as early next year, the first half of next year I think you should expect us to ship contracts plus a little. And on the back half of next year the contracts -- existing contracts plus a little more.

So other than that -- you had the headline. I actually got all rewritten. But you had the headline a week or two ago, when you said a relativity quiet quarter at JRCC. And I think that accurately describes it. We just keep on keeping on.

Jim Rollyson - Raymond James

Perfect. Last thing for me. There are actually two parts here. Number one, last year about this time you guys were talking about starting to sell some coal as a net product. And then when the market fell apart,--

Peter Socha

Yes.

Jim Rollyson - Raymond James

--you stopped talking about it. You mentioned it in your press release. What’s the status on that?

Peter Socha

Well, some of the coal -- one reason why we did get the prices we got is some of that coal did move over. And it was not from the Met Mines [ph]. We’ve actually idled those particular mines that we had got going on last year. What we did do was we mined enough to have that coal tested. And it is very good coal. It’s very good eyeball coal.

But it also opened up some sales channels for us that maybe we had not been as close to in the past because we didn’t have the product. And when they were looking for some flex coal earlier this quarter, we had some available. We had some coal that we could migrate into. So you’re right. It was a little nuance in the press release, but -- and in the slides but we are stating to sell some coal into the Met Market as a blending coal.

Jim Rollyson - Raymond James

Any plans to bring the high-volv [ph] Met Mines right back in given the market?

Peter Socha

No. We’re running everything right now quarter-to-quarter. And I think we’ll look at it maybe next year with the April anniversary dates on that contract. Maybe we’ll bring something back later in the second quarter or third quarter. Right now, no plans. C.K. and I haven't talk about it.

Jim Rollyson - Raymond James

I guess we’ll hear about that in February.

Peter Socha

Yes, you will.

Jim Rollyson - Raymond James

Great. Thanks Peter.

Peter Socha

Thank you.

Operator

We’ll take our next question from Jeremy Sussman with Brean Murray, Carret & Co.

Peter Socha

Good morning, Jeremy.

Jeremy Sussman - Brean Murray, Carret & Co.

Hi. Good morning, Peter. I was just wondering if you could give us a general sense of the difference in discussions with your utility customers and industrial customers now than on the last time we heard from you three months ago. What has been the key changes there?

Peter Socha

Well, totally different circumstance for both of them. In the utility side, you’ve got large stockpiles and they’re looking for what their burn requirements are going to be in ’10 and ’11. And so there’s a lot of strategic decision making on their side on what they’re going to do.

On the industrial side, the whole de-stocking cycle really was fairly dramatic this time. I don't know if you or some of the other people on the call saw the interview with Jim Owens of Caterpillar right after they reported earnings. And the interview -- where I think it was Maria Bartiromo was pressing him on, "How long are you going to stay at this reduced level of production?” And his response was, “Well, what we have had in discussions with our vendors is everyone has de-stocked so much that even at this lower level of production, you can actually make a great deal of money and you’re going to see a lot of business.” This was you -- meaning his vendors.

And he specifically mentioned on the metal side and on castings and things like that. Because whether it was the capital constraints or whatever the reasons were, people just de-stocked enormously. And so the question is, “What’s the underlying demand for those products?” And I guess we'll see as we move forward.

But right now on the industrial side, and on the steel side in general, I think that the inventory position is extremely low and -- it is encouraging. I will tell you, I was very encouraged talking to Mark on Friday about the fact that the industrials are now looking at longer term deals. They’re now looking out six to twelve months. And as I said in the opening comments, in June they were looking at three-month deals.

So that’s the primary difference. It’s just real different circumstances where one of them is bloated with inventories ad they’re trying to determine how are they going to work them down, and what is pricing going to look like, and what is burn going to look like. And the other one has no inventories at all and they’re looking for raw materials.

Jeremy Sussman - Brean Murray, Carret & Co.

Now that’s very interesting. And lastly, just turning elsewhere, India has been quietly doubled their imports this year so far from South Africa. South Africa, I should say doubled the amount of exports that it sent to India on a percentage basis. That scenario that you’ve obviously been close to the past and given us some color, so what are your thoughts there now in the next 12 months or so?

Peter Socha

Well it’s trending pretty well. What we’ve talked about going back to the fall of ’07. If you remember in the November ’07 call we did, where we talked about India and South Africa and the draw for coal that would be coming there. A third of the exports -- it used to be that South Africa would export just round numbers, say 60 million tons. Of that, 55 million will go to Europe and five would go somewhat else.

Now you’ve got about a third of their 60, and by the way if I remember correctly, September was -- the running rate was more like 52 or 53. So you’ve got fewer tons coming out of South Africa, and you got more of them getting pulled into India. And then you’ve also got the other Pacific. Half of the coal from Richard’s Bay, South Africa is now going East, instead of West. It’s going to Asia and India. India is about a third and then the rest is going to other countries there.

But I do think that the more interesting story right now -- I kind of describe Indonesia, India, and South Africa is like a spinning glass that everyone's looking at. And then it's sparkling and the lights. And it really is something to watch and it's something interesting. But I really -- as I said, if you and I have talked about before, I think Russia is the really interesting story.

Russia is the single largest supplier of coal to Europe. They are doing everything they can to increase their exports to Asia. Vladimir Putin has said that the better the national goal to export more coal out to the Pacific than it goes out of the Baltic and the Black Sea. And their production is down. So you've got production down and you've got more coal going out to East than you do the West.

Right now, Europe is similar to the US. It’s bloated with coal. But I think when you see -- when we shake all this out sometime in the next year or so, Europe is going to find that their replacement rate, similar to what we did on the slide, the replacement rate just isn’t there. And I did spend a week in Russia in September. I think of going back in February.

Under investment is a big deal in Russia. There’s not a lot of outside investment because of what they did on moving some assets from foreign companies -- the national companies over the last several years. The Chinese were all over Russia when I was there looking to invest.

I think that’s the bigger story. Right now I think that’s the bigger -- ‘11 and ‘12. And as I've said, I'm really looking at '11 and '12 right now. What we do in '10, we're going to be profitable, we're going to have a good '10. And the guys, Mark, and Mike, and C.K., and Sam, they're working through what we do on new contracts in '10. But '11 and '12, we're holding tight. Long answer. Sorry..

Jeremy Sussman - Brean Murray, Carret & Co.

Okay. Thank you, Peter.

Peter Socha

Okay.

Jeremy Sussman - Brean Murray, Carret & Co.

That was great.

Operator

Thank you. We'll go next to Michael Dudas with Jefferies & Co.

Peter Socha

Good morning.

Michael Dudas - Jefferies & Co.

Peter, I was surprised as an attorney, your front photo chart was confusing.

Peter Socha

Did you vote this morning?

Michael Dudas - Jefferies & Co.

The polls closed at 8 in New Jersey. I hope you and your family are early and off today.

Peter Socha

We will. That's a New Jersey tradition.

Michael Dudas - Jefferies & Co.

Peter, just that (inaudible) in your discussion on what you're going to do in 2010. You've committed 5.1 million tons of tons of cap coal. You're running at a rate of about 6.4 today, give or take. That delta, is that stoker flex or is that's some maybe export quote-unquote dedicated coal? Is that just--

Peter Socha

No. No. It going to be -- stoker is normally 8% of our production of the delta, of the 6-4. And we can run as low as 6, but C.K. really looks like he sucked on a lemon when we run that low. We really would like to be more in the 6.5 or up range.

Michael Dudas - Jefferies & Co.

Yes.

Peter Socha

And a greater percentage of that will be the stoker reflect than the overall portfolio. Just because we have more to sell, but also because we're seeing more activity in that market. We have some coal to sell next year. Probably somewhere between 800,000 and 1.4 million. 1.4 million would take us to the 6.5 level. And I would not be surprised to see 300 or 400 of that be stoker and flex. C.K., would you agree with that?

C.K. Lane

I think that will be the best market yet.

Peter Socha

Yes. That's why we were -- quite frankly, that's why we were able to get the prices we got.

Michael Dudas - Jefferies & Co.

And maybe, Peter, C.K. can remind us on -- without much additional capital will be spent. Because you have been adding to the machines and of course you've been adding to your labor. What is the effective shipping comfortable capacity in Central and in Illinois based on for the company based on a run rate basis in '11 and '12?

Peter Socha

Yes. We're in the budget season now, Mike. I'm going to take a pass on that one.

Michael Dudas - Jefferies & Co.

That's fine.

Peter Socha

Mainly because we're in budget season. And at some point in the next six months, C.K. and Sam and I, have each talked about it individually. I'm going to want to start looking at more growth in '11 and '12. So I'm reluctant to go out with a number until we settle on what that growth platform is going to be.

Michael Dudas - Jefferies & Co.

On your additions, talk a little bit about your labor pool and what you've been doing and what the turnover's been like internally, and what you're seeing in the marketplace? And again from your cap spending, maybe you can talk more about it in 2010, but are you comfortable with what you have in capital now and accessibility to improve efficiency or bring up a little bit more tonnage at the margin?

Peter Socha

C.K.?

C.K. Lane

The labor market has -- everybody's running less hours. Their starting, continuing to improve. The small contractors are cutting back more and more. So you see -- you don't see them trying to steal folks. So labor right now is very good, probably the best it's been in a couple of years. In that sense, pleased with where we're at on labor. And we're continuing to try to do as much training as possible and getting everybody -- electricians, foremen, MET, which is the Medical Emerging Technician papers to help that while we can do that with the work schedule we're on now.

So at capital, we did increase our capital from last year and mainly at the equipment and infrastructure, which is what you need to keep the mines running. We're looking at that going forward in the budget to try to continue that trend.

Peter Socha:. Hey, Mike?

Michael Dudas - Jefferies & Co.

Yes, sir?

Peter Socha

If I could interject here. One reason why we think there maybe a further reduction in production next year, AMSHA has just started improving emergency response plans which is the communication package. If you're a small company and you have an underground mine in Central App, you're going to have to start laying out big bucks starting in the first quarter, really. C.K., do you want to talk about that at all?

C.K. Lane

The ERP plans, which is the Emergency Response Plan, we did get our first ones approved just recently. We will start installing -- purchasing the communications systems early in the first quarter of next year. And will start installing them one to two a month. We have roughly 17 to purchase, just for our size. The company would be greater than probably 10 million in just the communications and tracking systems that we'll be putting in.

Michael Dudas - Jefferies & Co.

How long do you have to complete those requirements?

C.K. Lane

It's really subject to availability and delivery of the systems. Generally, you have to provide a delivery date working with whichever vendor you have chosen. And from that delivery date that they have committed to, you have 90 days to have that one in. So if you could do one or two a month, for us that would be a pretty aggressive schedule, I think.

Michael Dudas - Jefferies & Co.

Is that by district? Is it by State, how they're allocating or who's getting allocated these approvals? Kentucky? West Virginia? Is it just--?

C.K. Lane

That's AMSHA which is Federal. So I don't think there's any--

Michael Dudas - Jefferies & Co.

Okay.

C.K. Lane

--district, State as far as that's concerned.

Michael Dudas - Jefferies & Co.

All right.

Peter Socha

But Mike, I do think it's telling, they're just starting to approve on that. That will have an impact next year.

Michael Dudas - Jefferies & Co.

Understood. Thanks for your color, gentlemen.

C.K. Lane

Thanks.

Peter Socha

Thanks. Thanks, Mike.

Operator

We'll take our next question from Justine Fisher with Goldman Sachs.

Justine Fisher - Goldman Sachs

Good morning.

C.K. Lane

Good morning.

Peter Socha

Hey, Justine.

Justine Fisher - Goldman Sachs

I wish I could say the USD market was as sparkly and pretty as South Africa, India, and Indonesia.

Peter Socha

That's actually a funny thing. Because people don't believe me when I say this. But we actually -- the lower prices go and the longer they stay down, the better for us. And they think I'm absolutely nuts when I say that. But it will take more production out of the market. And so when the market does recover we obviously have good contracts. We have good relationships. But the longer it stays down, the lower it goes, I feel okay. I hear what you're saying. but on the other hand, it's hard for me to feel bad about it.

Justine Fisher - Goldman Sachs

Well my first question was along those lines. So you guys have obviously generated good margins in '09 because you were able to lock in the good contracts. And in 2010 and 2011, and 2012 frankly, you've got good levels. But I was wondering if any of the utilities you signed deferral agreements with you are looking at their inventories and thinking, "Wow. We haven't worked these down as much as we needed to. Do we need to go back to companies like James River and get additional deferrals or renegotiation for 2010, 2011?

Peter Socha

Keep in mind, Justine, we have not deferred any ton.

Justine Fisher - Goldman Sachs

Could you replace something like that? I know you--.

Peter Socha

Keep in mind, we re-price some. But we priced up 1,500,000 tons. We took higher priced tons out of '09 and pushed them into '11 and '12. And that's a good thing. I actually saw the CEO at (inaudible) utility a week ago. And if you remember, we did that because they had some industrial accounts near them that they wanted to protect the jobs and protect the community.

And we hadn’t heard back. I hadn't seen them in a while. But I saw him a few weeks ago and I asked him. I said, "By the way, how does it all work out?" He could not be happier with the way the whole amendment worked and their approach to the industrial accounts. He could not be happier with the result. And they have not come to us to defer any additional tons.

Now--

Justine Fisher - Goldman Sachs

Okay. So even--

Peter Socha

if one of them would, we'd consider. Sure. We've already proven we're considerate.

Justine Fisher - Goldman Sachs

And so, I guess deferral is definitely the wrong word to use. That if they came back and said, "Look. We need to re-price again in the 2011 from 2010 because we're still in phase three of the chart that you had in the presentation," you guys will be willing to do that?

Peter Socha

I'd consider it. I mean we did it once. If you actually sit down and look at it, that amendment we did was a phenomenal amendment. Both for us and for the utility. It was a very, very good amendment. To some folks win-win means, "I win twice."

In that case, win-win means we won and they won. We priced up 1,500,000 tons. That was very favorable. And if a utility wants to try to do something that is a win-win where we win once and they win once, these are long relationships. These are good customers. As I said, (inaudible) on Thursday, C.K.'s doing Davenport because I'm out surveying real estate with one of our customers.

Justine Fisher - Goldman Sachs

Got you. The other question I have is on the cost side. I would have guessed that in the third quarter where we’ve seen companies across the board paring back production, we would have seen cost go up even more just because of economies of scale. But it's not only you guys, but a lot of other companies have seen costs that are probably better than I would have thought in a lower production environment.

And I know your cost spread said that most of your cost reduction in the quarter was attributable to lower labor cost. Can you just dig in to what was in that number and how sustainable that is?

Peter Socha

C.K.?

C.K. Lane

It's just managing your schedule by not working the Saturday overtime and not as much overtime through the week. And the things that we've done with opening additional portals at several of our underground mines to cut down the travel time has helped managed that. So it's just really just a focus from our management at the mines, watching their labor cost and trying to manage each on a day-by-day basis.

Justine Fisher - Goldman Sachs

So then, if we -- I know you said you're not giving production forecasts. But if we have any higher production into our models, net net, would we expect to see some of that labor costs come back up because you've had to add some overtime shift? Or do some of the permanent changes you've made to the mine portals and does the travel schedules actually mean that we may not see as much of an increase in costs if and when production goes better?

Peter Socha

If you bring on tens, you can bring on extra (inaudible) or so. I mean, we do have our management in a bit better shape than what we've had in the past or as lighter configured. But we would increase hours and work some Saturdays, but we have the tons to offset that cost, we would hope.

Justine Fisher - Goldman Sachs

Great. Thanks so much.

Peter Socha

Thanks, Justine.

Operator

We'll take our next question from Mark Caruso with Millennium Partners.

Mark Caruso - Millennium Partners

Hey, Peter.

Peter Socha

Good morning, Mark.

Mark Caruso - Millennium Partners

Just a few annoying modeling questions, I guess the first is, last quarter in the slides you talked about booking (inaudible) sales almost 200,000 tons of stoker coal. And I want to see if you could help us -- I think you sort of answered earlier. But of the 389,000 that you've booked this quarter, how much of that is stoker? And how much of that is more traditional?

Peter Socha

I mean, obviously, because of the pricing, you could tell as much was stoker.

Mark Caruso - Millennium Partners

Okay.

Peter Socha

There's some steam in there, not a great deal. I don't remember off the top of my head. But there's some steam in there.

Mark Caruso - Millennium Partners

Okay. And then, just on the -- I think you were answering Mike's question, on the stoker volumes. So is it -- so it's 300,000 to 400,000 when production or sales is down to six-and-a-half. Because I thought back -- a couple of years ago, it was more like 800,000 of stoker.

Peter Socha

Well, we already have some price. I mean, obviously, we just priced some in the $389. You're looking at the aggregate, and I'm talking about the margin.

Mark Caruso - Millennium Partners

What's left.

Peter Socha

What is still to come, yes.

Mark Caruso - Millennium Partners

Okay. Perfect. I just want to make sure.

Peter Socha

And where historically that's been 8%. Well if we have, let's say, 800,000 or 900,000 left to price for next year, it would not surprise me if 300,000 of that turns out to be flex or stoker.

Mark Caruso - Millennium Partners

Got you. Okay. And then on the -- you're talking about the flex tons. Is that as a result of, I want to say, at some point last year you guys were doing some test burns of stoker to go into crossover. So this is that coming to fruition or is it just early stages to see if that can make the transition?

Peter Socha

Yes, I'll say it's related. We were doing some test burns and we had the mine open, and we sent it out to the lab, and things like that. I think it has as much to do with establishing the relationship during that process. It's not the same coal. It's not the coal that we mined from those mines.

Mark Caruso - Millennium Partners

Okay. Perfect. And then one last question, I know you guys didn't update on your EBITDA. But I guess, the implied guidance of DD&A suggests a really big up tick in the fourth quarter. Is there anything -- any reason so that could be the case?

Peter Socha

I'll have Sam come back to you on that one.

Mark Caruso - Millennium Partners

Okay. Perfect.

Peter Socha

Sam's in charge of working with people on models now.

Mark Caruso - Millennium Partners

Okay.

Peter Socha

He told me (inaudible). He said, "You go out there and your hands start flailing, and your eyes start bulging, and you start talking about India, and all they want to know is DD&A."

Mark Caruso - Millennium Partners

Got you. And then, on the Illinois Basin, we're starting to see the gradual up tick. When do we start -- when do we see the fore handle [ph] start kicking in? Is it not until 2010 just because of deferrals that we start to see the step change in revenue per ton in?

Peter Socha

Yes. We’ll see it next year.

Mark Caruso - Millennium Partners

Okay. Perfect. Thanks, Peter.

Peter Socha

Okay. Thanks, Mark.

Operator

Next is Shneur Gershuni with UBS.

Peter Socha

Good morning.

Shneur Gershuni - UBS

Good morning, Peter.

Peter Socha

How are you?

Shneur Gershuni - UBS

Pretty good. Most of my questions have actually been asked and answered. I just wanted to maybe if we can touch a little bit on the Kentucky permit situation with respect to the EPA. My understanding is that there was a watershed study that you and International Coal were working on. I was wondering if you can give us some color with respect to that study. Is it completely yet or close to completion and so forth?

Peter Socha

Okay.

C.K. Lane

ICG took the lead on one of the watershed studies, which was near to one of their permits. We completed the second one following the same model. And this is a group from the whole coal industry just -- not just one company doing each. That was completed, the punitive impact study on a complete watershed.

I think there’s seven in East Kentucky. So it's a very large study. Outside consultants handled it. And so that study has been completed for about three, I believe, watersheds in East Kentucky right now.

Shneur Gershuni - UBS

Okay.

Peter Socha

There are multiple. I mean there is more than just one.

Shneur Gershuni - UBS

Okay. So it will take some time before we get all the studies done and into the EPA so that they can make a decision on the other 49 permits?

Peter Socha

Well, that’s really not related. These studies were done for specific permits in a specific area that was submitted to the core. So these is just part of the permitting process that was submitted to the core. So I wouldn't say that the two are interrelated with what the EPA is doing.

Shneur Gershuni - UBS

Okay. Fair enough. And one last question. You’ve mentioned that you've done an extra idle day around a July 4th weekend. If conditions warranted, do you envision the possibility of adding some idling of mines around the Thanksgiving or the year-end holidays at all?

C.K. Lane

That depends on where inventories are at, and our shipping schedule at around Thanksgiving and Christmas in December. We do take quite a bit of time off already so, as always the fourth quarter production seems to trend a little bit lower because of that. So if our shipping continues where it’s at, we should be probably pulling some inventories down. So we’ll see how we ride and what the shipping does but there’s always the possibility that we don’t have anything planned right now.

Shneur Gershuni - UBS

Great. Thank you very much.

Peter Socha

Shneur? Shneur, while I got you.

Shneur Gershuni - UBS

Sure

Peter Socha

Because you sent me an email this morning on sales related. Sales related last year, third quarter was about $9. Your numbers were pretty much in there. And this year was about $12.26 like that. Of the $9 last year, about $5.75 was royalties. The rest was severance tax and reclamation of Black Lung. And this year, royalties were about $7.50. And then the balance was severance tax and Black Lung.

Shneur Gershuni - UBS

Perfect. Thank you very much.

Peter Socha

Okay. Thank you.

Operator

We’ll go next to Jeff Kramer with UBS

Jeff Kramer - UBS

Hey. Good morning, guys.

Peter Socha

Good morning, Jeff.

Jeff Kramer - UBS

Just following up on the (inaudible) tons for next year. It sounds like you guys are pretty comfortable you’re going to be able to replace those. Just a big picture of it, those don’t get placed -- do you take entire mines offline? Do you just further reduce the overtime and weekends? And how do you balance that with the potential for greater upsides later next year and into '11?

Peter Socha

Yes. That’s a great question. We have this conversation all the time. do you take a -- do you allow each mine to take another day off in February or March? I am confident we’ll be able to place it at that time. It's the first half of the year, I think the confidence level is a little lower, as I said, than it is in the back half of the year.

And it comes down to conversations C.K. and I have. Some of it is managing the stockpile and the quality composition of the stockpile depending on how the high sulfur mines are doing or the low sulfur mines are doing. And it’s just something we have to look at. I really feel strongly I want us to be prepared going into '11.

I want the equipment completely upgraded by the end of '10 and I want the -- I want the team of people trained up, rested up, and the mines all set to go in '11. My view is we’ve got $30 margins next year or right around $30 margin. I can give a couple of bucks off of that margin and take an extra idle day here and there with those kinds of margins.

When you get into closing mines and you get into long term closures of mines, that’s a more difficult decision. We’ll make it, and we have made it. But we’ve got room to give if we need to give. Good question, but it’s something that -- there’s not a generalization. I just can’t give you a generalization because -- we look at it certainly on a quarter-to-quarter basis and sometimes on a month-to-month.

Jeff Kramer - UBS

Okay. Thanks. And just given the available -- the news around permits and whatnot, can you just talk about where you guys are with mine plans and permits? I would assume for 2010, you'll find that this has become potentially impactful in 2011. I know this is a very fluid situation, but are you guys still have the operating flexibility that you guys need in the next couple of years?

Peter Socha

C.K?

C.K. Lane

As I said earlier, we’re in pretty good shape to -- through 2010 with the permits we have in place. Like everybody, I think you’ll see most people start saying in 2011, starts to become issues. When will the EPA release permits? When will the core start getting permits? That’s the question. And I don’t think anybody knows the answer to. The longer (inaudible) is delayed, the more impact it will have. I think in general, we’re in pretty good shape through 2010 with our current mine plans.

Jeff Kramer - UBS

Okay. Just finally on the DLC facility, would you just be opportunistic to the extent you can to re-finance that or--?

Peter Socha

As I've said before, it’s on my desk but not in front of my desk. Now it’s in front of my desk.

Jeff Kramer - UBS

Got it.

Peter Socha

Yes. We are working on it. As I’ve said earlier in the year, what we really wanted to do was to have the capital markets settle down a little bit. Costs were still too high in the capital market earlier in the year. We wanted to throw some good numbers up on the board and show that we could do that. And we wanted the coal markets to at least stabilize, even though their stable at a lower level. But to at least stabilize. And those three conditions precedent have already happened.

Jeff Kramer - UBS

Got it. Thanks much, guys.

Peter Socha

Thanks Jeff.

Operator

And we’ll go next to Garrett Nelson with Davenport & Co.

Peter Socha

Hi, Garrett.

Garrett Nelson - Davenport & Co.

Good morning, everyone. Most of my questions have been answered but after accounting for Q3 results, do you anticipate any variance in any line items from the prior full year guidance that we should be aware of, which would impact Q4?

Peter Socha

I’m sure there will be some variance, some positive and some negative. Being able to come out right on top of it within a quarter, Brett [ph] is always trying to get me to get quarterly guidance. And we always give him a high one. But right now we don’t see any material variance within anything. We're just plodding along.

Gary Nelson - Davenport & Company

Okay. Great. Thanks.

Peter Socha

Thanks, Garrett.

Operator

(Operator instructions) Okay. With that it looks like we're going to go ahead and turn the call back over to Mr. Socha for any additional or closing comments.

Peter Socha

Okay. Thank you, Robby. Thanks for your help today. And we appreciate everyone’s time and patience. And if you have any questions, feel free to give us a call. We will look forward to talking to you in February.

Operator

That concludes today’s call. Thank you for your participation.

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Source: James River Coal Company Q3 2009 Earnings Call Transcript
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