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Executives

Jim Kitran – VP, General Counsel & Secretary

Peter Socha – Chairman, President & CEO

CK Lane – SVP & COO

Analysts

Jim Rollyson – Raymond James

Jeremy Sussman – Brean Murray Carret & Company

Brian Gamble – Simmons & Company

Bill Burns – Johnson Rice

Shneur Gershuni – UBS

Justine Fisher – Goldman Sachs

Jeff Cramer – UBS

Garrett Nelson – Davenport & Company

Curt Woodworth – Macquarie

Brett Levy – Jefferies & Company

Mark Caruso – Millennium

James River Coal Company (JRCC) Q4 2009 Earnings Call Transcript February 26, 2010 11:00 AM ET

Operator

Good day and welcome to the James River Coal Company Fourth Quarter 2009 Earnings Conference Call. Today’s conference is being recorded. At this time I would like to turn the call over to Jim Kitran, Vice President and General Counsel. Please go ahead, sir.

Jim Kitran

Thank you, and good morning. Welcome to James River Coal Company’s Fourth Quarter 2009 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 the press release, we will be using an updated slide presentation today, which has also been posted to the Company Web site and furnished to the SEC on an 8-K.

With me today on the call are Peter Socha, our Chairman and Chief Executive Officer; CK Lane, Senior Vice President and Chief Operating Officer, and Sam Hopkins; Vice President and Chief Accounting Officer.

Before we begin this morning I need to remind you that this call will contain forward-looking statements. These forward-looking statements should be considered along with the risk factors that we note at the end of our press release as well as in our annual report on Form 10-K and other SEC filings.

Now I will turn the call over to Peter.

Peter Socha

Good morning, everyone and thank you, Jim. For those of you curious about Beth, Beth is home today. She has a son with strep throat, but more importantly, she has a new daughter, Addison Louise was born on February 1st and Beth is home taking care of her, but is participating in our call.

One other note on the family side, we did lose someone this quarter. We worked very, very hard as most of you know, to operate our minds in the safest possible manner, but on January 22nd, we did have a fatality at Bledsoe, one of our operating subsidiaries. Travis Brock, 29 years old, was killed. Travis does leave a wife Pam and a son Travis Junior, three years old. So, we certainly are keeping them in our thoughts and prayers and we would ask you all to do as well.

Just turning to the slides, for those of you it’s on the Web site, hopefully you’ve got them. We had a great year. 2009 was a great year. It was, I believe the most profitable year in the history of the company. 2010 will also be a very good year. Right now, 2011 is setting up to be a good year. So we’re actually very happy.

We hit a pothole in the fourth quarter where we had dialed back all the mines and then had some bad weather, had some icy weather and some snowy weather that impacted both underground and surface mines, both in the Illinois Basin and in Central Appalachia, but I’m not going to let that detract from the fact that we had an outstanding year during what was, as everyone knows a pretty severe downturn in the worldwide economy, and then also a severe downturn in the U.S. coal market, and we were able to generate free cash flow during that period. We’re, we’re very happy.

Operations are pretty much back to normal today. We have one mine that is going through a little bit of geology issues. It’s something they have dealt with in the past and we fully expect that they will be able to deal with it today, which they are.

And right now the coal market is metallurgical, which for us is high ball and PCI. So that is where we are spending our time and that’s where we’re seeing returns that are adequate for us to go out and price coal and I believe that will continue to be the case at least for the next several months. We’ll talk about that in a few more minutes.

And with that I’ll turn it over to CK to run through our operations.

CK Lane

Thank you, Peter. And I just want to echo Peter’s comments there that our thoughts and prayers are with the Brock family and the loss that they have suffered.

Turning to safety, 2009 when we look at it, it was a very good year from a safety standpoint for our company. Our NFDL rate which we track in the fourth quarter was a 1.16 and if we look at our NFDL rate we were 30% lower in 2009 than we were in 2008.

We dropped our accidents by 38% in 2009 compared to 2008 and our total number of violations went down 20% in 2009 and we’re very proud and focused on those achievements. Just as a side note, we had 19 locations in our company that worked all of 2009 without a lost time accident.

Moving on over to Central App, we did complete a project, opening a new portal at our McCoy mine 23-A mine. That will save approximately 45 minutes on travel time. Men are using that now and it cuts just off a lot of travel.

We completed a major grouting project. This project will allow us to access the red oak reserves. This is about a 9 million ton block of reserves at our Leeco mine 78 in the Hazard area. And we hope to start mining those reserves in the fourth quarter. On the Montgomery Creek surface mine, we acquired about 500,000 tons of additional reserves for that operation.

Moving on to the production side, we did limit our production in the fourth quarter. We reduced our overtime and limited our Saturdays. We did idle some of our mines for a total of 128 shifts in the fourth quarter and that was to match our production up with our sales.

As most of you know, with the winter weather, we did get hit with general major snowstorms that resulted in a loss of power at some of our operations. Totaled about up to 31 shifts.

As Peter mentioned, we did have three mines that hit some pretty difficult geology in the quarter. Two of those mines are back to normal and one mine is improving each day on that and we hope to be through that issue by the end of this month.

With the weather and the geology and the reduced customers at Maine, we did carry over 300,000 tons of coal from 2009 into 2010 at an average sales price of $84.88. But with the exception of the rail delay that’s just been due to the weather and the snowstorms that they’ve been dealing with, customer shipments and demand appear to be back on a normal level.

In the Illinois Basin, we reduced our production by 266,000 tons in the fourth quarter to match up with customer demand. A lot of that was due to the weather on trucking. Most of our coal goes in the coal truck to customers in Indiana. Of course, the weather did have some impact on our surface mine production and our customers did defer some shipments due to the higher stockpiles that they saw.

Carryover tons there were 360,000 tons at an average sales price of $38.65. Overall, the fourth quarter was a difficult quarter, but we did cut back production to match up with our sales, while we carried tons over in both CAPP and the Illinois basin.

And with that I’ll turn it back over to Peter.

Peter Socha

Okay, thanks, CK. Turning over to Slide #11, as most of you know, I usually start out with some headlines. The only one I’m going to talk about here because we do have a fairly full slide deck is the chemical shipments on CSX.

I think we’ve talked about it before where to us what drives the natural gas market is chemicals and petrochemicals, the headlines seem to always read shale gas, shale gas, shale gas, which is certainly true, but on the demand side, the petrochemicals take up quite a bit of demand and it appears as though those are starting to turn around. They’re up off of a very low base, but they are starting to trend up and so that’s a very good sign.

Turning to Slide #12, which is travel notes, I have been on the road a lot this year since January 7 out of eight weeks. Mike and Mark who handle sales for us as well, have been on the road and my view is that we are at an inflexion point in the market. Things are starting to turn around and that’s the time that we need to be closest to the market. We need to be able to try to figure out what’s happening and best way to do that is to go out and see people and not do as much analysis, but do more anecdotal and then see what’s happening. So that’s what we’ve done.

For Central App and the Illinois Basin, I’ve been to all the mines in Indiana, most of the mines in Central App, it’s really sort of seeing what stockpiles look like around the basins, talking to the customers out in those areas. And then what really became clear is that the barriers to entry, particularly, in Central App, but also in the Illinois Basin, barriers to entry are continuing to go up.

When the market, in fact, does turn around, which we expect will happen sometime in the relatively near future. We think you’ll see an immediate shock to production response and that would be from companies like us and Massey and Altherm [ph] and Patri [ph] and everyone else dialing back up the shifts that they have cut, but after that I’m not quite sure I see much of a response. That was a key, key item.

Our resident river at Mike went out to the rivers a week or two ago and it’s pretty clear that the Congo trade is really the primary item for why we have high river inventories, but there is some quality deterioration on those stockpiles, so what happens to them later this year, will be very interesting. But what the traders were doing was buying the prompt in the third quarter and fourth quarter last year and then hopefully selling them forward for this year and then pocketing the difference. And so as that unwinds, we think we’ll see channel inventories come back to normal.

Customer demand, I will say this. Customer demand, particularly in the Illinois Basin or in Indiana, we’ve noticed a marked shift up since early February. They tend to keep smaller inventories out there anyway. We’re seeing it a little bit in the Central App and in the Southeast, but particularly in the Indiana market. So we’re happy about that.

On the South Atlantic utilities been with four of them this week and they’re all over the map. The inventory levels for those utilities, we visited with one that has 40 days and is getting ready to buy prompt coal and we visited with another that has 90 days, probably won’t buy coal this year. So got a very varied interpretation of where the market is. Overall, I’m still very optimistic that the market will be picking up later this year, but it gave us good insight into what’s going on today.

Have been to the ports, went down to the Hampton roads ports, several weeks ago and they are blowing and going. One of them is at capacity today. The other one we think will be shortly and the third one being Lambert’s Point is primarily metallurgical coal. So, that is certainly going. And transportation issues, the rail roads have been impacted by the winter weather, but we expect that will clear up in a few months.

Turning over to Slide #13, South Africa, I spent seven days or eight days down in South Africa. The key takeaway there is something we talked about before. Most of the coal is now headed east. When it leaves Richard’s bay it turns left instead of right. It is not going to Europe except for on legacy contracts, multi-year contracts and even in that case, it’s going to Morocco, it’s going to Italy, it’s going to Israel, places like that.

I spoke with a couple of ship brokers down in Cape Town and they were quite surprised by the number of inquiries they were getting from China, starting in mid-December. I think that coincides with the time that Indonesia starting falling off a little bit. Indonesia had a great fall, just a phenomenon fall, but they did tail off a little bit towards the end of the year and I think that is what happened.

India is taking a huge amount of coal out of South Africa, but I do see longer-term I think the trade will be Richard’s bay to China and Colombia to India once India can handle the capesize vessels.

Spent eight days in Europe last week, had a phenomenal week, just a phenomenal week, very busy and very insightful. Did go up to the import terminals at ARA. There is absolutely a new higher normal and we could talk about that during the Q&A if you like, but when people look at these high stockpiles in Europe, I don’t think they’re realizing that what used to be normal just for EMO, for instance, which is the largest terminal, normal used to be 2.2.

Today, it’s probably over three for a whole variety of reasons but it’s probably over three and their stockpiles today are about 3.6. What really becomes clear when you’re in Europe is that there is not much of a safety cushion in the stockpiles in the European terminals or at the European power plants. So that was very interesting.

I was startled actually by the level of interest in U.S. thermal coal for 2011 and beyond. And in this case beyond in at least a couple of cases was very long beyond, multi-year contracts for a substantial number of years.

And then the last item is what’s going on with Greece. The whole idea of subsidies, government subsidies is changing the dynamic, what’s happening in Europe whether that’s for renewables or whether it’s for coal mining. Coal mining is heavily subsidized in both Germany and Poland.

Germany has a plan in place to reduce their coal mining industry and production. Poland does not, but it would not surprise either me or the people I was meeting with, would not surprise us to see the subsidy issue become bigger as far as coal mining in both Germany and Poland.

On sales commitments as CK mentioned we did carry over 300,000 tons. They were at almost $85 a ton, so it’s not such a bad thing that they carried over. We did sell 420,000 tons. It’s about split between thermal and stoker. And we are pretty well sold out for this year except for the PCI and stoker and the high ball, but the high ball is separate mine.

Midwest, we carried over some tons which we talked about in the past and again we’re pretty well contracted there. I do think that option tons will probably come into play in the Illinois Basin or in Indiana where we have max/min on the contracts. And we had been at the min level. We’re headed towards the midpoint level today and I think by sometime in the next several months we may, in fact, be at the max level, which is fine for us. And we’re very happy with the pricing and so that will help Don and his operations.

The highball and PCI, we talked about this a little bit on the last call. We will be opening our high ball mines in Q3. What has been surprising has been PCI. PCI really came out of nowhere in December and January as steelmakers are adjusting their blends and adjusting on what they’re doing and how they’re making their steel. So that is a higher margin coal for us. It’s probably stoker plus some amount and that’s where we’re focusing our efforts.

We did put in here what we have under contract and our annual capacity. We debated back and forth on whether or not to put the steam in there, but our annual capacity under this scenario, our annual bi-annual capacity for utility steam coal is somewhere between 7 million tons and 7.5 million tons for which we have 5.2 under contract. And at least for the immediate future I don’t expect we’ll put any more under contract.

Turning to the guidance, you can see where we did issue our initial guidance which we typically do. The earnings per share of $1.70 to $2.25. One item that we should have mentioned and didn’t mention, but I’ll talk about now. And that is on the convertible that we did in November, there is a cash interest piece of that at 4.5%, which is $7.8 million and then there is a non-cash or an imputed interest in it of $6.3 million. So the net effect is $0.51 per share, to the extent, you need to adjust your models taking that into account. We’ll be happy to work with you through that.

Nothing else really of note other than the fact that we have not put the high ball in there. We’ll do that in late July, early August, when we issue our update.

For the guidance by segment for Central App and the Midwest, you can see what we have left to sell. It will be all stoker and PCI and then high ball, but of course, high ball not in there.

On the cash costs we are guiding to $0.64 to $0.66. We’re below that today. You know I said earlier that we are at normal operations today. So we’re a little bit below that. There is a fixed cost absorption, which we’ve talked about in the past that once we get up to a normalized, not fully going, but certainly much greater than where we are today, we think our costs will come in. And we do assume that production is curtailed for the whole year.

To the extent we start ramping up production in the second half, which is what I currently think, we haven’t given the direction on it, but I currently think that’s what will happen, then we would expect those cash costs to come in. CapEx should not be a surprise to anyone.

Turning over to Slide #22, liquidity, you can see, obviously, the thing I love about this slide is where we came from. December 31st, 2008 we had total liquidity of 3 million. Today, we have 173 million. What I would draw your attention to is the restricted cash. Those are collateralizing the letters of credit today.

As we replace the letters of credit under the revolver facility that restricted cash will come back up and be unrestricted and Sam and our bonding folks are working on that right now. So, you would see availability from the 65 dropping down and the restricted cash going up.

And upcoming investor conferences, we’re at Simmons next week with Pierson Brian. CK is going to be in Dallas with SCHENER [ph] and Sam will be with Jeremy [ph] of the GREEN MARIE [ph] next week. I am speaking at Sirovi [ph] the following week and then I think Sam and I will be going over to the Davenport Conference with Garrett across Street.

And with that we are happy to entertain questions.

Question-and-Answer Session

Operator

Thank you. (Operator instructions) And our first question will be with Jim Rollyson with Raymond James.

Jim Rollyson – Raymond James

Morning, Peter.

Peter Socha

Hi, Jim, how are you?

Jim Rollyson – Raymond James

Not too bad. I guess first question, the 3Q start-up on the met side, is that just a function of how much time you need to get that up and running?

Peter Socha

No, not really. There’s just no hurry. The whole met market continues to tighten up by everyday and obviously, we’re generating, free cash today. We’re generating income today. If we had to start it up sooner, it would probably be – Oh, gosh, CK, I’m going to say, April or May. What do you think?

CK Lane

We could start one mine in April and then one mine shortly after that.

Peter Socha

Yes, minor vacations in July and I think right now what I’m targeting is after minor vacation we’ll kick it off. It gives us the market time, as you know, settlements are kind of in process today with the lowball market. Highball will follow off of that. And so let’s just see where this thing goes. Clearly, the met market is tightening up. So we’re not really losing anything by delaying by a couple of months.

Jim Rollyson – Raymond James

Right. And you’re going to sell the volume this year regardless. Sound like you’re pretty confident with the way the market’s going that you’re going to sell that. I’m just curious why you didn’t include that in guidance.

Peter Socha

Because we don’t know what the price is yet, Jim. Until I print that first ticket I’m reluctant to put it into a model and go out with you. You already have a high ball assumption, not with us. Obviously, not with us but with others. I may agree with it or disagree with it, but I’m not going to include it right now.

Jim Rollyson – Raymond James

So at the end of the day, your –

Peter Socha

I’ll give you, for instance, on why. I’ll give you a very good, for instance. Somebody I spoke to last week was asking about highball and they were asking about it quickly and so that may, in fact, bring in the scenario where we open one in April and one in May. All of a sudden the guidance I’ve just given you blows up. Better for me to wait until I’ve printed a ticket or two and until we’ve given the go ahead on yes, this is exactly when we’re going to open the mines.

Jim Rollyson – Raymond James

Yes. So obviously your volumes for Central App can pick up from I guess already factoring that into our existing numbers which your guidance looks quite a bit lower. Sounds like part of that is not including anything for met and then the other part to me is the non-cash interest part of your –

Peter Socha

Yes, yes. And then we can dial up on the thermal, but there’s just no point.

Jim Rollyson – Raymond James

Right.

Peter Socha

As I said, I think we were fairly clear on there on sort of what capacity is and I really went back and forth last night on whether or not to put in the thermal capacity. But we’ve said in the past our current capacity and our current structure is about 8 million tons and 8.5 million tons. So let’s say it’s 8.5. Just pick the high number. What I did in effect was break out what that 8.5 is for you. And then the met would be additive to that.

Jim Rollyson – Raymond James

Given your recent trips through the other side of the pond, kind of curious, what your thoughts process is right now on strategy for booking coal when you get into '11 and '12?

Peter Socha

Let’s see what happens with Europe coming out of this winter. The API2, everyone makes a big deal out of the API2 and it makes U.S. coal uneconomic. One thing I definitely learned while I was there was there is a trade going on with API2 right now that’s putting selling pressure on that instrument. It’s not really related to fundamentals in the European market, although power demand isn’t great, but it’s not just completely abysmal.

And what’s happening is people that were long the API2 are selling the API2, capturing the freight differential which is $6 or $8 and then selling the coal to India as an API for coal. So they’re unwinding a trade, which is putting pressure on that trading instrument. It’s really interesting. And there were several traders who I discussed it with.

Jim Rollyson – Raymond James

Any sense –

Peter Socha

Yes, what that does just to carry the thought forward, what that does is it makes the U.S. coal look more uneconomic into Europe than it would otherwise look. You just got a thinly traded market with more sellers than buyers and they’re selling for a trading reason, not a fundamental reason. I’m sorry, Jim. Repeat your question. (inaudible)

Jim Rollyson – Raymond James

No, the follow-up on I was just any idea how long that continues from your talks with those guys?

Peter Socha

I think it will be later this summer. I’m not really looking to move any thermal coal until sometime in the summer and fall. I think the U.S. market is probably a fall market and maybe Europe is a little bit ahead of that.

The thing that is just striking about Europe is the safety margin just isn’t there. Northern Europe is certainly north of 50,000 megawatts of coal, maybe north of 70,000 megawatts and the extra coal in inventory, you’re probably talking 2 million tons, maybe 3 million tons. So it’s not a whole lot for that number of megawatt. When we think of the U.S., we think of inventory being 50 million tons or 30 million tons or 20 million tons. They’ve got more like two.

And coal production in Germany is clearly coming down, which brings up the rail business because the local power plants that bought coal from the local mine. That mine shutting down. So they’re now looking to buy coal from ARA from the terminals, but they don’t have anywhere to store the coal. So they’re using the terminals and the storage, basically, the storage bin and that just cuts into the safety margin again. It’s really interesting, really interesting.

Jim Rollyson – Raymond James

So you’re in no hurry bottom-line?

Peter Socha

No. We’re generating cash. We’re doing fine. Financially, we’re doing fine and we’re going where the money is. We’re kind of doing the Willy Sutton thing. We’re going to the highball and we’re going to the PCI because I don’t need to go out and sell thermal now and take a negative margin on it. It’s not necessary. We don’t need to practice mining. We know how to mine.

Jim Rollyson – Raymond James

Fair enough. I’ll turn it back, thanks.

Peter Socha

Thanks, Jim.

Operator

And our next question will come from Jeremy Sussman with Brean Murray Carret & Company.

Peter Socha

Hi, Jeremy.

Jeremy Sussman – Brean Murray Carret & Company

Hi, Peter, how’s going?

Peter Socha

Good.

Jeremy Sussman – Brean Murray Carret & Company

When you met with utilities over there what were their thoughts in the sense of timing and all that maybe from an import perspective?

Peter Socha

Yes. Really '11, '12 and beyond. As I said in the opening comments, I was startled. There were a couple of meetings I had that I really expected them to be more sort of two cups of coffee and just exchange information and have a very social visit and they went right to missiles. They went right into the business conversation. There was not as much of the getting to know you type of thing. It was how much coal do you have available next year? Where do you ship it from?

As far as export terminals where would it come into, import terminals. It really turned into substantive discussions fairly quickly. So that part was very stunning. I don’t expect there to be much this year. There could be, but I don’t expect there to be a whole lot this year, but for '11, '12 and beyond I had one utility talking 5 year and 10 year deals, which was very surprising. So yes, as I said, startled is just the best word I can come up with. These are great meetings. I was very happy with the meetings. I was happy with discussion, but it was more substantive than I thought going into the meeting.

Jeremy Sussman – Brean Murray Carret & Company

That’s great to hear. How about on the highball side? Your highball mine, could you kind of characterize the quality a little more specifically, is it –?

Peter Socha

Yes. It’s probably a good B. It’s a solid B, B plus.

Jeremy Sussman – Brean Murray Carret & Company

Okay.

Peter Socha

It’s not the best of the highballs, but in this market, definitions kind of get stretched around a lot.

Jeremy Sussman – Brean Murray Carret & Company

Sure. And then just lastly, there’ve been some reports that China has been sniffing around the U.S. even on the thermal coal side. Are you seeing any of this?

Peter Socha

Yes, we have. Yes, actually we have. Within the last two weeks or three weeks we’ve gotten inquiries. Just we haven’t quite figured out how it works. Getting thermal coal over to China, expo can do it and all that, but I think the play for us is probably Europe. I’ll tell you what Europe is really looking at is they’re looking at all the coal that’s leaving South Africa and going to the east and then this whole thing of Colombian coal, Colombian selling CAPPs into China, has gotten their attention in a big way. And then you have the whole CV, the calorific value of both Richard’s Bay and more importantly, Colombia going down. So they’re not getting as many BTUs as they used to get.

Jeremy Sussman – Brean Murray Carret & Company

Makes sense. Thanks very much, Peter.

Peter Socha

Thanks, Jeremy.

Operator

Our next question is from Brian Gamble with Simmons & Company.

Peter Socha

Good morning, Brian.

Brian Gamble – Simmons & Company

Morning, Peter.

Peter Socha

How are you?

Brian Gamble – Simmons & Company

Doing well, doing well. Just to extrapolate on something you just mentioned. You mentioned that Europeans understand the South African coal that’s going east. Do they get to that same 75% number that you mentioned that the South African was moving east?

Peter Socha

Yes. That’s an easy number to get to. You look at vessel loadings. You get them every month and you can look and see where they’re going. Yes, they’re there. The real question mark on their side is more Colombia than South Africa. They in essence believe South Africa’s gone.

Brian Gamble – Simmons & Company

Okay. So they’re fully expecting that trend to continue and stay that high for the whole year?

Peter Socha

Absolutely.

Brian Gamble – Simmons & Company

And beyond I’m sure as well. The mines that were out for the quarter or for Q4 that kind of came back into the normal run rate, does that happen kind of at the beginning of the year or was that a more recent –?

Peter Socha

No. It was really within the quarter. Occasionally, mines hit bad geology which is not a big deal, but is when you dial back everything else.

Brian Gamble – Simmons & Company

Sure.

Peter Socha

The impact is just an outsized impact. When you’re running everything at 80% and then you have a mine that has very high costs for two weeks or three weeks.

Brian Gamble – Simmons & Company

Then those rollover tons that you mentioned both in Central App and in the mid west, are those going to be pro rata Q1, Q2 and Q3 or is that more shipping on in Q1 –

Peter Socha

The way they actually work is in some cases, they become the first tons you ship. In most cases, you catch them up. You actually catch up. So you enter the year with X number of tons with gamble utility. So I have a million tons with gamble utility. And I have 50,000 in carryover. The first five trains I ship you may be at the carryover price and then the next 950,000 tons are at the new price which in our case is higher. In other cases we just kind of intersperse them throughout the year.

Brian Gamble – Simmons & Company

Okay. So you’re not layering in additional tons into Q1. You’re just essentially pushing things out and changing the price –.

Peter Socha

Yes. Right now the railroad is struggling with the weather delays, so we’re getting what we can out today.

Brian Gamble – Simmons & Company

How strong do you expect the met market to be? I know you mentioned the PCI being intensely stoker plus. Is there a certain point where you think that it becomes instead of being stoker plus its more highball minus to get to what the fair price of PCI is?

Peter Socha

Yes. Yes, I think that’s very possible. There are just a lot of moving pieces right now and where those price, again, I think everyone’s waiting on the overseas settlements to get a better sense and my guess is that we will see some U.S. suppliers announcing settlements sometime here in the near future and then everything will key down off of that.

Brian Gamble – Simmons & Company

With your international discussions recently is the opinion of where the annual contract will be signed in from locations the same as it is over here? We’re seeing trade rights saying 240 was thrown out there, 200 is a definite possibility. Is that the same sort of feeling you got from a (inaudible)?

Peter Socha

Yes. Right now because everyone is supersensitive, the communication channels wide open between all of the people that are reporting this. At the same time that they’re hearing it overseas you’re hearing it here.

Brian Gamble – Simmons & Company

Appreciate it. That’s great. Thanks, Peter.

Peter Socha

Thank you, Brian. See you Monday.

Operator

And our next question is from Bill Burns with Johnson Rice.

Bill Burns – Johnson Rice

Good morning.

Peter Socha

Hi, Bill.

Bill Burns – Johnson Rice

Hey. In 2010 this year, are we going to see some like MSHA [ph] related expenses that we didn’t see last year? I remember last quarter call you talked about the new communication systems coming in this year or is that in your 10 million CapEx?

Peter Socha

It’s in there, but CK, you want to address that?

CK Lane

On the MSHA related atoms we are starting and actually just put in our first tracking and communication system, as we speak in the month of February, but the tracking and communication will be in the capital guidance on the safety items. There’s continuing regulations coming out on the desk initiatives and the rules to live by that MSHA has started and those aren’t finalized or firmed up, so we don’t know what those impacts will be, but the tracking and communication is in the capital number under the safety.

Bill Burns – Johnson Rice

Thank you. And then the other question, I think yesterday, CSX announced and kind of was telling its customers because of bad weather they should expect some shipment delays. So your first quarter are we going to have additional weather issues you think like we had during the fourth quarter?

Peter Socha

Not on the mines. On the railroads, as I said, they are working very hard at it, but particularly, the storms sort in Maryland southern Pennsylvania hit them very hard. So yes, I was with the railroad this week and there’s no question that they are struggling with it. From the mine standpoint I think we’re doing okay right now.

Bill Burns – Johnson Rice

Thanks, Peter.

Peter Socha

Okay, thank you, Bill.

Operator

And our next question is from Shneur Gershuni with UBS.

Peter Socha

Shneur, how are you?

Shneur Gershuni – UBS

Good morning. How are you Peter?

Peter Socha

Where are you? Are you back from Europe?

Shneur Gershuni – UBS

I am back.

Peter Socha

Oh, good.

Shneur Gershuni – UBS

Just a couple of quick questions, not sure, if this is for CK or not. I was wondering if we can get a little bit more detail with respect to the geology issues.

Was it sandstone intrusions? Something that could continue down the road or was it something related specifically to this quarter?

Peter Socha

No. I wouldn’t say. It’s something we run into on a regular basis. Its sandstone intrusion and then I’ll let CK talk about it in a little bit more detail in a minute. It’s something we run into on a regular basis. And it just so happens when you’re running at 80% and then you hit a sandstone intrusion, as I said earlier, the impact is magnified and then you’ve got fourth quarter issues. You’ve got all the various things that happen in the fourth quarter anyway, but you got an outsized impact, but primarily sandstone intrusion that we typically deal with. CK?

CK Lane

Yes. I mean we had one operation that we had a sandstone wash out that we had to mine through and then we had another area that had the low coal thickness area and those are just part of the mining and they just happen as Peter said that while we had cut our mines back and idled some of the other mines later in the quarter. So just normal parts of mining.

Shneur Gershuni – UBS

Okay. And guys, I was wondering if we can take a stab at kind of thinking about or talking about costs a little bit here. I was wondering if we can get some sensitivity about royalties and sales related charges. Obviously, you have fairly high revenue per ton, so, obviously that impacts that. At the same time, obviously, 2010 is not an optimum year from a production perspective, but, looking out to 2011, when you get to a more reasonable level, what can we see in terms of costs coming in with respect to fixed costs absorption kind of going the other way and also if you can sort of once again give some sensitivity around your royalty costs and so forth.

Peter Socha

The sensitivity, I think, the part of cost inflation next year that’s due to higher prices and higher royalties, I think is $0.13 or $0.16. It’s not a great amount. The sensitivity on the fixed costs absorption we’ve given. I think it’s somewhere between $5 and $7 or $8. I think what’s going to happen, if I had the prediction here, I think what’s going to happen is I’m going to call CK up or he and I going to be riding around the truck one week and I’m just going to say, you know what, CK, let’s start stepping on the gas in August and let’s start stepping on the gas in September. I feel good enough about the domestic thermal market that now is the time that we need to go ahead and start adding back shifts.

Shneur Gershuni – UBS

Right. And so we should slowly start to see the fixed cost absorption variable basically tick back down, is that correct?

Peter Socha

Yes, yes. And you’ll know about that. I’ll talk about that at various places, but right now, I think that will probably be late in the third quarter or sometime in the fourth quarter if I had to put a bet on it, but he and I have not had that conversation yet and I’ll let you know when we do.

Shneur Gershuni – UBS

Okay. And then one final question with respect to your 2010 guidance. Just kind of wanted to understand what your imputed sales per tons or for the uncontracted tons. Just putting the numbers together and footing them and so forth, it seems there’s a bit of a safety margin in there or fairly low assumptions for your uncontracted tonnage.

Peter Socha

Yes. The guidance is based on budget. I’m not going to give you exact numbers. That’s an algebra thing that you’ve got, you and your whole team will just come up with your own numbers. But the guidance is based on budget and budget was really finalized back in October and November. So I think to the extent you look at it saying this is being overly conservative in one way or the other, particularly on that item, on the sales price for uncontracted tons. That would be why. For obvious reasons I’m not going to go out with guidance just ahead of my budget.

Shneur Gershuni – UBS

Does your overall EBITDA budget include a range for SG&A? I know you gave kind of a point estimate and so forth.

Peter Socha

No. I think we feel pretty good on the SG&A. The biggest change in SG&A is that the letter of credit fees from last year, they were in SG&A and now they’re pulled out.

Shneur Gershuni – UBS

Right.

Peter Socha

Now they’re in the interest line.

Shneur Gershuni – UBS

Okay. And finally the (inaudible) below tax rate, if we can get a little color around that, is it NOL related?

Peter Socha

It’s NOL. Yes, it’s purely NOL.

Shneur Gershuni – UBS

Okay, perfect. Thank you very much, Peter.

Peter Socha

Thank you, Shneur.

Operator

Our next question is from Justine Fisher with Goldman Sachs.

Peter Socha

Good morning, Justine.

Justine Fisher – Goldman Sachs

Morning. Hi. I just had a question on the cost. So the cost guidance that you’re giving, that is including the 64 to 66 cost in cap that’s including the $5 to $7 of –

Peter Socha

Yes.

Justine Fisher – Goldman Sachs

Of fixed costs?

Peter Socha

Yes. What we’re saying is on a regular run rate we’re almost certainly sub-60 on costs, probably somewhere between 55 and 60. I need to add because somebody will call me this afternoon and ask this question. That includes high royalties. That includes much higher royalties than maybe some other people would have because we have $95 prices.

Justine Fisher – Goldman Sachs

Okay. And then –

Peter Socha

Let’s say it’s 58. When you look at that you’ve really got to back out your royalties and our mining costs do not look quite so bad.

Justine Fisher – Goldman Sachs

I’m just reconciling that with the 2Q and 3Q costs for '09. It seems as though there may have been the same fixed cost absorption in those numbers because you’re at, 1.6 million or so tons in cap in those quarters, but your costs were 63 and 65 bucks. So only in '08 was the cost in the high 50s. So what X the fixed cost absorption, what would have –

Peter Socha

The difference between '08 and '09 is you have got to back out the royalty difference.

Justine Fisher – Goldman Sachs

Okay. So that’s basically the $2 –

Peter Socha

Yes. You go from $50 to $90 on sales price.

Justine Fisher – Goldman Sachs

Okay, yes. That makes sense. That was a big jump.

Peter Socha

Okay. There’s one person on this call who always reminds me to say that and they will call me.

Justine Fisher – Goldman Sachs

Okay. And then the other question that I had was on the export potential. I know you were talking about the U.S. ports being clogged up. Is that going to reduce some of the opportunities that some Appalachia guys have been talking about exporting or what’s –

Peter Socha

No. I still think we get a knock on effect. We’ll probably export some, but not a lot just because of the nature of where we are and who we serve, but the people who have the major export opportunities, they have everything in place. They have the port capacity is in their pocket, the rail capacity to the ports is in their pocket. So, I think, particularly in '11 and '12, the European opportunity is very large for them. We will pick off some of that opportunistically or jointly or whatever. We’ll participate in some of that, but I think the opportunity is bigger for them and then we will backfill. Really the same as we did back in '08, Justine.

Justine Fisher – Goldman Sachs

That’s it. I’ll get back in queue if I remember my other question.

Peter Socha

Okay. Thanks, Justine.

Operator

And our next question is from Jeff Cramer with UBS.

Peter Socha

Jeff.

Jeff Cramer – UBS

Hey, good morning, everyone. Just on the liquidity front, you talked about this in the past. Can you just remind us if anything has changed, kind of some of the priority there I guess in order?

Peter Socha

In order, they are not to put a bid under your bonnet, Jeff, your question. I don’t know where Brett Levy is, but I’m sure that will be his first question. They are really internal growth and then a selective transactional growth. We are looking at where we want to be. As I said on the last call I think in response to Mike Dudas, we fully expect to be a larger company in '11, '12 and '13.

We had major elements we had to work on in our company. We’ve done that and the last one was to improve the balance sheet and we accomplished that in the fall. So I think will be a stronger market sometime in the next six months to 18 months. We head into it in relatively good shape and I think it’s a good opportunity for us to take the opportunity to kind of redundant there, sorry, but it’s a good time for us to take the opportunity to go ahead and grow our business, get a little bit more scale.

We’ve got a great platform of people, very, very happy with the people we have and they are capable of much more than they’re running today. And so I think this is the time that we need to start looking at pieces to go in there and CK has a process in place to do that.

Jeff Cramer – UBS

Okay. And I guess on the acquisition front do you get the sense that expectations are in line where we will see more of that in general?

Peter Socha

Yes. Pretty much. It’s still early. For us it’s still a little bit early. But yes, I think so. I think so. I think between regulatory and permitting is just absolutely driving some people crazy and it may be a good time.

Jeff Cramer – UBS

Okay. Just to clarify your point–

Peter Socha

But nothing, nothing, I’m done with capital as far as I told this to your guys in New York, the other day. I’m done with sort of the capital side of the business. I’m not going out and doing any more of that right now. We’re focused on the business and we’re focused on where we want to be in a year or two.

Jeff Cramer – UBS

Okay. Fair enough. Just to clarify in the fourth quarter, if geology or weather was not an issue, would you still have shipped those tons or was that kind of a –

Peter Socha

Yes. Weather had two effects. One was on us just both underground and surface on the people side on the run particularly, on the surface on running the mine, but also on the railroad. The last eight days or 10 days of December, the railroad had an incredibly difficult time in Eastern Kentucky and Southern West Virginia. So it was not just us. It was the whole supply chain.

Jeff Cramer – UBS

Okay, got you. And then just on pricing I know you kind of talking stoker plus or PCI right now. I guess could you help me with that math where I guess if you were to sell stoker right now –.

Peter Socha

No. Because, this is typical and seems to always be the case. Because we’re in current discussions I’d rather not go there, puts me in a corner.

Jeff Cramer – UBS

Okay, thanks. Good luck to you guys.

Peter Socha

Thanks, Jeff.

Operator

Our next question is from Garrett Nelson with Davenport & Company.

Peter Socha

Hi, Garrett.

Garrett Nelson – Davenport & Company

Hey, good morning. How are you doing?

Peter Socha

Good morning.

Garrett Nelson – Davenport & Company

On the 408,000 tons of stoker and 220,000 tons of PCI commitments, are those all 2010 volumes?

Peter Socha

Yes.

Garrett Nelson – Davenport & Company

And if you’re willing to provide it, the average pricing on –

Peter Socha

No. Yes, to question one, no to question two.

Garrett Nelson – Davenport & Company

All right. That’s all I have.

Peter Socha

I’m sorry, Garrett. And again it’s because on both instances we are in current discussions today and so we’ve never done it in the past and I think we work hard to provide clarity to you and to everyone else who follows us, but that probably goes further than we would like to go.

Garrett Nelson – Davenport & Company

Sure. Thought I’d try. Thanks.

Peter Socha

Okay.

Operator

Our next question is from Curt Woodworth with Macquarie.

Peter Socha

Hi, Curt.

Curt Woodworth – Macquarie

Hey, good morning, Peter. How are you?

Peter Socha

Good.

Curt Woodworth – Macquarie

So, it seems like right now in Central App the business is running below your cash cost guidance for the year. So if you think production is going to be about flat or even, seems like the risk would be to the upside in the back half of the year as things come back a little bit.

Peter Socha

Yes.

Curt Woodworth – Macquarie

Number one, why would your costs be going up from here and number two, if production does come back a little bit, would you be able to beat that cost number?

Peter Socha

I think we can beat that cost number. I mean there’s so much of that cost number that is tied up in absorption right now. That is so sensitive to whether it’s shipments or whether it’s production, but definitely, production that it’s so sensitive that I would rather error on the high side on the cost estimate than come in below it than the opposite. I just think it’s out of an abundance of caution. The domestic utility market is still very fragile. And if we have to dial back another notch, I don’t expect us to do, but if we have to dial back another notch, I’d rather give myself a little wiggle one.

Curt Woodworth – Macquarie

Okay.

Peter Socha

Quite frankly, we’re coming off of a quarter where we did see what happens when you have multiple things that hit you on the head, all within the same period of time. When you have dial back mines, when you’re running 80% of the mines and then you have a couple of mines that hit sandstone or hit bad top or whatever. So until we get the mines, until CK has stepped on the gas, he’s got everybody going at full tilt, the impact of that little geology issue is not going to be as great.

Curt Woodworth – Macquarie

Okay, understood. And then second question on the highball side what’s the cost structure look like for those mines?

Peter Socha

On the mines themselves, it’s actually a little higher, but it’s not materially higher than our other mines. Where we get dinged is on the processing cost because we do have a prep plant load out that’s capable of running a lot more tons. What we’re cautiously optimistic of is that there are other mines in that area that will be able to run their tons that are not ours that will be able to run their tons through our prep plant. So when you add in the prep plant costs, the costs go up. They’re materially higher than our regular mines, but on a mining cost itself they’re not that much higher. Would you agree, CK?

CK Lane

Yes. I think that’s a true statement on that. You’re just running a large prep plant without a lot of tons through it.

Curt Woodworth – Macquarie

So would the all-in-cost be more like mid70s and with the prep plant?

Peter Socha

I’m not going there. We’ll update the guidance in August and we’ll include them in there then.

Curt Woodworth – Macquarie

Okay, great, thanks.

Peter Socha

Keep in mind we only ran those mines for a fairly short period of time. We got in far enough to get out some good test material. We had the mines tested. We’ve had some test burns done, but until we have a little bit more track record on running the mines I’m a little cautious.

Curt Woodworth – Macquarie

Okay.

Peter Socha

Thanks, Curt.

Operator

Our next question is from Brett Levy with Jefferies & Company.

Peter Socha

Brett, I knew you were out there.

Brett Levy – Jefferies & Company

My questions been asked, but no, I got a couple other ones.

Peter Socha

That’s a question, it deals with quarterly guidance. I know you, Brett.

Brett Levy – Jefferies & Company

And you’re not giving that?

Peter Socha

No, I’m not giving quarterly guidance. Is there any company in your coverage universe that gives you quarterly guidance?

Brett Levy – Jefferies & Company

Absolutely.

Peter Socha

Any company in the mining industry?

Brett Levy – Jefferies & Company

Some.

Peter Socha

Go ahead. I’m sorry.

Brett Levy – Jefferies & Company

In any case. You said the 62 million of restricted cash, what is the timing to kind of get that bonded up and get that back in your coffers without restriction?

Peter Socha

I think it should be this quarter. I think it should be by the end of the quarter. There have been several large ones that have already been done as far as us substituting the LC and the cash coming back in. Actually, I’m not sure if the cash has come back in yet, but the LC has been issued and it needs to be swapped out, but I would say by the end of the quarter and there may be a straggler or two.

Brett Levy – Jefferies & Company

All right. And then with respect to the two highball mines can you draw us a little picture of kind of what the ramp up looks like how many years to get to 300, what do you think the target costs per ton is going to be, just sort of when it starts to become break even, that –

Peter Socha

Yes. They could probably run at break even today with today’s prices that we know were out there.

Brett Levy – Jefferies & Company

Right.

Peter Socha

Because I was saying with Rolly on the first question we could run those mines at a profit today. I choose not to. The market is coming up. I don’t mean that literally, but the market is tightening up in the highball, lowball, certainly, the whole metallurgical market is tightening up. So the market is going in our direction. We don’t have to rush into this. As far as ramping up the full production rate, I would say a matter of weeks, not months. And I’ll defer to CK on that.

CK Lane

We start the first mine fairly quickly, then the second mine, a couple months after that and then the other two mines are permitted and we just have to face those up and put those in, but that’s a three months to four months process there.

Peter Socha

I’m not going to go to individual cash cost on those mines right now. They’re not included in any guidance today and I think we’ll just keep them that way.

Brett Levy – Jefferies & Company

And the 300 is for the two mines or the four mines?

Peter Socha

Two.

Brett Levy – Jefferies & Company

That’s for the two? All right. I’ll get back in queue. Thanks very much.

Peter Socha

Thanks, Brett.

Operator

Our next question is from Mark Caruso with Millennium.

Peter Socha

Mark.

Mark Caruso – Millennium

Morning, Peter. Still its afternoon I guess at this point.

Peter Socha

(inaudible) we’re going to wrap in a few minutes.

Mark Caruso – Millennium

All right. Just two quick ones. One is interest expense. It seem like that was an area of confusion for a lot of people.

Peter Socha

Yes.

Mark Caruso – Millennium

Can you give a little more color around how much ballpark it should go up?

Peter Socha

I did talk about the convert. The convert is a 4.5% coupon. Sam did a little cheat sheet for me this morning. It’s a 4.5% coupon on the convert. The all-in by the time you get through all the accounting and if you have a question on the exact accounting, Sam will be in the New York next week, but the all-in rate that you assume is 10.1%. That gives you a cash interest expense of 7.8 million a year and then a non-cash amortization of discount and financing costs of 6.3 million a year, total 14.1.

Mark Caruso – Millennium

Great.

Peter Socha

We have 27.5 million giving us $0.51 of EPS.

Mark Caruso – Millennium

Perfect. Okay. And then going back on the stoker PCI, you mentioned earlier that the focus in terms of the balance are pretty much sold out on the steam side. Can you give us just a sense – I’m not going to ask about pricing, but just a sense of what left, the implied, what’s left versus the midpoint of guidance?

Peter Socha

The implied what’s left on the steam side is about 2 million tons. If you take 5.9, this is kind of how the math works there. We have 5.9 under contract today total at 95 and change. 700 of that is either stoker or PCI. So now you’re 5.2. Capacity on the thermal side is about 7.2, 7.3. So that gives us more additional capacity on the thermal side of 2 million.

Today, the market is certainly below my costs, and so every time I sell at that I’m going to lose money on it and I don’t have to do that. Given our cash flow and given our cash position I don’t have to do that, so I’m not going to do it. I’ll take the absorption issue and I’ll just deal with it and then when it comes time to ramp up, we’ll ramp up and I’ll step on the gas. I’ve got a full team and I’ve got a full set of equipment.

On the other side on the PCI and the highball, the PCI and the stoker, we put in there that those totaled to around a $1.2 million and there were 700 sold today. So we’ve got an extra capacity there of 500, and then on the highball we got another 300.

Mark Caruso – Millennium

I guess my main question is just sort of if I take the midpoint of guidance for this year and the 5.9 that you said, does that give around 500 of pure stoker industrial left to sell or is it a combination of these –?

Peter Socha

It’s a combination of either one. We can move them back and forth and CK can have a 30-minute conversation with you and he’ll do with you what he did with me, which is totally confusing, but basically, we have about 500 left and we could sell that to either the PCI market or the stoker market.

The reason we added the footnote, if you look at the footnote, I think it’s in the press release, if not, it’s certainly in the slides. We added a footnote one, which means and the reason I did that is we showed 480 of stoker and 500 capacity. So I didn’t want you to come away with the impression that we only have 20 more of stoker we can sell but that’s not accurate.

Mark Caruso – Millennium

Okay. But can you give a sense is it like 70, 30, 60, 40, where you can go in either market at 100%?

Peter Socha

No. Right now, the PCI is probably a higher market. So whatever I can move there I’ll move there and then the stoker would be lower.

Mark Caruso – Millennium

Okay, perfect, thanks.

Peter Socha

So it’s whatever I can move into PCI. Whatever is left I’ll put it in stoker.

Mark Caruso – Millennium

Okay, perfect.

Peter Socha

Thanks, Mark.

Mark Caruso – Millennium

Thanks, Peter.

Operator

And that concludes our question and answer session for today. Mr. Socha, I’ll turn the conference back to you for closing remarks.

Peter Socha

Thank you, Trisha and thank you everyone for joining us. We will, as I said, next week is a busy week. We’re on the road quite a bit and we’ll be back on a conference call, I believe, in late April or early May. Thank you very much.

Operator

This concludes today’s conference call. We thank you for your participation.

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Source: James River Coal Company Q4 2009 Earnings Call Transcript
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