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Peabody Energy Corporation (NYSE:BTU)

Q1 2014 Earnings Conference Call

April 23, 2014 11.00 AM ET

Executives

Victor P. Svec – SVP-Global Investor & Corporate Relations

Michael C. Crews – Executive Vice President and Chief Financial Officer

Gregory H. Boyce – Chairman and Chief Executive Officer

Analysts

Neil S. Mehta – Goldman Sachs & Co.

Brandon Blossman – Tudor Pickering Holt & Co. Securities, Inc.

Meredith H. Bandy – BMO Capital Markets

David Gagliano – Barclays Capital, Inc.

Paul S. Forward – Stifel, Nicolaus & Co., Inc.

Curt Woodworth – Nomura Equity Research

Mitesh Thakkar – Friedman Billings Ramsey & Co.

Luke McFarlane – Macquarie Equities Research

Caleb M. J. Dorfman – Simmons & Co. International

Evan L. Kurtz – Morgan Stanley & Co. Inc.

Dave A. Katz – JPMorgan Securities LLC

Lucas N. Pipes – Brean Capital LLC

Lance Rory Ettus – Tuohy Brothers Investment Research, Inc.

Operator

Ladies and gentlemen, thank you for standing by, and welcome to the Peabody Energy First Quarter 2014 Earnings Call. For the conference, all the participant lines are in a listen-only mode. There will be an opportunity for your questions, instructions will be given at that time. As a reminder, today’s call is being recorded.

I’ll turn the conference now over to the Senior Vice President, Global Investor and Corporate Relations, Mr. Vic Svec. Please go ahead.

Victor P. Svec

Okay, thank you, John, and good morning, everyone. Thanks for taking part in the conference call for BTU. With us today are Chairman and Chief Executive Officer, Greg Boyce, as well as Executive Vice President and Chief Financial Officer, Mike Crews.

We do have some forward-looking statements. They should be considered along with the risk factors that we note at the end of our release as well as the MD&A section of our filed documents. We also refer you to peabodyenergy.com for additional information.

And I will now turn the call over to Mike.

Michael C. Crews

Thanks, Vic, and good morning, everyone. Peabody’s first quarter results reflect the progress we’ve made on reducing cost, lower capital spending, completing asset sales, and maximizing cash flows, which help mitigate the effects of challenging external environment.

I will begin by discussing our quarterly result starting with the income statement and then provide an outlook for the second quarter.

First quarter revenues totaled $1.6 billion as a 7% increase in volumes was offset by lower realized pricing in the U.S. and Australia. Total shipments rose 7% to 61 million ton, primarily on higher PRB volumes. Adjusted EBITDA of $177 million reflects lower metallurgical coal volumes and the impact of more than $90 million lower pricing. First quarter results also include approximately $30 million of notable items that were not in our original targets. These include an arbitration ruling related to a commercial dispute under a terminated Eastern U.S. Sourcing agreement, as well as port logistic issues, where we experienced adverse weather conditions that delayed shipment loadings and impacted coal stockpile.

Adjusted EBITDA from U.S. mining operations of $253 million, reflects the impact of lower realized pricing and higher midwest costs partly offset by increased volumes and lower cost in our Western operations.

First quarter Australian results were impacted by a decline in metallurgical volumes from the ramp-up of a longwall top coal caving system at North Goonyella and more than $70 million in lower realized pricing.

Turning to taxes, the total income tax benefit of $52 million came in below previously issued guidance largely due to evaluation allowance recognized on deferred tax assets related to lower projected taxable income in Australia. Diluted loss per share from continuing operations totaled $0.18, while adjusted diluted loss per share which excludes the tax remeasurement impact was $0.19.

Now, let’s review the additional detail within our supplemental schedules. In the U.S. an 8% increase in volumes to 48 million tons, reflect strong thermal demand in the U.S. particularly in the PRB. As expected, revenues per ton declined 7% on the roll off of legacy contract primarily in the Midwest and a greater share of PRB volumes in the mix.

Midwest costs are being impacted by higher overburden ratios, one of our larger surface mines due to mine sequencing. Continued focused on cost improvements and increased PRB shipments led to a 4% decline in first quarter Western cost that partly offset the impact of lower realization. While Australian volumes of 8.2 million tons were in line with the prior year, our sales mix was more heavily weighted to thermal coal in the first quarter. So we expect metallurgical coal sales to increase as production rates continue to improve at North Goonyella.

Australian revenues per ton declined 17% on lower realizations for both metallurgical and export thermal coal and a greater mix of thermal coal sales. During the quarter, we shipped 3.2 million tons of metallurgical coal at an average price of $107 per short ton and we sold 3.1 million tons of seaborne thermal coal at an average price of $75 per short ton. A strong focus on productivity improvements in Australia led to a 4% reduction in cost per ton to help to mitigate the impact of port logistic issues and lower metallurgical coal volumes.

Trading and brokerage results of negative 1.9 million were primarily driven by the $15.6 million arbitration charge. I referred to earlier that was partly offset by improved mark-to-market earnings. Resource Management adjusted EBITDA totaled $9.5 million on the sale of surplus lands. And we also completed the sale of a non-core Australian reserve that generated more than $16 million in cash.

That’s a review of our income statement and key earnings drivers. Operating cash flow totaled $54 million in the first quarter and we reduced capital expenditures to $24 million the lowest level in 10 years. We are lowering our annual capital spending target to $250 million to $295 million in 2014, which is mainly focused on maintaining the existing production levels.

Our cash balance increased over $500 million and Peabody continues to have substantial liquidity of $2.1 billion. Now while our team has done a tremendous job of eliminating cost and tightening capital, we continue to take additional steps to maximize cash flows in the current environment.

We are targeting a further reduction of outside spending both in SG&A and through our procurement activities. We continue to pursue non-core asset sales. We are adjusting our mining methods and shifting production to increase productivity. We also look to fully realize the benefits of recent owner-operator conversions in Australia. And we are maintaining low capital spending, while improving safety and operational performance.

Peabody benefits from the sizable investments that have been made over the last several years and are newer fleet of equipment enables us to focus on sustaining current production with lower capital. I’ll close with the review of our outlook.

For the second quarter, we are targeting adjusted EBITDA of $140 million to $200 million and adjusted diluted earnings per share of a loss of $0.39 to a loss of $0.14. These range is reflect lower seaborne and metallurgical, thermal pricing. Lower expected tax benefit and a longwall move in Australia.

Both the quarter and the year will benefit from higher revenues as we finalized pricing under a long-term Western coal supply agreement. This along with improving PRB fundamentals allows to now projected smaller decline in 2014 US revenue per ton of 4% to 7%. I also refer you to our Reg G schedule in the release for additional quarterly targets of regarding DD&A, taxes and other line items.

As a brief review of our first quarter performance, for discussion of the coal markets and other updates I will now turn the call over to Greg.

Gregory H. Boyce

Thanks Mike and good morning everyone. Peabody's global platform continues to perform well while our Australian results reflect the challenging seaborne markets and continue to ramp up with the longwall top coal caving system at the North Goonyella Mine. Our teams culture of continuous improvement allows us to advanced productivity enhancements further reduce our cost, and drive capital efficiency across our operation that benefit Peabody now and over the long term.

Let me first share our view of the current market fundamentals and long-term drivers and then we will discuss Peabody's position. The seaborne coal market is currently pressured by rising supplies at about pace demand growth. We are now nearly end of the supply growth pace that began in 2012 when prices were sharply higher. Most new projects have been completed and we estimate capital spending in the sector has been reduced by approximately half over the last several years.

This is projected to limit future supply growth while demand continues to expand. We are now seeing signs of cutbacks are accelerating due to recent top pricing levels. Increasing demand should lead to improving fundamentals in the back half of this year and into 2015.

In metallurgical coal, imports continue to grow. India and Japan have been the bright spots up 40% and 10% respectively year-to-date. At the same time, China has had a slower start to the year that is recently announced a $175 billion stimulus package and the steel-intensive industries such as rail and housing, which is expected to accelerate economic activity in the second half of the year.

Longer term metallurgical coal demand will be driven by urbanization as countries such as China and India increase their steel intensity. Now that within the seaborne and thermal coal market we continue to see rising demand. Japan’s year-over-year coal consumption is increased 15 months in a row and coal generation has driven coal imports up 11% through February.

Japan’s major utilities are increasing coal generation capacity and the nation recently reaffirmed its commitment to coal. Developing nations including Pakistan, Mozambique, and Indonesia have all announced plans to build new coal fueled power plants. And China's coal generation is up 5% year-to-date while domestic production growth has been limited, resulting in a 13% increase in thermal coal imports through March.

Rail costs in China are escalating as the market deregulates and labor costs are rising as well, all supporting additional future coal imports. This year China is also increasing coal to gas conversion activities while installing emissions controls to a significant portion of their coal generating plants. These initiatives will boost coal demand while improving their emissions profiles.

Now turning to the U.S., we continue to see improvement in market fundamentals. We are raising our projection of current year demand growth by 15 million tons. Within the U.S. markets, coal demand rose 20 million tons in the first quarter from the cold winter and higher natural gas prices, driving one of the largest utility stockpile drawdowns on record.

Southern Powder River Basin inventories are now at 44 days used, down significantly from a year ago, and many utilities are reporting critical stockpile levels of less than 15 days. Prompt PRB prices are up more than 30% since last fall and are at the highest levels in over two years. While the cold winter and competition from other commodities has impacted PRB real performance, we are beginning to see improvements in service. But I would also note that Peabody's Western shipments were up 10% over the first quarter of 2013.

All of this translates into coals market share rising to 43% of total electricity generation in the first quarter while gases fall into 23% on higher natural gas prices. I would also note that this winter's experience has elevated conversations from generators, reliability council, and regulators about the importance of low-cost, reliable, baseload coal generation in the U.S. It is again evident that policies and fuel choices matter.

I'd now like to discuss Peabody's operations. We've had great success in leveraging best practices across our platform in order to improve productivity. And within our Australian operations, we continue to benefit from our transition to the owner operator model, which will expand in more than 90% of our Australian production after the Moorvale Mine is converted later this year.

Now Mike has reviewed our cost initiatives and capital spending targets, let me focus on a few projects for the year. First and foremost is finalizing the top coal caving system in North Goonyella mine. While we continue to make progress on a new longwall, it’s taking longer than expected to debottleneck the rest of the system.

Production rates are improving and we anticipate achieving targeted output by the end of the second quarter, increasing volumes of our highest quality metallurgical product. Second, is advancing the Gateway North Mine expansion, which will provide replacing capacity as existing operations have to transition to a new reserve area. The project management team is in place and the slope construction is on track.

And third is installing a new longwall at the Metropolitan Mine to improve productivity and lower costs. The longwall installation is commenced and this is a conventional longwall system, we expect a normal ramp-up process. So in closing, Peabody has spent the past several years coping a global platform. We've got an unmatched asset base to serve the highest growing markets and we are best positioned to manage through the current cycle and benefit as market conditions improve.

U.S. demand continued to strengthen. Seaborne fundamentals are expected to improve, and significant urbanization and development of the Pacific Rim economies will drive ongoing demand for our products. Peabody continued to take the necessary steps to confront present market challenges and we’re confident these efforts will further advantage Peabody first sustainable long-term growth in the years to come. Now, with that review the global market conditions in Peabody’s position operator will be happy to take questions at this time.

Question-and-Answer Session

Operator

(Operator Instructions) First in the line of Neil Mehta with Goldman, Sach. Please go ahead.

Neil S. Mehta – Goldman Sachs & Co.

Good morning.

Gregory H. Boyce

Good morning.

Neil S. Mehta – Goldman Sachs & Co.

Can you talk about the rail congestion issues that we've heard about at CRB other companies have commented on it – how’s is that impacting your occupations that all. How do you see that working itself out of the time?

Gregory H. Boyce

Well, give me just a minute to talk about our PRB operations particularly our flagship operation North Antelope Rochelle and how it’s situated. Given its location at the southern end of the Powder River basin, we have a much better balance of shipments that go after the southern part of the basin and those that go after the northern part of the basin that was the northern tier of rail that was most impacted by weather and congestion. We also have I think probably a better balance of the two rail shippers out of the Powder River basin and clearly moving to northern was disproportionately impacted by the conditions that were causing bottlenecks on the system.

In addition, we had strong deliveries under our contracts to our major utilities. All of those added up to we were actually able to increase our shipments from a year ago and while we could have shipped more, we were still able to grow our volumes from where we were because of the inherent benefits and structure of the North Antelope Rochelle operation and the contractual mix that we have.

Neil S. Mehta – Goldman Sachs & Co.

Great, and then on non-core asset sales you alluded to this comments in the first quarter it looks like you’re able executed $70 million. Can you give us some more color in what that is and then what's the opportunity that for non-core asset sales?

.

Michael C. Crews

Sure, this is Mike and this is something we had alluded to in the last quarter that actually closed in this quarter. As we look at the portfolio for optimization, we start with items that are non-core or non-strategic. This was a element that came over with the Macarthur acquisition. And as we look at the portfolio, our plans for that particular asset when we would get to it in the realizations that we thought we might achieve and taking market conditions into account, it was contiguous with another party.

So, with all I can have more value in their hand near term than ours and that's why we elected to sell that asset. While we were able to complete that we are happy to generate some additional cash as you noted it was Australia at $70 million, so a little bit more than $60 million of cash on a U.S. basis bringing the asset sales total to little over $130 million on two different transactions, one in the U.S. and one in Australia over the past 12 months.

Neil S. Mehta – Goldman Sachs & Co.

Great. Thank you very much.

Operator

Our next question is from Brandon Blossman with Tudor, Pickering Holt & Company. Please go ahead.

Brandon Blossman – Tudor Pickering Holt & Co. Securities, Inc.

Good morning guys.

Greg Boyce

Good morning, Brandon.

Brandon Blossman – Tudor Pickering Holt & Co. Securities, Inc.

Let’s do big picture in the press release Greg, you have a comment of southern Powder River Basin and Illinois Basin coal demand to grow $100 million tons by 2016. Any incremental detail or we talking primarily basin switching there or we talking incremental demand overall, and then just is the rail infrastructure sufficient turn to meet that demand level?

Gregory H. Boyce

Good question, Brandon, thanks. as we look at that growth, it actually does come from both of those components; it comes from basin switching as we continue to see a movement out of the Eastern coals into the Illinois Basin coals, as well as higher utilization. it’s interesting when you listened to some of the major Midwest utility folks talking now about, even some of the utility plants that were scheduled to be retired over the next couple of years, actually we’re running flat out during this past winter and that gets to my comments earlier about this higher conversation that’s taking place around, how much of this can actually be shut down in the near-term.

But in terms of the growth out of the Illinois and Powder River Basin, it is basin switching its higher utilization and both of those basins are competitive, certainly the PRB, very much competitive given gas – forward gas curves and what we’re looking at in terms of having to replace the gas storage capacity over the next couple of years.

Brandon Blossman – Tudor Pickering Holt & Co. Securities, Inc.

Okay. Is it…

Gregory H. Boyce

The other part of the question – sorry was about whether the rail infrastructure was sufficient. clearly, the rail infrastructure is sufficient. The rail roads will have to manage their rolling stock, their locomotive power and their crews, but the kind of volumes that we’re talking about moving had been moved in the past. so it’s really a matter of managing the logistics on the rail and also with the advent of the other movements that they’ve got on the rail system.

Brandon Blossman – Tudor Pickering Holt & Co. Securities, Inc.

Right. And just a follow-up Western Bit, how does that factor into that equation and kind of export outlook for Western Bit near-term?

Gregory H. Boyce

Well, all of the export coal, whether it’s Eastern and Western by two minutes and whether it’s Illinois Basin are really going to be dependent on what happens in the seaborne thermal markets. and while we see demand continuing to grow, we need to see some of that excess supply continue to work itself off and our demand outpaces before we see a significant increase in exports out of the U.S., in fact our view is obviously exports are falling this year and we’ll be under pressure for a while.

Brandon Blossman – Tudor Pickering Holt & Co. Securities, Inc.

Thank you very much, Greg.

Operator

Our next question is from Meredith Bandy with BMO Capital Markets. Please go ahead.

Meredith H. Bandy – BMO Capital Markets

Hey, good morning. I was wondering, first of all, how much did North Goonyella impact cost this quarter and what sort of benefit might we see if you get through the full capacity by the end of next quarter?

Gregory H. Boyce

Yes, I’d say a little broader than North Goonyella specific. we guided – did a low-to-bit 70s on our cost and we’re within that range for this quarter and continue to expect to be for the rest of the year. What I would say is the overall impact of the underground operations, including the longwall move that we had at Wombo was probably $4 a ton in total, offset by improved productivity and cost reductions at the surface operations, particularly the PCI operations. So those are the two major moving parts.

Meredith H. Bandy – BMO Capital Markets

Okay, thanks. And then just as a follow-up. If you saw the Q2 pricing continue for sometime, would you – do you think that you would consider closing any net operations?

Michael C. Crews

Yes, Meredith, I mean obviously as you look at our history, we are active operations portfolio managers. I mean we’ve in the past reduced production in the Powder River Basin when it was necessary to do so and we’ve closed operations in the Illinois basin whether if you recall little lake in air quality and impact Australia we closed Wilkie Creek operations. So what we do is we look at our portfolio of operations and then I can guarantee you that this is taking place now is ongoing.

Our portfolio net operations we look at their competitiveness and then we go down to our process which says, okay, structurally can we move these operations lower on the cost curve so they can remain competitive as the market moves. And you've seen us do a lot of that the whole owner-operator conversions strategy was a strategy to drive us down as a cost curves. Then we look at efficiencies, we move into a next phase which is what we are actively moving into now, where we aggressively talk to all of our suppliers. We look at all of our efficiency activities, we look at our mind plans and we make those adjustments.

I would just say that at the end of the day we have you know we have of you that our operations have to make money and they have to be sustainable. So actively under review, obviously with the change in the net environment here in this last quarter we've we are having some pretty serious looks at a couple of operations. But our main focus in Australia right now is again our flagship met coal operations North Antelope Rochelle, I mean, North Goonyella up and running at normalized capacity. That will have the largest impact on our Australian platform.

Meredith H. Bandy – BMO Capital Markets

Okay, thank you very much.

Operator

And next go to David Gagliano with Barclays. Please go ahead.

David Gagliano – Barclays Capital, Inc.

Hi, thanks for my taking my question. It’s actually related to Meredith's question with regards to the Australia operations. Obviously, we had pricing for Q2 coming lower than Q1 and just got the results here that show pretty lean operating margins already in Australia so my question is, how long does it take for the decisions to be made to shut in the next best maybe not shut in and out right but perhaps to the production and should we expect that perhaps next quarter if we have a similar pricing environment?

Gregory H. Boyce

Sure, as I say I think our history has shown that we don’t take a long time to make those decisions, once we gone through the analysis, I mean the last thing we want to do is to pretty maturely close something that’s structurally can be changed, I mean, North Goonyella as we go through the start up obviously was a significant impact in the first quarter and getting that up and running will make a very large difference in the performance of the platform. We’ve got a couple of better operations that right now are getting significant scrutiny because of this lower price horizon they're much more challenge. And part of our decision process is what can we do to further improve their cost are operating performance and/or what's our view as to what the next quarter and the subsequent quarter price horizons might be. And once we go through that analysis, we make very quick decisions and we move very quickly all I can say is we are in that analytical mode as we speak.

David Gagliano – Barclays Capital, Inc.

And add a 120 benchmark if that's where we are for now for a little while here, how much of that $16 million tons to $17 million tons of targeted net volume how much of that is actually generate the positive operating profit as it's reported in or as is classified similarly to the reported results each other?

Gregory H. Boyce

While, Dave, I mean, I don’t want to go into the details or give specific percentages. First of all, I would say, I think we all recognized just in the last two weeks fairly a large number of met coal operations that are being shuttered at these prices. So, our view is, we’re finally seeing that tipping point, where people that have been reluctant that are at a higher part of the cost curves and maybe, some of our high cost operations are starting to make those changes. But suffice it to say that, if you factored in a healthy North Goonyella in the first quarter and you factored in taking out some of these port issues that caused a bit of – we would have had enough cushion in the first quarter to absorb some of the price impacts for the second quarter.

So, don’t take the Australian platforms performance in the first quarter and say, you got to take the price completely off of that to really see what’s there. But I would just say we recognized that there has been a downward price movement. We are actively looking at their portfolio in Australia as we look at all of our portfolio, and we’ll make the right decision as we have in the past based on the final analysis of the competitiveness of the individual operations.

David Gagliano – Barclays Capital, Inc.

Okay, perfect. Thank you.

Operator

Our next question is from Paul Forward with Stifel. Please go ahead.

Paul S. Forward – Stifel, Nicolaus & Co., Inc.

Thanks. You had a – the CapEx number was all the way down at $24 million in the quarter and obviously, your guidance is suggesting that that number will be higher, the run rate will be higher in the other quarters. Just wondering, considering that you have the projects still ongoing North Goonyella and Gateway and Metropolitan. How did you keep that number so low in the quarter and what changes between the first quarter and the rest of the year?

Gregory H. Boyce

Sure. I think and we’ve had a lot of internal discussion around that, because it is quite a low number, particularly compared to recent history. And it’s a – there are no single items that are really sticking out in terms of timing. There is certainly timing of spending here. But this is really the business unit presidents on down taking a very concerted look at every dollar of spend. So it’s a lot of small items in terms of replacement capital that’s been deferred or reduced which has allowed us to bring our targets down for the year. We would have ongoing land sale or land purchases that we do to support the operations and that's a systematic process every year that we undertake that we look at what our needs are re-scrutinize, re-prioritize, and re-time. So it’s a lot of that just blocking and tackling looking at every dollar spend and cutting and differing where we can.

Michael C. Crews

And the other thing Paul, sometimes, it’s just merely timing is how the dollars get spent during the course of the year, because it’s a bit a number of things that typically you do in the first quarter, you do a lot of planning around engineering and finalizing, and then you get into project execution in the back three quarters and as we start spending the money. So you wouldn’t want to take one quarter and multiply it by four for the year.

Now, the lower quarter did allow us to take, as Mike said, a much deeper look and be able to revise downward the entire year. But that’s why you still see in the last three quarters of the year higher spending on a quarterly basis than what we had in the first quarter.

Paul S. Forward – Stifel, Nicolaus & Co., Inc.

Okay, thanks. And just as a follow-up on the same – onto those projects wanted to get your current views on Metropolitan and North Goonyella/Eaglefield, Metropolitan last year did 1.5 million tons, North Goonyella/Eaglefield did 2.3, once you've got the new longwall is operating as designed. What’s your current view on if you could, I don’t know, if you want to provide the detail on how much incremental production will be coming from those mines relative to they – what they did last year?

Gregory H. Boyce

Sure, Paul, in the case of North Goonyella you will remember that we noted that with the additional recovery that we would get from the top coal caving system that we would expect probably an additional half million to million tons on an annualized rate coming from that operation. Now for Metropolitan, this is really primarily a change out of the longwall is the conventional longwall you will recall, and so we would expect roughly stable production to come from that operation.

Paul Forward – Stifel, Nicolaus & Co. Inc.

Okay, that’s all. Thanks.

Operator

Our next question is from Curt Woodworth with Nomura. Please go ahead.

Curt Woodworth – Nomura Equity Research

Hi, good morning.

Gregory H. Boyce

Good morning, Curt.

Curt Woodworth – Nomura Equity Research

Just a question on the seaborne thermal exposure given that’s been repriced down about $13 a ton. Can you give us a sense for how much of that business is repriced on that April 1 benchmark, and also remind us the discount that your ASP typically has up that number I think it's around 6% or 7%?

Michael C. Crews

Yes, I think when you look at the amount of our volume that are priced always the vast majority of our seaborne thermal business price is April 1. And that’s roughly in a ballpark around where our pricing comes out given our quality relative to the benchmark.

Curt Woodworth – Nomura Equity Research

Okay. And then just on the coal plant retirements for next year, I mean, obviously there is a lot of consumption this year plans that are going to retire in the next several years. How much do you think your gross exposure is your volumes into those exposed plans?

Gregory H. Boyce

Well, I guess, we don’t have volumes that are exposed to any specific plant closure. To the extent that those plant closures are – because as we said, most of our plant closures are going to be offset by higher utilization at other plants. So when you look at growth out of the PRB and the Illinois Basin that 100 million tons that we talk about, that’s actually – we actually have positive exposure to that growth, even though with some individual plants maybe closing.

Curt Woodworth – Nomura Equity Research

Okay. So you don’t have a number for that plant specifically that will close that new service?

Gregory H. Boyce

Well, to a certain degree it's a bit fungible. I mean to give you a number of plants that are closing, we would have to give you the offsetting number of all the plants that are going to increase then we also serve. So not sure I have at a specific breakdown for you between those two, suffice it to say net-net, we anticipate our volumes are going to be, because there is going to be growth in the PRB and there is going to be growth in the Illinois Basin.

Operator

Our next question is from Mitesh Thakkar with FBR. Please go ahead.

Mitesh Thakkar – Friedman Billings Ramsey & Co.

Good morning, everyone, and congratulations on the strong U.S. performance.

Gregory H. Boyce

Thank you.

Mitesh Thakkar – Friedman Billings Ramsey & Co.

My first question is, so when you look at the utility stockpiles of under 120 million tons for February, which I think is lower since 2006 with all the issues going on in the Northern PRB rails and stuff. What is the sense you are getting from utilities as to how should we think about normalized inventory levels and particularly heading into the summer?

Gregory H. Boyce

Well, if you start with heading into the summer, I can tell you that there is a significant concern about having adequate stockpiles going into the summer and it’s one of the reasons why we are seeing such a increase and request for proposals, particularly for the big Powder River Basin plants that are low in terms of day supply. So I expect to see, I think a lot of activity in terms of near-term business over the next couple of months as we go through the shoulder season and we get ready for the summer.

I think longer-term, I think one of the things is winter has shown – was the – and we don’t have the final answer yet. As I think there is a lot of utilities that are rethinking what is an adequate inventory level that they ought to carry. We had seen those inventory levels start to shrink in terms of their normal operating inventories. But I think we would have – people got caught this winter with the cold weather. I think we may see normalized inventories begin to creep back up again as these utilities go back to holding a bit of extra inventory for the swing periods.

The view that the system was – had delayed and responsiveness in it, we’ve talked a lot about that over the last number of calls, and we always indicated we didn’t think it was loaded with excess capacities people though, and I think this winter proved it very, very well. So longer-term net-net, I think normal inventory carries as the utilities will begin to rise.

Mitesh Thakkar – Friedman Billings Ramsey & Co.

Okay. And will the PRB issues prohibit utilities from building the inventories heading into the summer like, you might want to build inventories, but whether you can’t get the coal, what are you going to do?

Gregory H. Boyce

Well, obviously there is really, really a lot of discussions between the utilities and their railroad suppliers about making sure that they have adequate coverage to be able to run their coal plant this summer. And I know those discussions are ongoing. We are starting to see the whole system begin to open up in a bit better rail performance. We would expect now that the weather related impacts rail performance in the first quarter are hopefully behind us then we will start to see some good rail improvements, which will maintain at least adequate stocks for the utilities be able to run their plants which are in the summer load.

Mitesh Thakkar – Friedman Billings Ramsey & Co.

Okay, great. Thank you very much guys. I appreciate it.

Operator

Next we’ll go to Luke McFarlane with Macquarie. Please go ahead.

Luke McFarlane – Macquarie Equities Research

Hi, guy. I might have – I got off a little earlier, so I may have missed it. But did you guys know exactly what the top coal caving issues you're still dealing with North Goonyella. I mean it’s already you are making progress, but is there any risk of pushing into 3Q?

Gregory H. Boyce

Yes, Glad you got back on. No, we haven’t gone into it in detail. But as we talked at the end of the last call, where we were then was a significant number of equipment issues specifically related to the longwall itself. And we had a very extensive team between the vendor, between the manufacturer, between the local supplier, and our teams that are working through all of those components.

I mean, where we sit today we’ve made great progress on those as evidenced by our increased equipment operating times since our last call. But as we also indicated, once you’ve got the actual longwall itself up and running, then we had the rest of the coal extraction system out of the mine to debottleneck. And I would say, we are into a lot of those issues right now in terms of, the conveying systems and the coal clearing systems. We’ve got some engineering fixes the modern rail is probably the last big fix, that’s going to take sometime, the engineering fixes design, and that will be sorted out during the quarter. so it’s a combination of getting the operations to not be able to drive this significant piece of machinery and get the most out of it, as well as debottlenecking the coal takeaway system. And as we look at where we’re at today and through the end of the quarter, we’re expecting to be at normalized levels by the end of second quarter.

Luke McFarlane – Macquarie Equities Research

thanks. And then my second question, as we look out into 2015 in the PRB, I mean how do you expect to go into your contracting, you’re just going to do it as it comes or is it a matter of actually holding out for some of these higher prices to actually start up on to realization?

Gregory H. Boyce

Well, as you – as everyone knows, we’re at 40% to 50% hoping based on this year’s production rates. We haven’t been contracting much this quarter. The normal heavy contracting season would not have started yet. Right now, a focus on midsummer season and then once we get into the summer, they begin to look at 2015 and beyond. So it’s – suffice it to say, we see continued strengthening in market and our contracting timing and philosophy will be standing around capturing the value of that increasing market.

Luke McFarlane – Macquarie Equities Research

Thanks.

Operator

Next we’ll go to Caleb Dorfman with Simmons & Company. Please go ahead.

Caleb M. J. Dorfman – Simmons & Co. International

…taking the question, Greg you discussed a lot about the improvement dynamics that domestic coal market. Can you talk about how Peabody is going to respond to this, will you increase or do you have the capability increasing production in the Midwest, how do you think about ramping up or getting the PRB ready to ramp up before the pricing has really started to move up?

Gregory H. Boyce

Well. A couple of things, I mean if you look at our platform, whether it's in the Powder River Basin or in the Midwest, we do have certain amount of incremental capacity that would be related to for instance, working over time in the Powder River Basin or adding a working day in the Midwest, North Antelope Rochelle would continue to be our biggest focus in the Powder River basin, given the productivity in the margins that we get there in the quality of the coal and in the Midwest, we’ve got a number of operations that we could, we could provide some increase.

At the end of the day, you’ve – if you’re going to have to have significant increases in volume, it’s going to take a bit of operating equipment in order to do that. Right now, the timeframe for some of that equipment are at the low-end of the historical ranges, because there hasn’t been a lot bought. So there will be opportunities to capture the upside, but in terms of any major large amounts of volumes, they’re going to be limited for a period of time until capital is actually spent. so we’re going to have to see price – a nice price horizon for a longer period of time before people I think really start committing major capital. So net-net, maybe you get a 5% or 10% increase in volumes over the next year to 18 months without significant capital. beyond that, you’re going to have to get additional trucks and loading capacity in order to move larger volumes of coal.

Caleb M. J. Dorfman – Simmons & Co. International

That’s really helpful. So when you’re thinking of that increased capacity, do you think the prices that we’re seeing in the curve for the PRB are sufficient or do we need to see prices go back to the late 2011 level?

Gregory H. Boyce

Well, I think what – I think what we need to see is, some more strengthening, as well as some more longevity in terms of seeing that strength in the market. I’d be very surprised, if a short-term blip; people are going to see it more than just a short-term blip before they commit major capital for expansion.

Caleb M. J. Dorfman – Simmons & Co. International

Thank you.

Operator

And we’ll go to Evan Kurtz with Morgan Stanley. Please go ahead.

Evan L. Kurtz – Morgan Stanley & Co. Inc.

Hi, good morning guys.

Gregory H. Boyce

Good morning, Evan.

Evan L. Kurtz – Morgan Stanley & Co. Inc.

So I had just a question on Australian met. I was wondering, I know that seaborne thermal market hasn’t been particularly fantastic this year, but do you have an opportunity to take some of your met production bypass the last plant sales into the thermal market particularly for some of those lower grades?

Gregory H. Boyce

We have a limited amount of cross over coal, because of our operating platform. I mean when you look at our met coal operations, North Goonyella, Metropolitan and the like; they have very little opportunity for crossover coals. Our PCI coals are kind of in a similar vein. In our New South Wales longwall operations, we’ve got some opportunity to there and we take that opportunity when we can. So unlike a few others, we don’t have – it's the semisoft world that kind of moves back and forth between thermal, and met coal and we’re not, a major large component semi soft producer.

Evan L. Kurtz – Morgan Stanley & Co. Inc.

Got it, thanks. And just one question on the revenue outlook for U.S. and I noticed you bumped a range up a little bit from last time. Is that surely because of an improving pricing outlook or is that of a little bit of mix in there as well?

Gregory H. Boyce

Yes. so what we did, we had a – in the last quarter, we had projected a decline – year-over-over decline of 5% to 8% that improved, it’s now at 4% to 7%. So while it’s a decline, it's a lower decline. It’s a combination of two things, improving PRB fundamentals and then also the finalizations of pricing associated with the Western coal supply agreement.

Evan L. Kurtz – Morgan Stanley & Co. Inc.

Got it, thanks guys.

Gregory H. Boyce

You’re welcome.

Operator

And we’ll go to Dave Katz with JPMorgan. Please go ahead.

Dave A. Katz – JPMorgan Securities LLC

Good morning. Thank you for taking my call. I was hoping to dive down at where is the last call, question there was about that I was showing in met, I was hoping to dive down into the thermal. Would you guys be able to at all break down that and obviously, provide the volume mix, could you break down the revenue per ton of the thermal just on an overall basis?

Gregory H. Boyce

On the seaborne basis, we don’t split out the thermal versus the met on the byproduct. Now historically, we give some of those breakouts, so within Mike’s remarks in terms of volume. Yes, our average price on our metallurgical coal in the quarter was $107 per short ton and on the seaborne thermal coal was $75 per short ton.

Dave A. Katz – JPMorgan Securities LLC

Okay. And how do you expect that to trend, given the pricing trends that you’re seeing specifically for the thermal over the next quarter or two?

Gregory H. Boyce

Certainly, you’ve got just a bit of price pressure that’s coming with the new recent annualized contract pricing there. and obviously, we’ll wait to see over time what occurs with the near-term business, the spot business, because there is some of that goes out – that goes out of the market as well, mix can also affect that. You’ll see us have a higher mix of metallurgical coal as we did into the last three quarters of the year with some of the challenges that we have in the first quarter with North Goonyella.

Dave A. Katz – JPMorgan Securities LLC

Okay. And on CapEx, you had $24 million in the first quarter, you’ve said obviously some of that was timing and should move up to, I guess around the $80 million level per quarter over the back half or the back three quarters of the year. Looking out beyond 2014, given that some of what occurred in the first quarter was due to deferrals. What do you think a more normalized level in this sort of environment would be?

Michael C. Crews

Well, if you look at our full-year guidance of $250 million to $295 million, we think we can hold our CapEx spending levels in total in that range over the next few years, certainly through the periods in which we complete the LBA payments, which is at the end of 2016. And that largely reflects the investments that we’ve made over the past few years in the portfolio. So what we’re doing is we’ve made those investments, we capitalized the portfolio whether it’s owner-operator conversions in Australia, the dozens we’ve made in Bear Run, continued improvement in the Powder River Basin, the El Segundo lines that the platforms there is capitalized and for us it’s about leveraging the investments we’ve made over the past few years, which drive those lower targets over the next, say, three years.

Dave A. Katz – JPMorgan Securities LLC

Excellent. Thank you.

Michael C. Crews

You’re welcome.

Operator

And we’ll go to Lucas Pipes of Brean Capital. Please go ahead.

Lucas N. Pipes – Brean Capital LLC

Hey, guys. Good morning, everybody.

Gregory H. Boyce

Good morning, Lucas.

Lucas N. Pipes – Brean Capital LLC

I wanted to circle back to your met platform down in Australia and I was just kind of curious if you had a sense on where it stands and what quartile it spends on the cost curve in Australia relative to peers?

Gregory H. Boyce

Well, I think everybody’s platform has got some on the lower quartile and some that are not on the lower quartile, and we’ve got some very competitive operations in Australia. And as we talked earlier, we’ve got a couple of challenged or higher cost operations that we’re looking at, given the current market conditions, obviously getting North Goonyella, the new system up and running, and up and running at normalized rate is a key component of moving that operation down the cost curve and overall, lowering our Australian met coal cost curve.

The operations that we picked up from the former Macarthur, our PCI operations, we’ve been hugely successful in moving those down the cost curve into some of the low – into the lower quartile, given the improvements and the productivities and the volumes that we’ve been able to achieve since we took over those operations.

So the new longwall at Metropolitan, it’s a conventional longwall, but it’s a significant improvement in terms of size and capacity and technology or operating capabilities from the existing longwall. So, again, all designed to move those operations further down the cost curve.

Lucas N. Pipes – Brean Capital LLC

I appreciate that. And earlier in the call, you discussed some of the parameters around your production profile in Australia, and wondered if you could also take a few moments maybe to elaborate on take-or-pay commitments or so on the rail side. So, costs that you would incur by not operating?

Gregory H. Boyce

Well, of course, that’s one of the factors that we look at when we analyze the portfolio. I mean, I would you say that all of our costs are embedded in our financials, out of Australia as they stand today. The take-or-pay whether Israel or poor commitments, our commitments that can be traded and transferred. And we’re an active portfolio manager of our rail and port capacity to try and match that to our operating capacity at any point in time.

So, we’re not really in a position to say exactly what our unused capacity is because it’s an area where we’re active participants in our marketplace down there. But suffice it to say that we are managing very aggressively, we continue to bring those costs down and as we look at what’s embedded in our second quarter guidance and our cost guidance for Australia for the year, we’ve incorporated all those in that guidance.

Lucas N. Pipes – Brean Capital LLC

I appreciate that. Good luck.

Operator

My next question is from Lance Ettus with Tuohy Brothers. Please go ahead.

Lance Rory Ettus – Tuohy Brothers Investment Research, Inc.

Hi, guys you’ve said you went to the steps of how you evaluate the portfolio and how you look about it. You said the current step I guess is you’re kind of looking at suppliers as best part of that process. Are you looking as far as giving a better pricing from suppliers seems to me that some of the suppliers are still doing pretty well even with met coal 120?

Michael C. Crews

Oh, yeah an active part of our program is going back and having conversations with all of our partners, in terms of the value proposition around these operations. So with supply chain, it’s going back and talking to all of our commodity and parts suppliers and the like. It’s our service to suppliers, our contractors, so it’s an across-the-board look and everything that we never doing, as well as our true full internal suite of cost structure as well. So, it’s not fully a supply chain, but that’s a major component of our cost structure. Is not only company without consumables, but it’s also services as well.

Lance Rory Ettus – Tuohy Brothers Investment Research, Inc.

And do you think these are bearing fruit so far, do you expect it to – can you give us an order of magnitude on how much of a discount you think you can get or what’s going on up there for the industry?

Michael C. Crews

Well, if I could just say it has been bearing fruit. We think we’ve got more opportunity and the Australian team particularly is moving into what we call the next days of all these discussions. But I think it wouldn’t be prudent to give any specific target levels as we go into those commercial discussions.

Operator

Our next question is from (indiscernible) with UBS. Please go ahead.

Unidentified Analyst

Hi, good morning folks.

Gregory H. Boyce

Good morning.

Unidentified Analyst

I guess just on the met coal again with the decline that we’re seeing in the benchmark here is all that impacting the second quarter or is some of that flow through into the third quarter as well?

Gregory H. Boyce

Did you say the closing to which quarter I’m sorry I didn’t hear that.

Unidentified Analyst

It is second quarter and the third quarter?

Gregory H. Boyce

Yes, I mean in any given quarter we typically have 20% to 30% of our volume is going to have a carryover price. So there should be some spill over into the next quarter.

Unidentified Analyst

Gotcha. And then just as a follow-up on the free cash flow side. Obviously your CapEx guidance there is LBA payments this year, there could be a bit of a gap there between your operating cash flows and what those outflows would look like. I guess what’s your degree of comfort with correct level of cash cushion I guess about 500 million and what other sources of funding would you look to first?

Michael C. Crews

Sure, great question. We did a positive operating cash flow in the first quarter. We continue to drive down capital spending, you referred some of the major fixed charges, I guess what I would – I think you hit on some of the key levers there. But also, we have some expectations for improvement in the second half, we’ve increased in met coal volumes. You’ve seen stronger performance out of the U.S. platform. We do have good cash on hand. We increased our cash over $500 million in the quarter. We have $2.1 billion of liquidity and that long with any proceeds from asset sales and I referenced the numbers that we have in the last 12 months in terms of asset sale proceeds. So all of those factors we think will allow us to be able to manage any near-term issues.

Unidentified Analyst

Great. Good luck.

Michael C. Crews

Thank you.

Operator

Our final question will come from the line of Michael Dudas with Sterne, Agee. Please go ahead.

Michael Dudas – Sterne, Agee & Leach Inc.

Gentlemen, you’ve been doing very good with the answers today, I’m also with questions. Have a good day. Thank you.

Gregory H. Boyce

Thank you, Michael.

Michael C. Crews

Thank you, Michael.

Operator

Turn it back to you Mr. Boyce for any closing comments.

Gregory H. Boyce

Well, thank you operator. I’m glad we are able to answer that last question so quickly. I want to thank everybody on the call today and – but I also want to thank the entire Peabody team for their focus on safe productive operations and the continued cost in capital management that we see throughout our platform.

As we say, Peabody has got a leading presence in the key growth regions in Australia, the PRB, in Illinois Basin and that will continue to allow us to supply the strongest markets in the markets within most growth potential. We are going to continue to aggressively manage our cost in our capital in order to deliver shareholder value, appreciate your interest in BTU, and we look forward to keeping you apprised of our progress. Thank you all.

Operator

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

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