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International Coal Group, Inc. (NYSE:ICO)

Q1 2011 Earnings Call

April 28, 2011 11:00 am ET

Executives

Roger L. Nicholson – Senior Vice President, Secretary and General Counsel

Bennett K. Hatfield – President, Chief Executive Officer and Director

Bradley W. Harris – Senior Vice President, Chief Financial Officer and Treasurer

Analysts

Michael Dudas – Jeffries & Company

Brian Gamble – Simmons & Company

Shneur Gershuni – UBS

Brett Levy – Jeffries & Company

David Katz – J.P. Morgan

Jeremy Sussman – Brean Murray

Mark Levin – BB&T Capital Markets

Jamie Melzer – Bank of America/Merrill Lynch

David Beard – IBS

Operator

Good day, ladies and gentlemen, and welcome to the First Quarter 2011 International Coal Group Incorporated Earnings Conference Call. My name is Francine and I am your operator for today. At this time all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. (Operator Instructions)

I would now like to turn the presentation over to your host for today’s call, Mr. Roger Nicholson, Senior Vice President, Secretary and General Counsel. Sir, you may proceed.

Roger L. Nicholson

Thank you. Welcome to International Coal Group’s first quarter 2011 earnings conference call. I’m Roger Nicholson, Senior Vice President, Secretary and General Counsel of ICG. We released our earnings report yesterday after the market closed.

With me on the call today are Ben Hatfield, President and CEO of International Coal Group; Brad Harris, Senior Vice President, CFO and Treasurer; Mike Hardesty, Senior Vice President, Sales and Marketing and Ross Mazza, Director of Financial Reporting and Investor Relations.

Before we get started, please let me remind you that various remarks we may make on this call concerning future expectations, plans and prospects for the company constitute forward-looking statements for purposes of the Safe Harbor provisions under the Private Securities Litigation Reform Act of 1995.

These statements are made on the basis of management’s views and assumptions regarding feature events and business performance as of the time the statements were made. Because these forward-looking statements are subject to various risks and uncertainties, actual results may differ materially from those implied.

Factors that could cause actual results to differ materially are contained in our filings from time to time with the Securities and Exchange Commission and are also contained in our press release dated April 27, 2011.

Non-GAAP financial measures will also be discussed. You will find a reconciliation of the differences between the non-GAAP financial measures and the most directly comparable GAAP financial measures at the end of our press release, a copy of which has been posted on our website.

At this time I’d like to turn the call over to Ben Hatfield for his opening remarks.

Bennett K. Hatfield

Thank you for joining us this morning. Increasing metallurgical coal production and steady operating performance at virtually all of our business units provided strong first quarter results. Despite weather related production challenges at Vindex unscheduled contract customer outages at ICG Illinois and erratic rail service that delayed shipments at several operations, we were able to expand metallurgical sales and achieve record per ton margins.

Improving demand for coking coal has lead to remarkably strong metallurgical pricing, a trend that we anticipate will continue into 2012. Although we expect the thermal market to strengthen in the second half of this year, low natural gas prices will likely continue to suppress coal-fired electricity output through mid-year.

At this time, I’d like to turn the call over to Brad Harris, our Chief Financial Officer.

Bradley W. Harris

Thanks Ben. For the first quarter of 2011, we reported total revenues of $302 million including $283.7 million attributable to coal sales of 3.9 million tons. First quarter 2010 revenues totalled $288.6 million, of which $270.5 million was attributable to coal sales of 4.3 million tons.

Adjusted EBITDA for the first quarter of 2011 was $65.1 million, which represents a 39% increase over the $46.9 million of adjusted EBITDA reported in the same period of 2010.

Net income for the first quarter of 2011 was $22 million or $0.10 per share on a diluted basis, compared to a net loss of $8.9 million or $0.05 per share on a diluted basis during the first quarter of 2010.

Net loss for the first quarter of 2010 included a $22 million pre-tax loss on extinguishment of debt related to the company’s capital restructuring. Excluding this loss, first quarter 2010 net income would have been $6.2 million or $0.03 per share on diluted basis.

Average coal sales revenue per ton for the first quarter was $73.67 compared to $62.57 for the comparable period in 2010, while cost per ton sold was $56.60 versus $50.90 for the same period in 2010. Cost per ton for the first quarter of 2011 was adversely impacted by rising diesel fuel prices and continuing regulatory issues that hampered production.

Also contributing to the increase in cost per ton over the prior year was our expanded metallurgical production, as these reserves are generally more expensive to mine than thermal serves.

Margin per ton increased by 46% to $17.07 for the quarter compared to $11.67 per ton for the first quarter of 2010, primarily due to higher price realization on increased metallurgical sales. Metallurgical shipments of 718,000 tons during the quarter represented a 53% increase versus the first quarter of 2010.

Depreciation, depletion and amortization expense totaled $25.7 million for the first quarter compared to $26.4 million for the same quarter last year. Corporate SG&A for the first quarter was $11.2 million compared to $8.6 million for the same period in 2010, primarily due to increased labor and legal cost and a reserve for potential bad debt.

Gain on the sale of assets totaled $6.7 million in the current quarter compared to $3.5 million in the same period of 2010. The current quarter included a $6.5 million gain related to the sale of an idle drag mine previously used at our ICG Eastern’s Birch River mine.

Our effective income tax rate for the quarter of 30% reflects the benefit of excess depletion. As of March 31, 2011 we had $186.6 million in cash and $39.2 million available in borrowing capacity under our credit facility.

At quarter end debt outstanding was $333.6 million, net of a $32.3 million discount, consisting primarily of $115 million aggregate principal amount of our 4% convertible notes and $200 million aggregate principal amount of our 9.125% senior notes.

On March 31, 2011 we announced that $115 million of our 4% convertible notes and $731,000 of our 9% convertible senior notes became convertible at the auction of the holders beginning April 1, 2011. Although the convertible notes are now classified as a current liability, we do not believe that a significant number of conversions are likely at this time and to-date have not received any notices to exercise. We do not expect the triggering of these conversion rates to have a material affect on our financial position.

Our total assets were $1.5 billion as of March 31, 2011, compared to $1.6 billion a year ago. Capital expenditures for the first quarter totaled $41.2 million.

At this time, I’ll turn the call back over to Ben.

Bennett K. Hatfield

Thank you, Brad. Now I would like to provide an update on key developments in the first quarter. Construction at the new Tygart Valley No. 1 deep mine complex is proceeding on schedule. Excavation of slope portal and two ventilation (inaudible) is ongoing and progressing as planned.

Foundation construction for the state-of-the-art coal preparation facility is also underway with steel erection expected to begin in June 2011.

Initial coal production is projected for late fourth quarter of this year. At full output, currently projected for early 2014, Tygart Valley No. 1 is expected to produce approximately 3.5 million tons per year. Although topping 2011 met tonnage guidance has not changed, the lower end has been adjusted upward as we have resumed limited processing of the (inaudible) resource at our Beckley complex. We expect to complete a $2 million coal handling system expansion during the third quarter in order to allow increased sales of this low volatile metallurgical product.

The company continues to wait a ruling from the trial court and the lawsuit with Allegheny Energy concerning the coal supply agreement serviced by the Sycamore No. 2 mine. While the ruling was expected in mid-March, the timing of the ruling is within the judge’s discretion. The company anticipates receiving the court’s ruling in the near future and will promptly disclose the ruling upon its entry.

Turning now to our current guidance. For 2011, coal production and sales are expected to be between 16.1 million tons and 16.5 million tons, including 3.2 million tons to 3.5 million tons of metallurgical coal. The average selling price is projected to be between $76 per ton and $79 per ton, with an average cost ranging from $56.50 per ton to $58.50 per ton excluding selling, general and administrative expenses.

Committed and price sales for 2011 totaled approximately 13.9 million tons or 85% of planned shipments, at an average price of $75.75 per ton. Unpriced tonnage includes approximately 1.8 million tons of thermal coal and 600,000 tons of metallurgical coal.

Adjusted EBITDA for 2011 is now expected to be in the range of $290 million to $320 million. Capital expenditures for 2011 are expected to be between $225 million and $245 million, including approximately $145 million related to development projects, primarily at our Tygart Valley No.1, Illinois and Vindex operations.

We expect to fund all of our 2011 CapEx with cash flow from operations. We project our 2011 effective tax rate to be approximately 30%.

Now shifting to 2012 guidance, coal production and sales are expected to be in a range of 16.5 million tons to 17.5 million tons, including 3.3 million tons to 3.7 million tons of metallurgical coal. The average selling price is projected to be between $83 and $89 per ton.

Committed and price sales for 2012 totaled approximately 4.2 million tons or 25% of planned shipments at an average price of $60 per ton. Unpriced tonnage includes approximately 9.6 million tons of thermal coal and 3.2 million tons of metallurgical coal. Most of the 2012 committed sales consist of lower priced Illinois Basin and Northern Appalachian legacy contracts.

At this time, I’ll open the call to your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from the line of Michael Dudas from Jeffries & Company

Michael Dudas – Jeffries & Company

Good morning, gentlemen.

Bennett K. Hatfield

Good mooring, Michael.

Michael Dudas – Jeffries & Company

Maybe this one for Mike. Maybe talk about strategies you have seen. You have a little bit larger thermal coal exposure to get a price in ‘11 and quite a bit in 2012. Comment on your strategy, what you’re hearing from the utilities and certainly from the conference calls and what we’ve been reading in the trade press? The export market is the story of the year and maybe of the next decade. How is that playing into one, how International Coal has been a so coal internationally? And two, how it’s playing through negotiations with the utility customers?

Phillip Michael Hardesty

Okay. Let me try to address the first part on 2011. We do have a fair amount uncommitted. We sold about 250,000 during the first quarter into the export market. I would like to do more, but frankly space, as you probably heard on a lot of the calls, is a restriction right now. I don’t think that we’ll be able to maintain that pace. We have proven and we will continue to prove that if the market prices are not there on our domestics, we will actually back production where we need to. And so, I feel comfortable. We’ll be able to manage through this position and actually I’m very optimistic once we get out of this stronger period that we’re in right now, that I think you’re going to see prompt prices domestically move up fairly substantially. What you are seeing is during times of normal weather patterns coal prices are at very attractive levels, but when you enter the shoulder periods where gas starts to cannibalize the coal market, then you see the coal demand fall off. I would predict that mid-summer we are going to see current coal prices back in high 70s to low 80s.

As far as 2012, we made a conscious decision during most of last year, not to forward contract at the prices that were prevalent at the time. And I think if you look at the forward curves I think we’ve been – as they were maintain, we will be rewarded handsomely for that strategy.

Michael Dudas – Jeffries & Company

And, Mike, maybe your thoughts on the metallurgical customers, your mix, domestic versus international and length of contract relative to what we’re seeing in the marketplace on a prom to quarterly basis, how young committed coals may turnout for you as you’re pricing based under quality specs?

Phillip Michael Hardesty

Today I think we will maintain a mix. We’re not going to abandon annual contracts for a company as ours. It’s just too important to have certainty of production outlets and revenue. So you’re going to see us maintain a very large position on annual contracts and also we’re going to focus more on the domestic side. We’ve been very pleased with our domestic execution on statements compared to some of the issues we are seeing on the export side. As far as the pricing environment, we are still seeing strong demand from both domestic and international. So we are very confident that based on today’s economy and the hopes that’s going to grow even more than that we’re going to receive even better prices going forward.

Michael Dudas – Jeffries & Company

Ben, certainly there is a lot of news in the coalfield over the past few months. Maybe you can assess how you will get at the central operating environment relative to regulatory issues, relative to the labor pool, how heated up do you think things will get as we move forward and maybe in early (inaudible) potential disruptions from UMWA negotiations for the vicious contract?

Bennett K. Hatfield

I think (inaudible). This is going to be a pretty interesting year and certainly we’ve I think not seen a period in recent years where there’s more in 10 years in motivation toward the consolidation. You heard me comment previously about the risk of scale. The risk of scale in the coal industry particularly in Central Appalachia has just become more substantial than I’ve ever seen it. The risk associated with an adverse EPA decision or an adverse (inaudible) conflict of some sort makes demand on the pattern of violations, but you’re at greater risk if you’re a smaller sized company. And as I said before, I think that’s likely to create a lot of interest in M&A and consolidation over the course of this year. I think at the forefront probably the smaller independent operators but I think you can do see some serious discussion among more substantial players as well. So, certainly the climate is one where it’s likely to be a year of substantial discussions on consolidation.

And from the standpoint of supplier, as we look toward the end of the year, certainly there is going to be a growing concern about the risk of supply disruption due to the UMWA contract negations. They have some really tough issues to deal with. First and foremost obviously the huger burden is associated with maintaining and funding the retiree healthcare obligations that just becomes such a huge number. It is going to be a tough issue to resolve.

So, I think that certainly puts an air of uncertainty with respect to supply risk and disruption and predictability if you will over the course of this year. So all that is to say I think it is going to be a pretty interesting year and you could see a lot of activity and I think it’s probably leading more and more utilities to look toward contracting earlier versus later. If I were in that position certainly I would be thinking in those terms, and indeed I think Mike would confirm that over the last few months we are seeing a significant step up in solicitation activity among the utilities. So I think it is going to bore well for the companies that are well positioned and non-unit companies that are somewhat will take advantage certainly in that climate.

Michael Dudas – Jeffries & Company

Like yours.

Bennett K. Hatfield

Yes like ICG.

Michael Dudas – Jeffries & Company

Of course, one final thing for Brad, in your prepared remarks you did mention cash flow from operations is expected to cover CapEx need this year. Is that a change from last quarter or have you moved the numbers a little bit or is it still you are still very comfortable with those thoughts. Or could we see more little bit excess cash.

Bradley W. Harris

Still very comfortable, that comment is consistent. We have always said for 2011 and going forward that we would be able to cover our CapEx through operating cash flow. We did anticipate that I think mid-year here we will see the cash on hand balance decreased just a marginal amount a little bit, but then it should be back up to its levels we had experienced here the last couple of quarter by year-end.

Michael Dudas – Jeffries & Company

Appreciate your thoughts gentlemen. Thank you.

Bennett K. Hatfield

Thank you.

Operator

Our next question comes from the line of Brian Gamble from Simmons & Company.

Brian Gamble – Simmons & Company

Good morning, guys.

Bennett K. Hatfield

Good morning, Brian.

Brian Gamble – Simmons & Company

Couple of things, just to follow on Mike’s questions first I guess when you look at the (inaudible) in that regions and you think about what opportunities are out there for consolidation. What do you think are the most likely types of consolidation? You mentioned the risk of size, I’m guessing you don’t think it’s big anymore, do you think it’s more of a bolt-on you guys are looking for or how do you assess both from what you guys want to do and then how you think the overall market views are based by and large?

Bennett K. Hatfield

I think you could see activity in different tiers, obviously as you proceed through the course of the year and we get a better feel for what regulatory issues are going to pop up, but certainly the early focus in my view is likely to be the bolt-on type acquisitions and you’ll see that kind of opportunity being pursued by large coal companies and small coal companies, because frankly it’s a cheap add-on. You add on production capacity without having to substantially expand your infrastructure and in many cases how you are going to expand your management requirements.

So it’s an improvement in efficiencies so to speak on a regional basis that I think creates value and it’s likely to be the first level of activity that you see. Beyond that, I would speculate that you’re going to see some companies interested in the security of market diversity. It’s our single basement focus they’re going to lift attractive opportunities to be in more than one base. And of course that brings with it some benefits not only of market diversity but also labor diversity with labor certainly being a constraint in Central Appalachia on any efforts to grow. So there are I think various motivating factors, but you’re likely to see that sort of activity move forward in stages.

Unidentified Analyst

It’s a little early, you did give a little color on ‘12 as far as what your current expectation for realization is, is there any way to try to quantify what that sort of increase in realizations and what you are seeing so far does to the cost number for 2012?

Bradley W. Harris

I mean the obvious math is the self-related component. For every dollar in price increase you have combination of royalty and severance tax cost that may take depending on the situation anywhere from $0.10 to $0.14 out of the dollar and it goes straight to the cost line, depending on whether you have own coal or leased coal and what states you are operating in from a severance tax standpoint. Certainly $0.12 to $0.14 of that number flows to the cost line.

And generally speaking, as price goes up more and more companies tend to want to take advantage of it by reactivating idle production. So what you often see happening in the industry is that higher cost production gets brought into the marketplace and that raises the average cost because you are reactivating some production that’s been shut in during leaner times.

So I think generally speaking you’re going to continue to see the cost ramp up across the industry for a combination of those reasons as well as obvious commodity cost creep like diesel fuel for instance, and that certainly have been a big factor in the Appalachian region recently. That certainly hits charcoal producers much heavier than underground, but it affects tracking costs as well as production costs and that’s been one of the issues impacting our cost targets quarter-over-quarter. So there are different things in play, but I think that recaps the bulk of them.

Unidentified Analyst

Do you think that those factors, obviously you guys you have 11 tons as well next year. Do you think that causes your cost numbers to be impacted on par with where it was in 2011 and in your guidance are talking about your double-digit increases from last year just dollar per ton number, is that a fair way to look at it or do you think you could be possibly be better than that.

Bennett K. Hatfield

Well, again it’s all speculation at this point, but I would say the bigger factor looking at ‘9 to ‘10 versus ‘10, ‘10 to ‘11, and ‘12 is the shift in regulatory impact. With the UBB accident, that UBB explosion and other factors we’re seeing a huge step-up and enforcement by Mine Safety and Health Administration and that’s had a very substantial effect on dampening underground productivity, that’s probably one of the biggest factors grabbing up underground producers costs in that timeframe of 2009 and ’10.

I would not expect per se to see that component accelerating at the same rate as I look forward to ’12 because in many respects, I think the industry is kind of stepping up to the challenge if you will and investing money and investing additional resources and meeting the higher standard and I wouldn’t expect that ramp up to continue at the same pace.

And conversely on the surface mine and other things, I think surface mine costs are going to continue to push up for different reasons that comes back to the issue of no valid deals getting approved. And as surface mines become more and more material and they’ve used up the valley fields that are in close proximity for job. They have to hold material further and that’s going to have a dampening effect on their productivity. So surface mine costs could probably climb more steeply going forward than underground costs and but for the most part I think the industry has seen the steepest part of the curve on the underground side.

Unidentified Analyst

Excellent color Ben. Last question the purchase coal that was access for the quarter I know there were some older contract that we are rolling off. Is that the end of your plant purchases or what should we be thinking about moving forward.

Phillip Michael Hardesty

This is Mike. We’ll just approach purchase coal on an opportunistic basis. What we’re really been focused on right now is trying to fund some net coals to bring into some of our plans to capitalize on that. But I would not model in a big chunk of purchase coal, that’s not going to be our model going forward. But we will use it opportunistically where it makes sense.

Unidentified Analyst

Thanks Mike. I appreciate it.

Operator

Our next question comes from the line of Shneur Gershuni.

Shneur Gershuni – UBS

Hi, good morning, guys.

Bennett K. Hatfield

Good morning.

Unidentified Analyst

Just a couple of quick questions. In the past you’ve talked about 200,00 to 400,000 incremental tons, some of them crossover quality, some out of equity and so forth. The market kind of remains strong in that market right now, I know it’s at the bottom end of your guidance but you can take up the top end. Is it space is the issue that’s keeping you from taking that number up further still evaluating. I was wondering if you can just sort of give us some color with respect to those thoughts?

Bennett K. Hatfield

Well, to put a little more color on that we’re still moving forward with efforts to try to move those opportunities into production. And I think you’ve already seen a piece of it with our reactivation of the Eccles reprocessing operations at our Beckley complex for bringing new tons into the markets at attractive cost positions. And we expect to be able to step up that pace in the third quarter of this year with an expansion of raw material handling facilities spare that list, segregate the products from our normal underground production and market them more effectively. So we’re already moving in that direction.

One reason, Shneur, that you didn’t see us move up the guidance as much as we had a fairly unique set of circumstances with a couple of our crossover coals where we had a utility customer that essentially got in and needed some tons moved on a short notice and we were able to move some tons that otherwise would have been crossover. Two utility customer process that were essentially even with crossover met. These were essentially (inaudible) and we had an unique situation we were able to move on the order of 50, 000 to 70,000 tons in that direction. So otherwise you would have seen us push up the guidance close to another 100,000 tons but we’re still getting some of the revenue benefit from it. So there are different things going on there that are causing us to continue to be pretty cautious with the mid guidance.

We’re still not giving up on the other piece. There is a underground land development that we’re moving toward bringing into production over the next few quarters and it could indeed and still could be a step up in that fourth quarter timeframe of 2011, but until we see coal exposed and the opportunity to deliver we’re not ready to bump the guidance yet.

Unidentified Analyst

Okay, fair enough. And then I guess as a follow up to some of Mike’s and Bryan’s questions, you sort of – Charles, you gave some great color on the different phases that different companies may look to expand or acquire and so forth. In your conversations with the Board where do you feel ICG is at? Is bolt-on acquisitions still kind of the target for you? Are you pursuing some other opportunities? You mentioned other basins and so forth. I was wondering if you can expand on that color specific to ICG?

Charles G. Snavely

The marching orders I got from our Board of Directors is to continue to grow the company by the most effective means to do so. And as you know, it’s in our long-term plan to grow with organic projects, you know a key example being Beckley and say, we came into production in 2006, 2008 timeframes and now target moving forward to construction, total expected to come out the ground late this year.

Those are examples of our big organic growth plans that are coming to fruition and we have several other complexes of that nature that we also expect to move forward with, but the delays in permitting have been a substantial hindrance to moving forward at a rapid pace of any kind of organic growth plan, it is taking process far now to get a underground – process long now to get an underground mine complex permitted as it did as recent as two to three years ago.

So, in light of that we are focusing even more intensely on bolt-on acquisitions. There is an opportunity to potentially grow faster and just as effectively while we are keeping the plate spinning and bringing new mining complexes into position. We have four different mining complexes we are moving forward now. Doing drilling, permitting feasibility studies we have a lot of things that are moving forward in the queue, but for near-term benefits we have been asked to focus on both on acquisition opportunities and are expecting to continue doing so.

Unidentified Analyst

Okay and final question you’ve mentioned tightness of labor in Central Appalachian so forth. We saw this in 2007 production get cut, prices go up we saw this again recently. Do you think that you know, I recognize that there are some mines that are not operating at ideal capacity and could probably be brought up, but do you think that there is an opportunity for some supplier restrain to continue and no price for labor is going up why bother bringing it on line they just take the price. You know it’s not like gas prices are sitting at $6 or $7 it is currently at $4.5. Do you think that potentially, given the tightness of market maybe we will see some restrain continue on the production side or is just the whole export thing going to just drive production or begin as usual.

Unidentified Company Representative

I think the industry learns from lessons with our experience in 2008 where we had literally every coal company in the business trying to grow at an unprecedented pace, kept raising weight rates and essentially had not only no growth, but shrinkage of production because of the low productivity associated with turnover and the other obstacles, but I think that caused the industry to be quite a bit more disciplined with respect to growth plans and I think that you have seen that echoed probably in several conference calls over the last few quarters. We are being more cautious in boosting guidance. We are being cautious in how we lay out our ramp up plans because labor is certainly a constraining factor. So, I don’t expect us to go to what I see as a value disruption base that we saw in 2008. Where you see unprecedented wage inflation in those kinds of factors that drive turnover rates up to the 30%, 40%, 50% level.

I think we’ve learnt that lesson, but at the same time I think we’re also putting plans in place that mitigate that kind of behavior. I know across our company, we put radar-training programs in place at all of our major mines for essentially growing our own coal miners.

And in case of our Tygart project where we see a substantial need to staff over the next few years, we’re using three regional operations and essentially a garden, if you will, a feedstock to grow experienced miners, put in training so as we ramp up by adding sections of Tygart we will be positioned to do. So I suspect that many of our competitors are taking the same approach and trying to mitigate this sort of value disruption behavior we saw on labor competition in 2008.

Unidentified Analyst

Great. And thank you very much for your color. It’s a pleasure as always.

Bennett K. Hatfield

Thank you.

Operator

Our next question comes from the line of Brett Levy from Jeffries & Company.

Brett Levy – Jeffries & Company

Hi guys. You talked a lot about, a little bit about the whole idea that you could have a mine that gets into a mode where it starts to go down a path of getting a negative reputation with the regulators. Do you get the sense that there is an increasing amount of unevenness where firms with excellent safety reputations get less scrutiny, less good safety reputations get more scrutiny and that to some extent to be a driver of the M&A activity we see going forward?

Bennett K. Hatfield

Well, I can’t speak specifically on behalf of our partners at the Mine Safety and Health Administration, but I think it’s fair to say that they are going to generally discriminate in favor of good performance. If they see a company that is trying to do the rat thing, that’s reacting quickly to citation, that’s staffing up and adding resources that is needed to meet the standard, I think that that company is likely to certainly be treated somewhat more favorably than a company that’s not being responsive. I think that just stands to reason.

I don’t think there is any kind of official policy in place that does that, but I think it’s a normal human behavior that inspectors recognize a the company is trying to do the right thing and that company is generally going to perhaps has a benefit of some degree or tolerance to the extent at a lower level.

I think it certainly makes a difference, I think clearly that companies in an adverse position with regulators are likely to be those that become early candidates for consolidation, because I think once you get into that hole of being seen as unresponsive and you develop a bad violation history as we’ve seen from recent media accounts, it’s a tough hole to get out of and it certainly becomes motivation for an ownership change. So I think it is certainly a factor to kind of agree with your point but I don’t think there is per se an official policy. I just think it’s a likely outcome.

Unidentified Analyst

And then in terms of the 145 that you guys have got for development project, can you split it up between Tygart and Vindex?

Phillip Michael Hardesty

With respect to the 2011 CapEx?

Unidentified Analyst

Exactly.

Phillip Michael Hardesty

I believe that Tygart’s number is about $80 million and Brad you recall how much of that in Illinois I think Illinois is about a $25 million component. Those are the two big pieces that I recall, that $80 million is of Tygart this year and about $25 million I believe is Illinois with the new (inaudible). I mean there is another component associated with Vindex where we’re building out some of the large production.

Unidentified Analyst

And what’s the number there?

Phillip Michael Hardesty

I don’t recall the breakout.

Bennett K. Hatfield

It’s about $15 million or so.

Phillip Michael Hardesty

About $15 million in round number.

Unidentified Analyst

Thanks very much guys.

Phillip Michael Hardesty

You are welcome.

Operator

Our next question comes from the line of David Katz from J.P. Morgan.

David Katz – J.P. Morgan

Hi. You guys have talked about the board as I understood I’m asking you with looking at bolt-on acquisitions. One of your competitors this morning said that an asset, which they were looking to sell, they are no longer selling because they think that there are better opportunities for them to hold on it for themselves. Can you talk about what you are seeing with regard to smaller assets that you could purchase is there a wide opportunity out there or is it a pretty tight right now?

Phillip Michael Hardesty

I would say that the early candidates are more in the category of thermal coal producers and metallurgical coal producers because with attractive metallurgical coal passing certainly there the operators have a pretty hefty margin that allows for some inefficiency and regulatory challenges and still make a decent return. But certainly the smaller thermal coal producers that are facing some of these challenges are likely to be early in the pack in my view to become part of the consolidation effort. And with respect to that particular competitor if I recall that’s a metallurgical coal opportunity which they were initially looking and selling and since determined to bring in the market. I think there we got a much different situation than as the norm across the industry.

David Katz – J.P. Morgan

Okay. And your board when you say they’ve tasked you for both thermal and met?

Phillip Michael Hardesty

They task us to roll the company. Again with acquisitions, I believe they are good rate on return. We certainly see the benefits of that in metallurgical reserves and metallurgical production in the near term but I think we shouldn’t under estimate the opportunities on the thermal side as we’re envisioning a much stronger thermal coal market 2012 and subsequent years. I don’t think the export thermal market is going to go away. I think it’s going to grow. I think the U.S. is going to become a more and more substantial exporter of thermal coal and I think that’s going to create opportunities in several basins. So I think its safe to say we’re looking at both and measuring them I think appropriately with respect to the margin that we expect to deliver.

Unidentified Analyst

Okay. And would you be able to remind us of your 2011 and then 2012 sensitivity to for example a $0.25 change in diesel prices.

Bradley W. Harris

I believe our annual diesel consumption is on the order of 26, 27 million gallons. So you do the math. It’s about 26, 27 million gallon consumption rate. And so it demonstrates to you that’s a substantial factor on cost. Now, we do hedge forward normally at the level of 60% to 70% of that number. We have a rolling hedging program that ties up about 60 process, if you will, 60% of our diesel as we look forward.

Unidentified Analyst

Okay. Thank you very much.

Bradley W. Harris

You’re welcome.

Operator

Our next question comes from the line of Jeremy Sussman from Brean Murray.

Jeremy Sussman – Brean Murray

Hi, good morning.

Bradley W. Harris

Good morning, Jeremy.

Jeremy Sussman – Brean Murray

I think then in the past you said that you expect to sell about half of Tygart sale for 3.5 million funds of output into the met market. If I think about the current environment as it is today would it be reasonable to assume that the vast majority of that could be just sold into as a met product?

Bradley W. Harris

That’s a good observation, Jeremy. We’ve tried to explain in different forms. The underlying assumptions on Tygart envision that we would sell essentially as 7 ash or less met coal as a hallow light to the market and the balance to hire grade thermal market. And that was I think the right assumption in a period of time where generally domestic steal makers in particular weren’t willing to buy higher ash off grade products. And we’ve seen an evolution over the last two years were it certainly higher ash product that have strong pictographic qualities, strong reality are in demand. Indeed our Centennial high volume met is a good example of that. We are selling a non-dry met coal as fast as we can produce it, as essentially a (inaudible) because of the favorable attributes.

So the market has changed from the assumption that we use to justify Tygart early on. So I think it was probably, good appropriately conservative number that time to say that half of Tygart is likely to go into the hollow met market. That we are making based on the fact we’re selling non-ash coal today at probably north of $150 at the mine. I think one would safely assume that you could easily sell 70% to 80% of Tygart as high volume A met. So, yeah, the number certainly is looking more favorably now as we move more and more toward bringing project on line.

Unidentified Analyst

That’s great and very helpful. And just as a quick follow-up, can you give us a sense of what price you signed your net product at? I think you locked up about 400,000 tons of net during the quarter and maybe a breakdown between how much of that was high wall and how much of that was a higher quality low wall?

Phillip Michael Hardesty

This is Mike. As you just noted, we committed about 400,000 tons since first of the year, this price is averaged around $175 and it have would been a blend of primarily Beckley and Central was some, but also some of our crossover coals that tend to pull that down a little bit.

Unidentified Analyst

And so what you have left for the year in terms of a breakdown?

Phillip Michael Hardesty

We have about 600,000 tons left as noted in our press release and of that probably 250 is on the low-wall variety, 150 is probably is Central and the rest would be crossover coals.

Unidentified Analyst

Excellent. I appreciate the color.

Phillip Michael Hardesty

Thank you.

Operator

Our next question comes from the line of Mark Levin from BB&T Capital Markets.

Mark Levin – BB&T Capital Markets

Thank you very much. Jeremy, just asked the question I was going to ask, but let me focus a little bit on 2012 if possible, you guys laid out $83 to $89 pricing guidance. I guess you guys have committed plus or minus around 25% of your shipments. So I’m curious as to sort of what assumptions would underpin that $83 to $89 guidance for next year? Thanks.

Phillip Michael Hardesty

This is Mike. I will take that. First of fall, of that 25%, the majority of it is over the legacy contracts. So that’s why see that is priced at $60. During the first quarter, we did commit about 600,000 tons of new business. I think about 5.25 of that was thermal business right at $80 in a railcar out of Central App. We also had a small amount of met business committed 175 plus, we had some carryover coal because one of our customers was having some issues.

As far as going forward, we based our forecast on the prevailing prices what are indicated by industry experts from met coal and forward curves on the traded coal. And I would say right now prices on the thermal coal I think are certainly on the conservative side that we used. Prices have moved up several dollars since we put that projection out.

Mark Levin – BB&T Capital Markets

Okay, great. And how about on the met side if you would?

Phillip Michael Hardesty

It’s like I said, I will try to look – on a near-term it’s easy we can see what we are selling going forward. As you move into the outer years that tend to rely on what a lot of you folks are saying because I want to try to keep in line with what expectations are, but we certainly feel like the met story is going to continue for at least three or four years. Actually, I think that there are circumstances were supply gets more constrained because of some of the regulatory issues that Ben’s already noted.

Mark Levin – BB&T Capital Markets

Sure, sure. And then one last question for Ben. Ben you had alluded to the importance of size and scale in Central Appalachia. When you think of that concept and obviously you’ve been in the region for a long time, if you had to kind of – and I know it is such sort of a specific question to be broad interpretation, but we think about what is sufficient scale for a Central Appalachia producer in this environment and going forward. If you had to think about that from a production base perspective what do you think that might be.

Bennett K. Hatfield

You know there is really no right or wrong answer there really Mark, I think what is safe to say is that figure provides some security of ability to observe an adverse regulatory impact and if you are getting 40 or 50% of your earnings from two or three coal mines then and you are maybe in a ten coal mine company then that certainly creates some (Inaudible) that things can could go the wrong way and you could have a period of time perhaps treating for several quarters where the P&L is impacted with a bad outcome. So, I think generally speaking most companies’ look at the benefit of mitigating that risk with the diversity of supply and more mines is better. So, I wouldn’t – I guess there is a lot of hesitation putting out a number of this below this level you are consolidating above that level you don’t need to.

Mark Levin – BB&T Capital Markets

Sure. When you look at your uncompetitive position it is sort of in the 16.5 to 17 million tons, I mean in your opinion does that meet the definition of sufficient scale going forward given the environment.

Bennett K. Hatfield

I think we are certainly well positioned in that regard, particularly with the fact that we are operating in three different basins, if I would just start operating in one basin with 4 mines of 5 million tons a year each. I will be a little more concerned.

Mark Levin – BB&T Capital Markets

Sure.

Bennett K. Hatfield

So, I think we are at a good size, particularly given the fact that we are substantial producers in three diverse basins, but it is always generally speaking bigger is better and somewhat better protected from an adverse outcome. So, I think different folks will provide different assessment in that regard.

Mark Levin – BB&T Capital Markets

I appreciate the color. Thanks very much Ben.

Operator

Our next question comes from the line of (Inaudible).

Unidentified Analyst

Hi, guys just want to know you talked a little bit about that port spaces starting at (inaudible) you also talked about potential M&A. Would you guys consider either a JV or something like that is port space or port capacity is going to become a big consideration when you talk about the deals or is it more kind of efficiency at the mines.

Phillip Michael Hardesty

This is Mike. Yes port space is certainly an issue. I don’t think it is an issue so much in an M&A discussion although it could be I think it’s more of a the industry itself developing partnerships with the railroads and some of the terminal providers to provide more outlets for export coal. And my view is I think we will be somewhere over a 100 million tons in exports this year as an industry which is pretty remarkable, we haven’t seen that type of level, I don’t since the 80s. But there are several initiatives underway by multiple parties including the railroads to try and expand and optimize the supply chains to allow more exports, and we’re certainly going to try to participate in that where we can.

Unidentified Analyst

Okay, great. Thanks a lot.

Operator

Our next question comes from the line of Jamie Melzer from Bank of America/Merrill Lynch.

Jamie Melzer – Bank of America/Merrill Lynch

Hi, good morning. Thanks for taking my question.

Bennett K. Hatfield

Good morning, Jamie.

Jamie Melzer – Bank of America/Merrill Lynch

Couple of quick things; on your last earnings call you had mentioned that you are being somewhat conservative particularly pertaining to the cost side but somewhere you increased the guidance somewhat, but do you still think that you are being some more conservative with that.

Bennett K. Hatfield

I think we are conservative but we are always reflecting a reality that became apparent as we move from our discussion in three months ago to today. The biggest shift that impacts that cost guidance is essentially mix more so than the individual mine inflation. We have seen a substantial constraint on our Illinois Basin production. And again that’s a mine that performs very well with cost in the mid-20s range, and we are somewhat, customer constrained there with a requirement contract that substantially reduced their burden and two other customers that had different issues related to their facilities that further cut us back. So we were forced to train our Illinois production forecast and that takes a lot of low cost tons out of that average cost number.

Similarly in Northern App one of our lower cost operation, our small (inaudible) plan is facing a constraint because of the court challenge to an improved permit that’s forced us to work a reduced schedule and project lower App from that location as well. So when you start taking tons out of the mix that are in that $25, $30 cost range, that has about the nature of, the math involved (inaudible). We are seeing somewhat more cost pressure then we were envisioning particularly from diesel fuel. I don’t have a number for it, but probably the single commodity impact has had the greatest impact on our cost over the last three months has been in the upward movement of diesel fuel processing.

So combination of the mix with low tons coming out of the mix low cost tons and the added pressure from diesel fuel cost are probably the biggest factors that caused us to move that guidance upward. I wouldn’t expect that to be the continued pattern because I think we have been somewhat conservative in our assessment but I think is the right range to indicate this point.

Jamie Melzer – Bank of America/Merrill Lynch

Okay. Thank you. And then I guess so do you expect to see the step up in cost in Illinois Basin, you know for the reason you just mentioned kind of continue at that level throughout the year?

Bennett K. Hatfield

Well, again it’s more, there are going to be some cost creep in Illinois Basin, but the biggest factor has been forcing a reduction in total tons. So again its taken $25 ton double the total mix. We do expect to be constrained in their fashion for probably the next two quarters – hopefully worst case. The worst case, two quarter we’re hoping to get things back inline by our fourth quarter, but it’s kind of a moving target right now.

Jamie Melzer – Bank of America/Merrill Lynch

Okay, perfect. And then can you just elaborate a little bit on what you’re talking about with the permitting issues at Birch River the correlated issues?

Bennett K. Hatfield

I guess, that’s a kind of a unique situation where we hadn’t improved from where we had been through all of the regulatory hurdles and it was challenged in court by that I mean environmental activists follow the claim that’s a permit it was issued in error without sufficiently, I guess patterns of water quality standards. So that became an issue where the CR club, I think specifically filed a lawsuit, challenging the issuance of the permit and they filed it before the West Virginia Environment Quality Board.

And in that form a decision was made that essentially put our permit on hold, so we can’t move to the new permitted area as we had planned to do. And that forces us to essentially slowdown the phase of producing from our old permit. So that we don’t run out of the place to work and so we don’t fall short pretty maturely on our customer obligations. So we’re essentially slow walking in operation while we try to resolve that challenge where West Virginia’s state regulators are essentially being sued by the CR club trying to force a tougher environmental standard. It may take the kind of things that make it worked out in a couple of quarters or it may take longer, but at this point that’s what’s going on. I believe that’s also been addressed in our 10-K, Roger?

Roger L. Nicholson

Yes, sir.

Jamie Melzer – Bank of America/Merrill Lynch

Okay, sorry I missed this. How much production do you think that impacts at this lower rate versus what you have previously forecasted?

Bennett K. Hatfield

The total Patriot output is on the order of about 600,000 annual tons annually. So we’re essentially had a drop production by about 25%, order magnitude. Now those aren’t for fast numbers but that’s about the order of magnitude of what we’ve had to drop back. And there has been some cost inefficiency from happening to work short and close. So there are different factors there but if you talk about exactly how many tons were impacted its essentially 600,000 annual ton operation and trended by about 20% to 25%.

Jamie Melzer – Bank of America/Merrill Lynch

Okay, thank you. And, then just one kind of housekeeping question. On the met tons that you have on your guidance for this year, can you break out home much of that’s coming from Northern App versus Central?

Phillip Michael Hardesty

This is Mike. In total or on sell piece?

Jamie Melzer – Bank of America/Merrill Lynch

I guess in total or actually both of those.

Phillip Michael Hardesty

In total it will be approximately 1.7 million tons, you my correct that approximately 1.9 million tons.

Jamie Melzer – Bank of America/Merrill Lynch

And is that from Central Illinois?

Phillip Michael Hardesty

At Central Illinois.

Jamie Melzer – Bank of America/Merrill Lynch

Yeah, okay.

Phillip Michael Hardesty

The remainder would be Central App.

Jamie Melzer – Bank of America/Merrill Lynch

Okay. And do you happen to have the unsold breakdown?

Phillip Michael Hardesty

The unsold I went through that before, hope in my (inaudible) for us that before but Central would have been a neighborhood of 150 which is more than half, Vindex would been a neighborhood of 125, which is Northern App and we’re probably in the neighborhood of 100,000 or so for the other locations that’s also in Northern App. And again the remainder would be Central App. I hope that’s been helpful.

Jamie Melzer – Bank of America/Merrill Lynch

Yeah, thank you very much.

Operator

We have a question from the line of David Beard from IBS.

David Beard – IBS

Hi good morning guys.

Phillip Michael Hardesty

Good morning.

David Beard – IBS

Could you just as a follow-up when you look at the lower cost mines being taken off line, how much do you think that boosted your total cost guidance or another way to ask the question what are you guys assuming for an underlying cost trend?

Phillip Michael Hardesty

I really couldn’t offer a best label. David it’s more complicated than that you see there is a mixture of things going on. We had to take some low cost tons out of the mix in Illinois and Patriot. And then we’re trying to add some higher cost metallurgical tons. So it’s a mixture of things that I just can’t re-sort this specifically.

David Beard – IBS

Yeah, I know that’s what I was going to try to get a feel for that because it’s all with the numbers should be lower. It has got higher taxes, I mean there is a lot of moving parts as well.

Bradley W. Harris

Then you have – the increased realization certainly has a little bit to cost on the order of 12% to 14% of the increase in realizations. So there are different things going on there.

David Beard – IBS

Right, and those are high quality problems to have, but its still increases your reported cost numbers. I mean it feels like it’s a little bit lower underlying, but as you said there is four or five moving parts in there so?

Bradley W. Harris

I wish I could provide more color but it is tough to get into that level of precision now at this point.

Operator

Ladies and gentlemen that concludes the Q&A portion for today. I’d like to turn the call back over to Mr. Ben Hatfield for closing remarks.

Bennett K. Hatfield

We thank you for your interest in International Coal Group. Please plan to join us again for our second quarter conference call in July 2011. Have a good day.

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