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Walter Energy (NYSE:WLT)

Q2 2011 Earnings Call

August 04, 2011 9:00 am ET

Executives

Robert Kerley - Chief Accounting Officer, Vice President and Controller

Neil Winkelmann - President Of Cd & Europe Operations

Paul Blalock - Head of Investor Relations

Joseph Leonard -

Walter Scheller - President of Jim Walter Resources and Chief Operating officer of Jim Walter Resources

Michael Madden - Senior Vice President of Sales & Marketing

Analysts

Mitesh Thakkar - FBR Capital Markets & Co.

David Beard - Iberia Capital Partners

Jackie Przybylowski - Scotia Capital Inc.

Lance Ettus - Mortar Rock Capital Management

James Rollyson - Raymond James & Associates, Inc.

David Lipschitz - Credit Agricole Securities (NYSE:USA) Inc.

Andre Benjamin - Goldman Sachs Group Inc.

Shneur Gershuni - UBS Investment Bank

Mark Caruso - Millennium Partners

Brian Gamble - Simmons & Company International

Jeremy Sussman - Brean Murray, Carret & Co., LLC

Meredith Bandy - BMO Capital Markets Canada

Operator

Welcome to Walter Energy's Second Quarter 2011 Earnings Call. [Operator Instructions] I would like to now turn the meeting over to Mr. Paul Blalock, Head of Investor Relations. Sir, you may begin.

Paul Blalock

Thank you, Marla. Good morning, everyone. I'm excited to be here at Walter Energy. On behalf of our management team, I thank you for joining us for our second quarter 2011 earnings conference call. Today's call is being webcast live over the Internet, and the recording will be archived on our website for up to 30 days.

On this call we may refer to forward-looking statements in yesterday's press release and may make those and other forward-looking statements on today's call. For more information regarding risks associated with forward-looking statements, please refer to the company's SEC filings.

Joining me on today's call are Walter Energy Interim CEO, Joe Leonard; Chief Accounting Officer, Robert Curley; President, U.S. Operations, Walt Scheller; and President, Canada and U.K. Operations, Neil Winkelmann. We also have a number of other members of management available for the Q&A portion of today's call.

Today, we will discuss our operating and financial results for the second quarter of 2011, our views on the market and our updated business outlook. Now, I'll turn the call over to Joe.

Joseph Leonard

Thank you very much, Paul, and good morning to everybody and thanks for joining us here. First, as we always do, we start with safety, and our safety record for the second quarter of 2011 improved by 27% over last year, and we're making steady progress toward our goal of having an injury-free workforce.

We have some strategic highlights in the second quarter, led obviously by April 1 acquisition of Western Coal. This was the right transaction at the right time, transforming Walter Energy into the leading publicly traded pure play metallurgical coal producer in the world. And that's what we are today, but we're not standing still. We also executed the Chevron transaction in Alabama which included lease agreements for 68 million metric tons of Blue Creek coal, some of the best coal in the entire world.

We also purchased River Terminal at Mobile, which will assure our ability to ship additional production in future years and will also create a more efficient and cost-effective terminal area in Mobile. We are extremely well positioned for the long term in order to sustain the strong global demand for high-quality metallurgical coal. We are targeting a 50% growth in met coal sales by the end of 2013, and we believe that we're on track to accomplish that.

I'll now turn the call over to Robert to discuss the financial results for the quarter.

Robert Kerley

Thank you, Joe, and welcome back. Many of you would've noticed that we changed several elements around reporting our results for the quarter versus that of the past. As I believe we mentioned in the past, the acquisition of Western Coal was a transformative transaction for the company, and we are now reporting volumes in metric tons; we have structured our segments into geographic segments of the U.S., Canada and U.K. and other to highlight how the company is managing our operations; and we now provide statistics around 2 key product offerings of metallurgical coal and thermal coal, as these are the 2 drivers that are key to the business results.

These changes are meant to help align the reader with how the company's management evaluates its performance. Last night, we reported record revenues of $765 million and second quarter EBITDA growth of $268 million. These represent improvements of 88% in revenues and 38% in EBITDA versus the prior-year period, primarily due to the acquisition of Western Coal.

Net income for the quarter was $107 million, or $1.71 per diluted share. Results for the quarter include a number of ongoing purchase accounting impacts and onetime charges, with the combined impact to net income of $41 million. Adjusting for these charges, net income would've been $148 million and earnings per diluted share would have been $2.86.

We have ongoing purchase accounting impact to net income of $27 million related to increased depletion and depreciation, as we assigned acquisition cost to the mineral interest and property in excess of their historic costs for Western and North River. You can see the biggest impact of this process included within our balance sheet as we now disclose mineral interest of approximately $4.4 billion, virtually all of which came from Western. We will continue to have similar charges in future periods. They will, however, fluctuate based on production.

We also had $14 million in net onetime items impacting net income for the quarter. These items were primarily related to the increased cost of sales to adjust inventory to fair value as part of the purchase accounting process and acquisition cost, partially offset by a gain in the fair value of our initial investment in Western that we acquired in January of 2011.

Operating income was $154 million, down $17 million compared to the prior year. Operating income was lower primarily due to the ongoing and onetime purchase accounting charges I just mentioned.

The company sold a record 2.7 million metric tons of metallurgical coal in the quarter compared with 1.5 million in the prior year. Metallurgical coal sales volume increases were primarily the result of the addition of tons by our Canada, West Virginia and Wales operations that we're paying through the Western acquisition.

At our U.S. operations, revenues were up 24% to $507 million, primarily on the inclusion of results from the acquired operations. Operating income for the U.S. operation was $169 million, down from $182 million in the prior-year period, primarily as a result of higher cost per ton on lower production and increased freight expense, partially offset by higher prices.

The U.S. Operations segment sold 1.5 million metric tons of metallurgical coal in the second quarter, essentially even with that of the prior year, with the inclusion of sales from West Virginia, that more than offset the slight decrease from Alabama. Second quarter average pricing for met coal was $236.37 per metric ton, up 11% versus the comparable period last year. Sales prices were impacted by 706,000 tons shipped in the second quarter at first quarter prices averaging $223.

Operating income at our Canadian and U.K. operations was $12 million on revenue of $266 million, inclusive of the impact to purchase accounting I mentioned earlier. The segment sold 1.1 million metric tons of metallurgical coal at an average price of $231.54 per metric ton.

As I mentioned in our press release, since we acquired these operations only on April 1, 2011, and we didn't have them included in our results prior to that, we are not reporting comparable prior-year results within our press release. Now I'd like to turn the call over to Walt so that he can further discuss the results from our U.S. Operations segment.

Walter Scheller

Thanks, Robert. U.S. met coal production for the quarter totaled 1.6 million metric tons, virtually even with the prior-year period, with average production cost of $75 per metric ton compared to $66 per metric ton in the prior-year period. Met coal production costs were higher primarily due to lower volumes from the Alabama operations related to some of the geology and weather issues I will discuss in a moment.

As you may know, safety and continuous miner improvement were 2 key focus areas of mine when I joined the company last year, and I'm pleased to report solid progress on both of these fronts. We had excellent year-over-year improvement in safety performance, with a 30% improvement in our incident rate over the last 12 months, highlighted by a 76% improvement at Walter Coke.

At Mine No. 7, continuous miner production was up 40%. We initiated a new process improvement program we've called Raising the Bar. This program has proven successful at our CM units, and we are in the process of instituting this program to our longwall at Mine No. 7 and to our continuous miner units at Mine No. 4.

In addition, we have been pleased with the performance from our new North River steam coal mine. The mine has been producing well overall and even achieved a record day in the second quarter. While the addition of North River was the primary driver of the 700,000-ton increase in thermal coal sales for the quarter, our focus remains the production and export of high-quality met coals into the seaborne market.

We value the Chevron transaction for their long-term strategic fit as they allow us future access to 68 million tons of high-quality coal reserves and a trained underground mining workforce. These reserves represent the last significant block of Blue Creek coal reserves large enough to justify a greenfield development of a new coal mine. In addition, we would expect to gain certain synergies by developing such a new mine in an area so close to our existing mining operations.

If you'll recall, we acquired a terminal at the Port of Mobile in December 2010. We are also working with the state docks to convert one of their berths from an inbound dock to a berth capable of handling both imports and exports. Both of these initiatives are designed to help handle the additional production that will come from such a new operation.

Our Maple met mine in West Virginia obtained a permit to the Eagle seam, allowing access to additional reserves contiguous to our existing mine to expand capacity.

We had a couple of issues that negatively impacted production this quarter. First, and most significantly, we had 2 squeezes at the East longwall at mine -- at the No. 7 Mine. Typically, in longwall mining, the shield support the immediate roof. The shield advances as we extract the coal in the panel, allowing the roofs to fall safely behind the shields. However, at Mine No. 7, beginning in April, we encountered a massive section of sandstone above the immediate roof. The longwall shields we have on that panel are greater to 950 tons of support capacity. When the sandstone failed to break, as expected, its effective weight increased to a point where it exceeded the working capacity of the shields. This additional load caused the shields to compress to their minimum height interrupting longwall production.

Process to free the squeezed shields is difficult and time-consuming. As a result, we've made a number of changes to mining techniques and equipment, and we believe these changes give us the best chance to succeed as we continue in this panel, and we have recently seen advance rates return to improved levels. These shields were scheduled for replacement at the end of this longwall panel and new shields have recently arrived to replace this set as planned. However, if we encounter further geologic events, we will put these new shields into service early. These shields are raised to 1,350 tons of capacity, and we have similar equipment installed on our other 2 longwalls, and these have been operating without issue for some time. If this approach is necessary, later in the quarter we will update you as appropriate.

We also experienced some impacts from the April 27 tornadoes in Alabama. Although most of our facilities were spared the worst of the damage, we did lose a couple of days of production due to power outages in the area and starved with miner pool capacity due to the impacts on our employees and the community. Looking forward, we have 3 weeks of planned miner’s vacation in the third quarter and 3 longwall moves in the fourth quarter at our underground met mines.

With regard to our marketing, with the combination of our 2 great companies, we now have a global marketing effort with access to customers in both the Atlantic and Pacific Basins led by Mike Madden. I'd like to take a moment to talk about what we are seeing in South America and Europe, and maybe able to take -- make a few comments later about what we're seeing in Asia.

The market for premium hard coking coal remain tight due to strong demand and lower-than-expected recovery from seasonal rains in Queensland, Australia, as well as industrial action at BMA operations and ongoing production problems at key U.S. mines.

Daily global steel production hit a record high in June, with Asian nations leading the way and China and South Korea both setting monthly highs for production. We saw a strong coking coal prices in the second quarter and expect to see strong albeit slightly lower prices continuing this quarter. In Europe, Germany continued to lead the European economy, driven by demand from the automotive sector. In South America, very strong currency in Brazil continues to constrain the country's participation in the export market for their products. This also puts more pressure on their raw material costs.

All geographic segments for our markets are performing well, and demand remains strong. Looking at some of our other U.S. operations, Walter Coke achieved solid shipments in the quarter at excellent prices. A particular note, we had multiple shipments to international steel customers, and this is a market we're eager to explore further.

U.S. thermal coal production was 900,000 metric tons compared to approximately 275,000 metric tons in the prior-year period. As mentioned before, the increase in tons is primarily due to additional tons from the North River mine. Thermal coal production costs were $63, down 18% from $77 in the prior-year period, primarily as a result of the additional low-cost tons from North River.

Now I'd like to turn it over to Neil to discuss our Canadian and U.K. operations and our market outlook in Asia. Neil?

Neil Winkelmann

Thanks, Walt. For the quarter, our Canadian operations produced a total of 850,000 metric tons of metallurgical coal. The production costs were $137 per metric ton. At the Wolverine Mine, production and costs were adversely impacted in the quarter by a mining sequence with high stripping ratios, as well as difficult weather conditions and the scarcity of waterproof blasting supplies.

The mine is now moving into more favorable lower stripping ratio and mining sequences. The second Hitachi EX5500 27-cubic meter face shovel has been commissioned, allowing the older 2800XPC shovel to be retired from service, thus reducing the production risk. We also have a new EX8000 40-cubic meter capacity shovel scheduled for delivery later in the year.

At the Willow Creek Mine, we experienced production and project delays due to record rainfall in the region that washed out the main public highway and caused a weeklong shutdown of the mine and project works. The rail line and other mine access roads were also damaged. All access and rail issues have now been resolved.

The Willow expansion project received the amended environmental permit after several months of processing delays. These delays caused increasing constraints on mine waste and coal sequencing, which impacted production and costs for the quarter. With the permit now in place, we are opening up the mining sequence and increasing the production as per our plan.

The equipment delivery for the Willow Creek expansion project is progressing well. The new Hitachi EX8000 shovel mentioned earlier has been secured for near-term delivery to Wolverine, freeing up a Hitachi EX5500 to transfer to Willow. This strategy fully mitigates the potential risks related to shovel delivery schedules caused by the extremely tight global market for this type of specialty mining equipment and positions us positively for our planned growth.

The Willow preparation plant upgrade is well under way, with some minor delays attributable to the local play. The commissioning of the plant is expected at the end of 2011.

Finally, at the Brule Mine, waste rock removal rates and raw coal mining rates have ramped up, and production process has been now running very well, as the new large shovel and trucks have moved into larger and more productive mining sequences. However, difficult road conditions on the new Falling Creek connector road to Willow Creek related to Spring storm [ph] and to those flooding events, limited coal volume during the quarter during the alternate longer and lower capacity route to Wolverine. This negatively impacted clean coal output, mining costs and increased haulage costs.

Haulage on the Falling Creek connector road will recommence this week and will offset [ph] the logistics constraint that affected the second quarter reported production. Mining costs were higher in the second quarter due to plant high waste volumes and the lower coal haulage volumes. For all mines input cost pressures, primarily fuel, also impacted costs.

Moving to Wales. The Aberpergwm project continues to make good progress towards full production and is currently scheduled to reach that point in the fourth quarter of 2012. Equipment deliveries are on track with the first full production unit now equipped. Construction of the new preparation plant is on schedule and on budget.

Turning to our markets in the Pacific Basin. In Asia, although we saw some steel production slowdown from Japan as a result of the tsunami and earthquake, we did not see any production slowdown from our other Asian customers in South Korea, Taiwan and in China. However, negotiations for settlements achieved were more difficult in China as prices for domestic hard coking coal in China remain below international prices.

Now I'll hand it back to Joe to wrap up today's call.

Joseph Leonard

Thank you very much, Neil. Turning now to our outlook. The company expects metallurgical coal sales in the second half of 2011 to total about 5.9 million metric tons. Going forward, the company expects to expand metallurgical coal sales from our existing operations by approximately 50% by the end of 2013.

If there's one thing I want you to take away from today's call is that we have both the assets and the management team to continue to realize and deliver value for our shareholders. We had a record year in 2010 when we last work together, and I look forward to once again working with both our corporate and operations teams to help drive performance and advance our strategic initiatives. Walt and Neil continue to provide strong leadership over our operating businesses, and they are the people closest to the ground, responsible for delivering our operating results, and they remain in place.

Many of our customers from all around the world had welcomed our acquisition of Western. They view our new arrangement as a marriage of 2 companies with similar customer cultures, offering a broad product line with logistical alternatives to Australia.

Finally, we are very proud of our record of delivering value to shareholders, and we're also pleased that our strategic advancements the company has made with the acquisition of Western Coal and Chevron transactions. In addition, we are reinvesting in our operations to expand our global production footprint.

That concludes the prepared remarks for this morning. I'd now open the call for questions.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from Shneur Gershuni, UBS.

Shneur Gershuni - UBS Investment Bank

Given the cost structure that we've seen in the production that was there, which was somewhat disappointing this quarter, but it does appear to be that it was -- you got a lot of weather issues and a lot of onetime items it seems in every single operation. I was wondering if you can sort of -- if you think that everything is going to continue to improve and so forth, is if you can kind of put the guidance that you've presented today with where the operation with respect to how Keith presented it back in -- on the last conference call. On a short ton basis it looked like it was about 20 million tons. Is that something that the organization is still targeting? Or has that changed based on where we sit today?

Walter Scheller

This is Walt Scheller. Looking at the total tonnage projections and the guidance or the projections we gave, looking to get to 20 million tons, we are still at that range. What we've done by changing the way we're reporting is we have converted everything to metric tons, and the 20 million ton target, it was not a metric ton target. There were a couple of a different things happening. Part of that was a combination of short and metric tons, partial year to full year. So there are some moving parts there. And what we're looking at now is growth toward a -- in 2013 a 16 million ton metric coal sales target. And in addition to that, probably 4 million to 5 million tons of thermal coal as well. So we are still targeting in excess of 20 million tons.

Shneur Gershuni - UBS Investment Bank

I noticed the prepared remarks, not a lot was said about search for a new CEO. Given how long it dragged on last time, assuming you had some candidates you've spoken to in the past, I was wondering if you can give us some color on the deadline on when we'll see one, and if you've spoken with Ben Hatfield, former CEO of International Coal?

Joseph Leonard

I didn't hear all of -- you broke up a little bit there. I didn't hear all. This is Joe. We are moving very rapidly toward the recruitment of additional CEO. We've also done some -- started assessment of some of the candidates. We will be conducting interviews within the next 2 weeks. All of the names that we are looking at, you would recognize, and you would be very pleased if any of those individuals join our team. So this will be -- we actually -- the last time around, we actually found a person within 90 days, and then he turned us down at the very last minute. We think this process will move much faster than that. It has been a wonderful job for us.

Shneur Gershuni - UBS Investment Bank

And just one final question. Walter, historically, was very good on disclosure. Since quite absent from the press release yesterday, will we be getting a lot of those details in the Q? Or it's permanently changed, the way you'll report costs and so forth in Walter Coke on a go-forward basis?

Robert Kerley

The way we structured this is, as I mentioned earlier, how we manage the business and the key drivers to the business. The other businesses that were disclosed in the past, minerals and coke, they are not -- although they are important to the business, they are not the key drivers behind the results of the business, and what we wanted to focus, the readers, the investor on is really what impacts our bottom line and our overall results. So we don't plan on giving a huge amount of detail in those going forward. There'll be some, obviously a lot more, disclosure of everything in the Q, but it won't be in the detail at that level of operation.

Shneur Gershuni - UBS Investment Bank

But we will get sales costs, as well as production costs?

Robert Kerley

You'll get -- not for those operations, no.

Shneur Gershuni - UBS Investment Bank

For main operations?

Robert Kerley

Yes. And, actually, that's included in our press release. There's a statistics sort of page at the back.

Operator

Our next question is from Jim Rollyson, Raymond James.

James Rollyson - Raymond James & Associates, Inc.

I guess maybe for Walt first. It sounds like a lot of the issues in the second quarter are making progress towards kind of getting back to normal as you move to the third quarter and into the fourth quarter. But the 2 specific questions on that. You mentioned the new shields that are coming or at the mine but not in place yet at 7 East. How much longer do you have to go on the current panel before you get to the next panel and with the new shields and hopefully a problem-free operation?

Walter Scheller

We have 5,000-foot left to mine in the current longwall panel, and we have a little bit slightly thicker sandstone or the thicker sandstone in front of us for about the next one 1,000 feet. So the next one 1,000 feet is where we're really focused on the operational changes, mining a little extra mining height which slows us down a little bit, but it gives us a little more breathing room if we start to squeeze to keep it from minimizing the height of the shields, are pushing them back down. So the next 1,000 feet is kind of a critical area. As of yesterday afternoon, I guess one of our key -- one of the keys for us was getting to that first several hundred feet without incident. We are -- as of yesterday afternoon, we were through about 200 feet of that area and continue to progress well. So we believe we're making good headway.

James Rollyson - Raymond James & Associates, Inc.

Okay. That's helpful. And, Neil, up at the -- in B.C., you mentioned the weather issues with the connector road you get coal actually out to ship. Obviously, weather-related issue, I understand. But is there a solution longer term to -- I saw like you've been putting down [ph] weather there down the road, I'm just wondering if there's some solution to that problem over time that you can avoid to deal with a potentially closed or washed out connector road.

Neil Winkelmann

Yes, there is. The weather issues were particularly severe this year because the road was brand new. These roads, when you put them in, in this region require a season a season or two to bed them in and to get the drainage 100% right, to get your maintenance regime on them correct. For example, like the older road off of Brule, it was not flooded. It was a little bit affected by the weather through in Siberia, but we did continue hold coal down that road. Going forward, the new Falling Creek connector road will be more like that; it will be much more reliable. And in any case, we will always have both those roads available to us to coal off Brule. We see the weather-related effects on coal haulage out of Brule in this quarter as being very much an event that is behind us.

James Rollyson - Raymond James & Associates, Inc.

Okay. And, Joe, last couple of quarters you had a little bit of carryover tonnage. Just given some of the volume shortfalls, I presume that might be the case going into the third quarter. Just wanted some color on carryover tons, pricing and kind of what's open for 3Q and 4Q.

Robert Kerley

I can go ahead and take that. It's -- we have 706 -- actually, 600,000 tons at prices of $270 per ton carrying over from Q2 to Q3, and that's within the U.S. And then within the Canada and U.K. operations, we have approximately 300,000 tons, had a carryover price of $260 per ton.

James Rollyson - Raymond James & Associates, Inc.

And then for 4Q, you're wide open?

Robert Kerley

It's all open.

Joseph Leonard

One thing, if we find that our recovery plans are not moving as planned, we will certainly put out a notification to that. But we're very confident in the plan. Walt has done a really good job with his crew, working the shields, working around the shields, but if things don't work out, we will notify the market to that effect.

Operator

Our next question is from Andre Benjamin, Goldman Sachs.

Andre Benjamin - Goldman Sachs Group Inc.

A couple of questions. The first, in light of the weather and permitting challenges, I was wondering if you would be able to update us on the timing of the ramps as you go through your Canada properties. We know where you're trying to get to by 2013, but a little help as we walk through the second half of this year and then 2012 will be helpful.

Neil Winkelmann

Are you talking about the timing of the production build-up, Andre?

Andre Benjamin - Goldman Sachs Group Inc.

Yes.

Neil Winkelmann

Yes. Okay. By the end of this year, I mean, the fourth quarter of this year, we're going to be at about 1.35 million for the quarter. The calendar year next year, the total between 5 and 6 and then close to the 6 in Europe and Canada. Sorry, was there -- sorry, I missed a bit of -- there was a question on permitting, was there?

Andre Benjamin - Goldman Sachs Group Inc.

Well, I know you mentioned that there were some permitting challenges, but that was largely behind you, so I didn't how that impacted the sequencing and how we should be changing our models to account for that.

Neil Winkelmann

Yes, the impact of that on the production ramp-up of Willow is really going to be restricted to this year, but that's taken into the account in that number I just gave you for the fourth quarter, between $1.3 million and $1.4 million for the quarter.

Andre Benjamin - Goldman Sachs Group Inc.

Great. And then I guess on the cash cost in both the Canada and the U.S. as you move through your recovery plan, is the any view on how that should look both in the second half of this year and as we move into next year as well?

Neil Winkelmann

Yes, the best way for us to think about it is that the cost will come down as a result of increase in volumes on a unit cost basis, and probably a 20% or 30% reduction is a reasonable assumption there. The input cost pressures remain, and that's across all the 3 operations in Canada, and that's input cost pressure on things like fuel, the price of explosives, contract to services particularly around maintenance. Just direct labor cost, they're under pressure, with increasing economic activity in the region. So those things are a little bit difficult to predict, but it is fair to say that, that is going to continue to apply some pressure to the costs and needs to be taken into account when you are forecasting this.

Walter Scheller

In the U.S., Andre, the -- our costs are up about $9 or $10 a ton, and that is almost all driven by volume.

Andre Benjamin - Goldman Sachs Group Inc.

Great. That's helpful. I guess the last question will be for Joe. I know coming out of the last quarter, you guys are preparing the market for an update on strategy. You obviously have a lot in your plate as you work through what's going on with your operations. But I'm just wondering if we can maybe expect an update sometime soon, maybe next quarter, or if not soon, when you'll be likely to do so?

Joseph Leonard

We've started wall-to-wall look at what we've got, what assets are, what our core competencies are, and we'll be developing that over the next quarter. I'm not sure at this point when we will be prepared to talk to the market about it, but it will be sooner rather than later.

Neil Winkelmann

Andre, just -- if I can just jump back to the cost a little bit. I just like to mention a couple of other factors that need to be taken into account. One is, that we didn't see in this quarter, we won't to see for the remainder of this year, but we will see next year, the benefit of the Willow plant -- Willow Creek plant upgrade and the low haulage cost in the Falling Creek connector road for the Brule Mine. So the cost of transport and processing the Brule coal is higher than what we'll expect into next year. That price, Willow Creek and Brule, we do have a strategy to move from contract operation and to learn to operate it, and that is also expected to draw down the cost. And I did touch on this, but I just want to mention it again, that at Wolverine, the ratios for the quarter were atypical, and in the next quarter and the remainder of the year move back into more favorable ratios. So that needs to be taken into account when modeling the projected costs for that operation.

Operator

Our next question is from David Lipschitz, CLSAC.

David Lipschitz - Credit Agricole Securities (USA) Inc.

A couple of questions. In the slide we had from the first quarter, you had, I think, total production for 2012 of around 20 million tons. Is that still a good number? Or is that being cut for next year?

Walter Scheller

In 2012, the current target is 14 million tonnes metric coal -- metallurgical coal, I'm sorry. So that remains the target, and when you convert that to short tons, that brings you up to about 15.5 million tons. And then we have about 4.5 million to 5 million tons of thermal coal as well, which brings us up to that 20 million ton range.

David Lipschitz - Credit Agricole Securities (USA) Inc.

No, the slide is metric tons, so that's why I'm confused.

Walter Scheller

They're all metric tons.

David Lipschitz - Credit Agricole Securities (USA) Inc.

The slide says metric -- I'm just wondering if you're cutting production on a metric ton basis like 2 million tons for '12, based on what the first quarter guidance was.

Walter Scheller

Right now, for 2012, what we're looking at is 14 million met tons, and then another 4.5 million -- 4.5 million to 5 million thermal.

David Lipschitz - Credit Agricole Securities (USA) Inc.

Those are both metric tons?

Walter Scheller

Yes.

David Lipschitz - Credit Agricole Securities (USA) Inc.

And then my next question is, the realization of second quarter was relatively low obviously compared to benchmark, and I know you have some carryover tons. But in the last quarter you talked about sighing deals of 330 and 275 for PCI and things like that. So just wondering -- and you only have -- your carryover at 270, 260. I was just wondering what happened. Did you have to take discounts to the benchmark? Or what happened that your prices are well below what the benchmarks are and even in the carryover from second to third quarter?

Michael Madden

David, this is Mike Madden. In Q2, we had a little over 700,000 tons of carryover which was brought forward from Q1. And as you know, the pricing in Q1 was around 225 level benchmark. And then we had intermingled in the first 6 months of calendar year '11, we had some 6-month deals which were booked in January. So we got the benefit of those in Q1, but we lost the benefit in Q2.

David Lipschitz - Credit Agricole Securities (USA) Inc.

Where were they done?

Michael Madden

They were done in about the 270, 275 range. And so for the -- I guess the average that we looked at in Q2 was around 275. That's how we got to the number for Q2.

Operator

Our next question is from Lance Ettus, Tuohy Brothers.

Lance Ettus - Mortar Rock Capital Management

Just a question -- I heard you kind of pretty talk too much about the met coal pricing environment. Obviously, I think people out there saying that it's coming under a huge amount of pressure, and then there are some people saying that kind of staying firm and then around 300 or a little bit underneath that level to the benchmark. I just want to hear your comments there I guess.

Michael Madden

Yes. This is Mike Madden again. Well, frankly speaking, I think a lot of people were a bit surprised that the 315 number for Q3, I think a lot of people were modeling the prices below that. But we now also are hearing -- we're hearing the same rumors that things are coming off a bit, but we did hear yesterday that the BMA price number for September, the monthly delivery, is now around 305 to 308. So if it's coming off, it's not coming off in big strips at all right now. We don't see that.

Operator

Our next question is from Meredith Bandy, BMO Capital Markets.

Meredith Bandy - BMO Capital Markets Canada

So Neil gave a very good overview of getting to the growth in Canada. I was wondering if we could do the same -- something that Canada number includes the U.K., which often in the division and the U.S.

Neil Winkelmann

The U.K. -- would you like me just to talk to the U.K. a little bit rather?

Meredith Bandy - BMO Capital Markets Canada

Yes, and then if we could talk to Walt for the U.S.

Neil Winkelmann

Okay. It's still very much in project size there. It is progressing reasonably well, although the drift from the surfacing to the new mining area is going a bit slow than we'd like, but everything else is going well. The first production unit, the first of the 3 production units that are in the current plan, is now fully equipped to continue as motor is being assembled as we speak, which is the last piece to put in place, and then they'll start developing and ramping our production from that. Over the next 12 months, the second 2 units get in place and get commissioned in full production towards the end of next year. And that will be production at the rate of about 1 million clean tons per year. In fact, for 2012, the forecast that we're showing is around 300,000, but the run rate at the end of 2012 is considerably higher than that, and then we're showing 800,000 into 2013 as a component of the forecast. We're now getting for that business to the run rate of around 1 million tons per year once we get it fully up and running.

Meredith Bandy - BMO Capital Markets Canada

Okay. And then, Walt, how much improvement -- how do you expect the improvement to go in the U.S?

Walter Scheller

As we look at the -- and I'll just stick with the 2 big operations, the No. 4 Mine and the No. 7 Mine. The No. 4 Mine, the growth will come from getting to longer longwall panels. For the past year and for the next probably 18 months, we have much shorter longwall panels than we would like have, and that's just a matter of working through the reserves to the point where we can get back to longer longwall panels. And those sort of longwall panels impact the total production of that operation to the tune of about 300,000 to 400,000 tons a year. And so that's where the improvement will come at Mine 4. At Mine 7, the infrastructure is in place. At this point, it's about getting the continues mining units far enough ahead of the longwall which we're making great progress on, that we don't have delays associated with continuous miners and to get this second set of larger shields in place and to run at the expected capacity. So it's more about operational efficiency. So I would expect both of those to progress the longer longwall panels will be what really impacts us are shorter longwall panels in 2012, and we expect to be about 7.5 million tons in 2012 total and about 8.5 million tons in 2013. But that does also include a little bit of coal out of West Virginia as well.

Meredith Bandy - BMO Capital Markets Canada

Okay. So it does include West Virginia. And then with the -- I think you mentioned in the remarks the Maple Mine got a permit. Does that take the -- I know Western had talked about taking those West Virginia operations from 2 to 4, I believe. Is that still on the table or...

Walter Scheller

First off, I was incorrect. The 7.5 million and 8.5 million on the previous answer did not include West Virginia. And the West Virginia tons excluding the some -- when we just look at met coal production, we intend to grow that metallurgical production up to about 1.3 million tons from where it is today at about 1.5 million tons. So part of that come 800,000 tons, 700,000 tons of that of improvement will come out of the West Virginia met coal.

Meredith Bandy - BMO Capital Markets Canada

Okay. And then can we talk about with the growth, can you tell us a little bit about what the CapEx should look like on the new divisions?

Robert Kerley

The CapEx that's expected for this year is roughly $500 million. That is a lot of projects going on within the 2 operations, but primarily within Canada and U.K. Our maintenance amount of that CapEx is roughly $120 million. So the rest is related to projects for this year.

Meredith Bandy - BMO Capital Markets Canada

And would it come down then somewhat next year?

Robert Kerley

It depends on what projects we do. It should come down some, but you'll never know what we may do between now and then.

Operator

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

Brian Gamble - Simmons & Company International

Couple of clarifications, if I may. On the cost side, Walt, it seems to indicate if you guys get back to a higher production run rate when you're more comfortable with the cost could actually be down year on year? Is that what you're trying to imply?

Walter Scheller

I think the overall cost year-on-year in Alabama are going to be, assuming we can get back to a normalized run rate, are going to be close.

Brian Gamble - Simmons & Company International

Okay. And then, Neil, you gave incredible details including your short-term expectations for 20% to 30% decrease in cost. Can you kind of sum up all the parts that you mentioned for 2012? What are you expecting? If the 20% to 30% happen in the short term, get you closer to $100 a ton, what are you expecting for 2012?

Neil Winkelmann

I think that's probably within a reasonable outlook for 2012. I think it will be 2 things, pushing in opposite directions, one, as we do have some further cost damage that I talked to earlier. But against that, I expect to see some continued pressure on those input costs. So I think that 20% to 30% reduction on what you see as the quarter costs is a reasonable number you're going for in the remainder of this year and 2012.

Brian Gamble - Simmons & Company International

Walt, is there any way the handicap the probability that those shields that you replaced in No. 7? Or is it really just a day-by-day just getting better but hoping it stays better and really don't have any way to know until you get there, if the shields really need to be removed or not?

Walter Scheller

I'm pretty confident that the changes we've made will work well, and that we'll be able to progress through this area without having an additional squeeze. The key is going to be not to get in too much of a hurry and try to push for the area too fast, because what will happen is if we're not taking enough mining height, and that takes a lot more time, that's when we will run the risk of getting ourselves in trouble. So I think we're just patient and work our way through it, I'm comfortable we will be okay.

Brian Gamble - Simmons & Company International

And then last for you, Mike. You mentioned the BMA monthly still north of $300. Do you expect that to stay around that $300 range for the rest of the year given what you're seeing throughout the international steel market, and the supply and demand fundamentals of the entire global chain?

Michael Madden

I think it's still a little premature. I think a lot of focus is coming on how the Japanese recovery ramps up. And then don't forget we've got some -- the traditional rain seasons in Australia starts in October. So a lot of things can happen yet before we can put a real finger on what that number is going to be, but obviously, steel prices around the world have to get a little bit healthier.

Operator

Our next question is from Jeremy Sussman, Brean Murray.

Jeremy Sussman - Brean Murray, Carret & Co., LLC

I know you guys are working through a number of things. But as I think about your strategy going forward, it's clear that you're focusing more on the met coal front. Are there areas either in the U.S. or Canada or perhaps elsewhere you could look to pick something up perhaps, whether it be reserves or production?

Joseph Leonard

Yes. I would just say in that regard, we've got a healthy pipeline here of potential reserves, potential companies. Right now, we've got a lot more questions than we have answers, but we're working through that. And I think we'll be as aggressive this year as we were last year, which was a pretty aggressive year for us strategically, and we have the way with all to significant number of projects that we choose to do so.

Jeremy Sussman - Brean Murray, Carret & Co., LLC

Okay. Great. And just a quick follow-up. A couple of your competitors are having some significant issues on the low-vol side in the U.S., where there is some mines that are going to be out, what looks like for -- could be as much as the rest of this year. If we get into the latter part of the year where domestic prices look attractive enough, would you think about selling some of your Alabama product into the domestic market? Or are you going to continue to focus basically on the export side of things?

Michael Madden

This is Mike Madden again. No, basically our coal is committed, but it's on price. So we really don't see that switch. All it will do is put more pressure on the international side as well.

Operator

Our next question is from Mitesh Thakkar, FBR.

Mitesh Thakkar - FBR Capital Markets & Co.

So I know mining is a really tough business, particularly with the geological issues and stuff. Can you kind of provide us some thought about on the guidance and kind of risks which are there for the -- for achieving that -- those numbers in 2012 and 2013?

Robert Kerley

Well, I can tell you for the numbers that we've got, we do believe they're achievable, as was discussed earlier. If it was another squeeze, then obviously this year would be impacted. It's hard to forecast what you're going to run into out in the future, but those numbers we believe to be achievable.

Neil Winkelmann

Add I'll just add a little bit of color on the Canadian operations. Looking at Wolverine, it's a material mine, the planning process is there, they're well established, the geology is well understood and mine processes themselves are very consistent. We've reduced the risk there by investing into new larger equipment, and in particular the shovel fleet now is a new fleet, compared to what we had there previously, which was a very old 2800XTC shovel. So the production risks around that is the moving of the waste. The other burden is very much reduced, and plus the planning and execution risk there is, I believe, well under control. Moving to the Brule Mine, until this quarter just gone, it was a complex mine with a lot of small sequences working around some infrastructure, an old gas well, there's a range of things that make mining difficult. What the mine looks like now is a different place. It's -- the mining sequences are now much more straight forward, they're larger and more predictable. Our mine planning team there is being significantly boosted with the -- we have a new senior mine planning engineer there who's doing a terrific job. The new equipment there, the EX8000 shovel and the 793 trucks are all performing well. The availability on the trucks is coming up, and I think the production risk out of the pit there is now very much under control and analogous to what we see in Wolverine. The risk -- the part that has been affecting us is the haulage logistics off the hill. And it is true that they have not demonstrated the capacity of the whole significant falldown of Falling Creek connector road yet. It reopens tomorrow, is the schedule. And I've recently driven the route, I've looked out and I understand the trucks and the plans there, and I'm confident that we'll get that working and that, that logistics constraint will be lifted. And then moving to Willow, we're not in as good a position to that as we anticipated 3 months ago. The delight of the permit is really processing into the corner and the mining sequences remain tight and difficult. And we'll work our way out of that through the remainder of the year. Having said that, the risk around the permit now is behind us, we have the mine permit, we have the authority to go ahead and do the mine civil works associated with the expanded fit, and the preparation plant work is under way and progressing well. So we are on track, I think, to reduce the risk at Willow as well, but we are not as far down that track in terms of risk mitigation as what we're in the other 2 mines. Does that help?

Mitesh Thakkar - FBR Capital Markets & Co.

Yes. Those are great color. Fantastic. One just follow-up question to that. If you assume that we are able to achieve this production number, first of all, how much is the impact of purchase coal, if any in this? And how do you expect the -- what is a steady-state cash cost for both operations?

Walter Scheller

Mitesh, this is Walt Scheller. First of all, talking a little bit about the Alabama operations, we expect the cash cost to move back down into the 60s and while be able to hold it there. When we were talking a little bit about why we think we'll be able to improve and what some of the issues are. One of the things I want to point out is we matched last year's production with 2 major squeezes in the second quarter. So we are making -- while we had some geologic issues, we are making headway at these coal mines, and I feel very confident about the future as we roll forward. We've had, in the last 6 to 7 months, we've had a total of 3 squeezes. We had one at the end of last year beginning of this year at Mine 4. That squeeze and these 2 squeezes were both scenarios where we were utilizing these 950-ton capacity shields. Those were all out of service at after this panel. So I feel very confident about that. We've seen at Mine 7, 40% improvement in continuous miner development. So there's some very good things happening. Unfortunately, we had a couple of real setbacks this quarter with the squeezes, but we feel very confident and very comfortable about where we are headed.

Robert Kerley

Mitesh, I would like to add one thing to what Walt said. There's about $10 per ton in both the Canadian cost, Canadian and U.K. cost, and the U.S. cost that relates to the depreciation. So U.S. being a cash cost number, that helps get you there.

Mitesh Thakkar - FBR Capital Markets & Co.

Perfect. Sounds good. And what about the steady-state Canadian cost on a cash basis?

Neil Winkelmann

Yes. This is [indiscernible] probably the best way to think of that going forward is to anticipate a 20% to 30% reduction associated with that volumes coming back in line with expectation. And then steady state with some pushes in both directions from cost-saving initiatives that, if the market stays strong and the industry continue to expand, we -- it's difficult to see really from some of those input cost pressures going forward as well. I think labor cost and contracted cost could be -- could continue to be difficult, they're to reduce.

Operator

Our next question is from Jackie Przybylowski, Scotia Capital.

Jackie Przybylowski - Scotia Capital Inc.

You mentioned that there'll be 2 longwall moves coming up in the fourth quarter. And what do you anticipate the impact on your operating cost will be, say, for Q3 and Q4?

Walter Scheller

I'm sorry. Jackie this is Walt. We expect our cost to normalize back into the mid-60s, and that includes the impact of these longwall moves, and it's 3 longwall moves in the fourth quarter. We have one -- 2 of them at Mine 7 and one of them at Mine 4.

Jackie Przybylowski - Scotia Capital Inc.

Okay. So even with those moves, you'll still be able to achieve mid-60s for the rest of the year, do you think?

Walter Scheller

That's our expectation, yes.

Jackie Przybylowski - Scotia Capital Inc.

Okay. Great. And maybe just to follow up on a question that Meredith asked a while ago. Regarding the guidance for the U.S. operations, I think you said 7.5 million tons in 2012 and 8.5 million in 2013. What will be the comparable numbers on the thermal side?

Walter Scheller

On the thermal side, we are expecting Walter Minerals to stay flat at a little over 0.5 million -- or, I'm sorry, about 800,000 tons a year. We expect North River Mine to be in a 2 million ton range, and we expect West Virginia to be probably getting towards 1.5 million, 1 million to 1.5 million tons.

Operator

Our next question is from Mark Caruso, Millennium Partners.

Mark Caruso - Millennium Partners

I was wondering if you can help me understand a few things. I don't think anybody has asked the question. First, is if we can get a real update on what happened with Keith. And the second I guess is a question for Joe, and if there's any board members on how we are supposed, shareholders, have faith in your outlook and the business plan and financial controls when there was no update mid-quarter on anything that happened with this, when you were drastically different than what we heard on the call last time? And how we're supposed to have faith in your outlook on the tons when you haven't hit the tons going all the way back to 2008?

Neil Winkelmann

As far as the updates go, I think in retrospect we should have come out with a mid-quarter update if we have -- under my watch which started today. If we have misses of projections, I can assure you we will do that. We've had some very tough mining conditions in both Canada and Alabama that weren't predictable. And so we've had to deal through that. And I think if you look at our track record of shareholder value creation, we're the best in the industry both at 2007 and in the last 12 months. So though we have to deal with turmoil from time to time, our track record is unsurpassed, and that's something we're very proud of. We, last year, while we had an Interim CEO, we made a number of strategic moves strategic acquisitions. So we don't -- and we may have some disruptions from time to time. We don't stop moving forward. And the board is very proud of what we've created for shareholders with us as a board and is very, very shareholder. Oriented. We understand what our responsibility is, and we understand what our mission. And I think our track record speaks for itself.

Mark Caruso - Millennium Partners

So I guess going forward, we should expect interim updates if there is any delta because I -- well, I understand what you're saying. Outside having with keys and a few other people, the senior leaders of the company, have been in place for a very long time, did not update us on any of this, that's all, which is the responsibility of the board. And Joe, you've been involved prior to this as well.

Joseph Leonard

Right. I can assure you on my shift we will make sure that there aren't any surprises as move forward.

Operator

Our next question is from David Beard, Iberia.

David Beard - Iberia Capital Partners

Maybe a bit of corollary to the previous question relative to the Canadian division cost. When we look at public filings from Western previously, the costs were roughly $70 a ton, and we used your 20% to 30% reduction from our 137 number, you get 96 to 110. It is a pretty significant step-up in the underlying cost structure in Canada. And on the surface I can't really explain it the way with just diesel fuel and wages. So maybe you could help me understand why the company originally was a $75 a ton operating cost and now it's $100 in just a few months.

Neil Winkelmann

Part of it is related to the input cost. So it may not explain at all. I think that's a reasonable observation. But I think business has become more expensive there. Some of the other things that have contributed to that has been some slightly lower yields out of some of the seams that we are mining so that the, if you like, the VCM move has been hard. We're also been delayed on our strategy to -- well, we haven't progressed as quickly as we would've liked on Australia due to move from contract operations at Willow Creek and at Brule to run and operate, but we will be doing that. And we will perhaps be able to provide some more color on what we anticipate in terms of cost savings and doing that in the future. Part of it is in relation to the delay in the ramp-up of Willow Creek related to permit delays, that we are in more difficult, more expensive mining sequences than what we have anticipated, and that is pushing the cost up. We'll work our way out of that over time, but that's certainly impacting the cost right at the moment. The other thing that was factored in or sort of being factored into projection in our cost savings is the coal haul out of Brule and the connector route, and that's slightly being realized, and you're seeing that in the $137. We will improve on that as we do increase the haul and increasing percentage and call down the Falling Creek connector roads to Willow. The use of that for 100% of the Brule coal requires the commissioning of Willow Creek plant upgrades at the end of the year. So not until 2012 we will realize the full savings of that connector road haul.

David Beard - Iberia Capital Partners

Okay. That's helpful. And I don't know if you could address what type of cost increases assuming that your guidance for the third and fourth quarter come in to the levels that we talked about in the U.S. and Canadian operations. What type of cost increases can we look forward into 2012?

Robert Kerley

Well, actually as we've discussed earlier, when volumes increase we're anticipating, the cost per ton, the production cost per ton to drop. And so we think Neil has already mentioned he expects a 20% to 30% drop once we to normalize volumes. Again, it would mainly be inflationary factors, rent, fuel cost, maybe contract labor, but we'll do it from that point.

Joseph Leonard

Okay. Seeing that there are no further questions, that concludes the call for this morning. We expect to be out in the road shortly to meet with some of you and look forward to participating in a number of conferences this fall. We certainly thank you for joining us today, and we appreciate your interest and support for our company, Walter Energy. Thank you very much.

Operator

Thank you for participating in today's conference. You may disconnect at this time.

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