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Alpha Natural Resources (NYSE:ANR)

Q3 2011 Earnings Call

November 03, 2011 10:00 am ET

Executives

Paul H. Vining - Chief Commercial Officer

Kurt D. Kost - President

Frank J. Wood - Chief Financial Officer, Executive Vice President and Chairman of Safety, Health, Environmental & Sustainability Committee

Todd Allen - Vice President of Investor Relations

Kevin S. Crutchfield - Chief Executive Officer, Director and Member of Safety, Health, Environmental & Sustainability Committee

Analysts

James M. Rollyson - Raymond James & Associates, Inc., Research Division

Mark A. Levin - BB&T Capital Markets, Research Division

Meredith H. Bandy - BMO Capital Markets Canada

Lucas Pipes - Brean Murray, Carret & Co., LLC, Research Division

Andre Benjamin - Goldman Sachs Group Inc., Research Division

Michael S. Dudas - Sterne Agee & Leach Inc., Research Division

David Gagliano - Barclays Capital, Research Division

Shneur Z. Gershuni - UBS Investment Bank, Research Division

Brian D. Gamble - Simmons & Company International, Research Division

Operator

Greetings, and welcome to the Alpha Natural Resources Third Quarter 2011 Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Mr. Todd Allen, Vice President of Investor Relations for Alpha Natural Resources. Thank you, Mr. Allen. You may begin.

Todd Allen

Thank you, operator, and thank you everyone for participating in today's Alpha Natural Resources third quarter 2011 earnings conference call. Joining me on the call today are Kevin Crutchfield, Alpha Natural Resources' CEO, who will summarize our third quarter 2011 results and provide a brief market outlook; Frank Wood, our CFO, who will comment on Alpha's financial results and updated guidance; and Kurt Kost, President of Alpha Natural Resources; and Paul Vining, Alpha's Chief Commercial Officer. Both of whom will be available to address operational and marketing questions following our prepared remarks.

Please let me remind you that various remarks that we make on the call concerning future expectations for the company constitute forward-looking statements under the Safe Harbor Provisions of the Private Securities Litigation Reform Act of 1995. These statements are based made on the basis of management's views and assumptions regarding future events and business performance as of the time the statements are made. Actual results may differ materially from those expressed or implied. Information concerning factors that could cause actual results to differ materially from those in forward-looking statements are contained in our filings with the United States Securities and Exchange Commission, including our annual report on Form 10-K and subsequently filed Form 10-Qs. This call is being recorded and will be available for replay for a period of 2 weeks. The call can also be heard live over the Internet, and both the replay and the downloadable podcast of the event will be archived on our website at alphanr.com for a period of 3 months. With that I'll turn it over to Kevin.

Kevin S. Crutchfield

Thanks, Todd, and good morning, everyone. We've always started our calls with a discussion about the safety performance and it's never been more important than it is today as we integrate the operations of Massey. Today, I'd like to highlight our recent successes in our Kentucky operations. In addition to the Underground Safety Awards recently earned by Enterprise Mining and Love Branch South, our Black Mountain White mine rescue team from Benham, Kentucky won first place in the National Mine Rescue Competition. This team was 1 of 3 Alpha teams that placed in the top 10, and 1 of 7 in the top 25. I want to personally thank our entire workforce for their commitment to safety and to our mine rescue teams in particular for this momentous achievement and for their ongoing sacrifice and dedication.

On a related topic, our initial integration efforts following the acquisition of Massey have focused on Running Right training and these efforts have been swift, comprehensive and very successful. By the end of August, we completed Running Right training for the entire workforce at all Massey operations covering approximately 7,300 employees. And we've launched our Leading Right training program, which is designed for employees in a supervisory or managerial role. This has been a tremendous undertaking, and we now have some concrete data to demonstrate the success of these efforts. Though I must caution that we're still very early in the process.

The year-to-date incident rate for our legacy Massey operations has decreased by more than 13% compared to the incident rate at these operations in 2010. Employees have been very receptive to the Running Right culture. And in fact, the legacy Massey workforce is now generating more than 11,000 observation cards, which is the basis of the Running Right program per month, up from just 3,000 in June. This number of observations is nearly equal to the number generated by the Alpha workforce with a similar number of employees where the Running Right system has been in place for many years. In other words, buy-in and participation at the legacy Massey operations is already running at roughly the same level as Alpha on a premerger basis.

The key for success is having the management system and the infrastructure in place to prioritize and address the actions on the observation cards in a swift and deliberate manner.

The Running Right culture, which at its core is centered on employee engagement, not only fosters a safer work environment, it also has direct implications for morale, employee retention and ultimate productivity and improved operational performance. And we can see clear benefits in the turnover rates, which fell to approximately 10% in September at the legacy Massey operations, down from a peak of more than 20% earlier in the year. I could go on and on about the virtues of the Running Right system, but nothing can speak louder than the words of the newest members of the Alpha workforce.

As one former Massey employee put it, "My opinion of what I thought was well managed has completely changed. Premerger, we made decisions based on the experience of only a handful of select people. Today, we utilize the experience of every employee involved when making a decision. I now realize that being in control means that every employee is involved and working to achieve a common goal."

While we've made substantial progress since the acquisition closed, the full benefit of Running Right takes time, and we've only scratched the surface at this point. We still have a great deal of work to do in order to get the Massey operations in line with legacy Alpha in terms of safety, compliance and overall employee involvement. But the improvement is measurable and the trend is consistently in the right direction.

Now I'd like to briefly discuss our third quarter financial results. After backing out a number of unusual items, which is not unexpected in the first full quarter following a major acquisition, Alpha generated adjusted EBITDA of $373 million. We knew going into the quarter that we've had some challenges in terms of the scale and scope of the integration, a massive Running Right campaign and ongoing geological issues at our Emerald mine in Pennsylvania.

However, as we outlined in our announcement on September 21, we encountered a few challenges that have not been fully anticipated. First, protracted quarterly price negotiations with some Asian customers that led to delayed shipments. This was not due to any lack of demand. In fact, these customers continued to take coal from other sources until the negotiations were completed. We've ultimately reached agreement with these customers and deliveries have resumed on their normal pace. This temporary issue reduced our met coal shipments by approximately 300,000 tons during the quarter.

Secondly, we received a force majeure notice from a Middle Eastern met coal customer. Due to physical problems with the customer's facilities, approximately 200,000 tons of contracted met coal did not ship in the third quarter. We expect that the conditions that prompted the force majeure notice should be rectified and shipments should resume in the first quarter.

Third, geology constrained production at our Emerald mine. We grappled with sandstone intrusions for most of the year, and we expect that these issues would continue into the third quarter, but would gradually improve. While conditions did improve late in the quarter, the geological challenges resulted in production levels that were below our original expectations, with total production of approximately 900,000 tons for the quarter. We're up about 200,000 tons from the prior quarter rate.

Cumberland on the other hand, produced very well and collectively, the 2 Pitt #8 longwall mines shipped 2.7 million tons with average realizations of approximately $64 a ton and average cost of coal sales approximately $42 a ton.

Production at Emerald has improved since early to mid-September, but we expect to encounter geological issue challenges from time to time for the foreseeable future, and we expect the Emerald mine to produce between 4 million and 5 million tons annually going forward.

And lastly, lower-than-expected production at several legacy Massey mines. While the majority of these operations -- what we acquired in the Massey transaction generally performed as we had anticipated, several operations fell short of our expectations. Not surprisingly, the Randolph and Revolution were just as #1 mines in Coal River West have been under intense regulatory scrutiny since being placed on potential pattern of violation or PPOV status by MSHA. We have a specific and detailed action plan to address the compliance issues of these mines and Alpha is committed to getting all of our mines Running Right, not just operating in compliance with applicable laws and regulations, but also running in accordance with Alpha's own standards and expectations.

In the near term, this regulatory activity and associated productivity impacts that restrict the production at these mines in this situation can be expected to continue until the PPOV status is removed. Additionally, some of our Eastern surface mines have also had production shortfalls resulting from regulatory and sequencing issues. We're working through these challenges and we expect to see improved productivity in the fourth quarter.

Another improvement strategy is optimization, which is thoughtfully deploying our people and equipment in order to maximize our most productive and profitable operations. With regard to optimization, we continue to identify numerous opportunities. These projects run the gamut, from idle mines and prep plants to adding sections to our profitable mines, accelerating new mine development and redeploying resources in order to make more efficient use of our existing logistics and prep plant infrastructure. Since our last update, we've implemented 3 additional optimization projects.

We added an additional section at our Taylor Fork[ph] mine, and we idled the Solid mine [ph] in Northern Kentucky. We diverted the coal to Sidney plant for processing and idled our Spruce Creek [ph] prep plant and we're diverting coal from our Long Fork plant to our Sidney plant, which will increase our coal recovery and provide more optionality for transporting the met coal that is produced.

Optimization will be an iterative and ongoing process at Alpha, and these represent only the first steps of what we expect to be many over the coming months. At this point, it's probably too early to quantify the expected impact beyond what we stated publicly today. But with just what we have identified so far, optimization should improve our free cash flow generation by tens of millions annually. Going forward, we'll continue to update you on our optimization projects as they're implemented.

Now I'd like to briefly discuss our view of the current market environment. Despite predictions in the financial markets that the sky was falling in August and September, which by the way, afforded us the opportunity to aggressively repurchase shares of ANR at very attractive valuations, we've not seen any real change in worldwide demand for either met coal or thermal coal.

On the contrary, China has continued to ramp its steel production and China set a new record for its coal imports in September. Likewise, India continues to grow its net imports. And given the lack of indigenous supply, we believe that Indian imports will continue to grow over the long term.

The global benchmark project for metallurgical coal has moderated from recent record highs due to a combination of factors, much notably the recovery of Australian production after historic flooding in early 2011 and lingering concerns about the European debt crisis. However, the recent benchmark of $285 per metric ton for high-quality met coal remains one of the strongest prices in history. And while most analysts are predicting some further backwardation in 2012, we anticipate that the market will remain constructive for the foreseeable future given the structural scarcity of high-quality metallurgical coals around the globe.

The worldwide consumption of thermal coal continues to grow, fueled primarily by Asian demand growth. According to the most recent EIA estimates, global coal demand is projected to increase from 7.5 billion tons in 2011 to almost 9 billion tons by 2025, a 1.5 billion ton increase in just 14 years, with China accounting for 1.1 billion tons of additional consumption, but with India growing at the fastest annual rate. We clearly believe there's an attractive long-term opportunity to participate in the seaborne and thermal coal market. With 25 million to 30 million tons of export capacity, more than any U.S. producer, Alpha is uniquely positioned to take advantage of this growing demand for seaborne and thermal coal.

The domestic thermal market is somewhat less exciting. In the face of regulatory uncertainty, not just around CSAPR, but also in Maximum Achievable Control Technology requirements, utility buying has been muted compared to a normal shoulder season and competition from abundant, maybe even overly abundant natural gas is effectively creating a ceiling on Eastern coal pricing, which is tending to compress margins especially for higher cost production at Central Appalachia.

Fortunately, Alpha has been at the vanguard on this point. In this environment, it's critical that we execute our optimization strategy in order to ensure that we are running the most productive and profitable operations that we'll be able to dispatch economically in any market, and it's also critical that we leverage our industry-leading export capacity in order to place additional coals on the export market.

On the positive side, constrained buying on the part of the utilities has taken domestic stockpiles down to approximately 147 million tons, a level below the 5-year historical average.

Once the regulatory landscape settles down, the current inventory levels should lead to additional contracting activity, which should result in a more robust market for domestic thermal coal in the near future. With that, I'll now turn the call over to Frank, who will discuss our third quarter financial results and provide an update on our current guidance and our ongoing share repurchase program. Frank?

Frank J. Wood

Thank you, Kevin. Good morning, everyone. Coal revenues during the third quarter were $2 billion versus $0.9 billion last year, and total revenues were $2.3 billion compared to $1 billion in the third quarter last year. The year-over-year increase are primarily due to the inclusion of the first full quarter of legacy Massey operations and a 38% year-over-year increase in average per ton realizations on metallurgical coal.

During the third quarter, Alpha shipped 31.2 million tons of coal, including 5.9 million tons of metallurgical coal, 12.7 million tons of Eastern steam coal and 12.6 million tons of PRB coal. Average realizations for metallurgical coal were $168.49 per ton in the third quarter, up from $122.24 in the third quarter of 2010. Eastern steam coal realizations were $67.07 compared to $67.72 last year. And the PRB realizations were $11.98, up from $11.10 in the year ago period.

Total cost expenses were $2.2 billion in the third quarter, compared to $952 million last year and the cost of coal sales was $1.7 billion versus $665 million last year. Third quarter cost of coal sales included UBB charges of $11 million and closed mine asset retirement obligation charges of $37 million, as well as merger-related expenses, including a $40 million noncash charge from selling acquired coal inventories written up to fair value and acquisition accounting, and retention, severance and benefits alignment charges of $23 million.

Our per ton cost of coal sales has been adjusted to exclude these merger-related or unusual items. On a per ton basis, Alpha's third quarter adjusted cost of coal sales in the PRB was $10.34 per ton, compared to $8.57 in the third quarter of 2010, and the adjusted cost of coal sales in the East was $75.81 per ton, up from $63.04 in the year ago quarter, due to lower-than-expected production from our lower cost Eastern thermal mines, more metallurgical coal production, higher variable cost due to higher volumes and prices of met coal, higher purchase coal expenses, higher diesel fuel cost and general inflationary pressures.

During the third quarter, Alpha's adjusted weighted average coal margin was 22.8% compared to 26.2% in the year ago period. Alpha reported third quarter 2011 net income and income from continuing operations of $66 million or $0.29 per diluted share, compared with net income and income from continuing operations of $32 million or $0.27 per diluted share in the third quarter of 2010. Excluding $102 million of pretax merger-related expenses, $11 million of pretax UBB charges, $37 million of pretax closed mine and asset retirement obligation related charges, $62 million of pretax net unrealized mark-to-market gains on derivative instruments and a pretax net benefit of $73 million from amortization of acquired intangibles, a $5 million pretax loss in early extinguishment of debt and the $6 million tax effect resulting from these adjustments.

Adjusted income from continuing operations were $80 million or $0.35 per diluted share compared to adjusted income from continuing operations of $69 million or $0.57 per diluted share for Alpha standalone last year.

Adjusted EBITDA from continuing operations, which also excludes merger-related expenses, UBB charges, the mark-to-market impacts of derivative instruments and closed mine asset retirement obligation-related charges was $373 million compared to $205 million for Alpha standalone last year.

Capital expenditures during the third quarter were $142 million compared with $87 million for Alpha standalone in the third quarter last year. After these expenditures Alpha generated free cash flow, which we define as cash flow from operations minus capital expenditures, including LBA installment payments, were approximately $82 million during the third quarter of 2011.

Turning to a discussion of our current guidance. We are leaving 2011 shipment guidance ranges and most of our expense ranges unchanged. However, we are tweaking our DD&A range to $700 million to $750 million. And our interest expense range to $135 million to $140 million, compared to the previous ranges of $750 million to $780 million and $125 million to $140 million, respectively. We are also adjusting our Western cost of coal sales per ton to $9.80 to $10.20, up from a previous range of $9.60 to $10.

Based on the midpoint of our shipment guidance ranges, we are now essentially sold out for 2011, with 100% of our Eastern thermal coal committed and priced at an average realization of $66.75 per ton, 100% of our PRB output committed and priced at an average realization of $11.93 per ton, and 98% of our metallurgical coal committed and priced at an average realization of $162 a ton.

We have updated our 2012 guidance, and now expect to ship between 118.5 million and 131.5 million tons of coal. Including between 23.5 and 26.5 million tons of met coal, a 500,000 ton increase relative to our previous guidance. 46 million to 52 million tons of Eastern thermal coal, which has been reduced from our previous guidance range of 49 million to 54 million tons to reflect our optimization efforts and current demand. And 49 million to 53 million tons of PRB coal, a 4 million ton increase from our previous guidance range.

Based on the midpoint of our shipment guidance ranges, 89% of our met coal in 2012 remains open to pricing, while only 38% of our Eastern thermal coal and 8% of our PRB coal is currently unpriced. We expect the Eastern adjustment cost of coal sales to range from $70 to $75 per ton, and we expect Western adjusted cost of coal sales to be between $10.50 and $11.50 per ton next year. Our 2012 SG&A guidance is unchanged at $230 million to $270 million. We are guiding back our DD&A expense range $1.05 billion to $1.15 billion, compared to previous guidance of $1.1 billion to $1.2 billion, and we are fine-tuning our estimated 2012 interest expense to a range of $175 million to $185 million, compared with the previous $160 million to 175 million guidance. Finally, we are decreasing the lower end of our CapEx guidance to a new range of $650 million to $850 million, compared to the previous range of $700 million to $850 million. Finally, we remain on track to achieve our targeted synergies of $220 million to $260 million by midyear 2013.

So far in 2011, Alpha has purchased approximately $200 million worth of its common stock, including $179 million spent since the beginning of third quarter, with which we acquired 6.7 million shares at an average price of $26.74 per share. Of the $179 million, $79 million was spent under the $210 million authorization, fully exhausting that older authorization, and the remaining $100 million was spent under the new $600 million authorization announced in August of this year.

Including amounts spent in 2010, Alpha has now repurchased a total of $225 million since announcing its first repurchase authorization in May of 2010. We believe that shares of ANR continue to represent our outstanding value, and we will continue to pursue repurchase opportunities at attractive valuations.

As of September 30, Alpha's available liquidity stood at approximately $1.8 billion, including cash and equivalents and marketable securities of $766 million in addition to just over $1 billion of available under the company's various credit facilities.

Turning to our financial strength and flexibility, we continue to generate positive free cash flow as we have throughout our life as a public company. And our focus on consistently free cash flow generation remains a primary objective as we integrate the legacy Massey operations into the Alpha organization. As an industry leader with global scale, Alpha is dedicated to enhancing value for our shareholders over the long term. That concludes our prepared remarks. Operator, we will now open the call for questions.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question is coming from Brian Gamble of Simmons & Company.

Brian D. Gamble - Simmons & Company International, Research Division

Kevin, maybe you could give us your sense for how the international met market is behaving. You noted that you had solved the issues out of Asia, but given consistent I guess, these disturbances within the European markets, given what some of the steel companies have talked about on their quarterly calls. How do you see the met market rolling into next year? And if you want to differentiate between the quality met coal and then maybe some of the substandard stuff that would be helpful as well.

Kevin S. Crutchfield

I think Brian, what we're seeing right now is there's just a lot of uncertainty and the visibility is not certainly what we'd like to see. So far this year everybody's, other than the stuff we announced on September 21, the [indiscernible] issue hasn't been too bad. We continue to believe that there is a structural undersupply of the higher-quality metallurgical coals, not only in the U.S., but on a global basis. So right now our sense is that those are going to move. But there is a lot of uncertainty right now as it relates to what the ultimate demand is going to be. I think a lot of it's a function of whether Europe gets its problem sorted out and whether we have a view towards getting our problems sorted out here in the United States. But so far, clearly, I kind of characterize it generally as having solved and move a little bit, I think it's more driven by just the lack of visibility on what the economic cycle is going to look like. The recent transactions that we've completed here domestically in the last little bit are pretty positive. We still need to get some of those inked up. But I'm reasonably positive, and the higher-quality stuff is continuing to trade, the number is very consistent with what we're hearing on a global basis. I think it remains to be seen what's going to happen with lesser quality products. I think it's ultimately a function of demand. To the extent that there is demand, I think they'll move, and I think that's kind of our sweet spot, just given our met franchise. We have the ability to move those lesser grades of coal into the marketplace and at disproportionally less exposure there than some of our peers do. So all in all, it's certainly not ideal. But we're still in our view, a pretty healthy environment. Do you have anything to add to that, Paul?

Paul H. Vining

No.

Brian D. Gamble - Simmons & Company International, Research Division

Great. And maybe as a follow-up, you noted obviously that the Running Right is going well, turnover is coming down, but obviously it's still having some impacts of the PPOV side at some of the legacy operations. Any update you want to give as to your thoughts on either trying to divest some of those assets and/or idle some of those assets as you look forward in bouncing that with what you're committed to actually producing in some of those mines?

Kevin S. Crutchfield

Yes. I think the way to think about this is kind of a three-pronged approach. The first prong was this massive deployment of Running Right that we talked so much about. It's really been the centerpiece. We've conducted something on the order of 55,000 hours of classroom training. We've lost something like a couple hundred thousand tons of production associated with missed time, since folks are in the classroom and not running coal. We think that's a worthwhile investment. It's getting the benefits and weight structures synchronized, so we don't have folks working over the ridge from one another under different systems. So it's kind of a table setting exercise that we focused on very heavily here in the first few months. The second phase is really, really getting focused on these value creation opportunities that we've talked about, the synergies, the sales, the blending, the purchasing, the operating and maintenance synergies et cetera, as well as this, the rapid deployment of this optimization process. So that will be -- that's going to be all consuming between now and probably for the next 18 months or so getting in place to begin harvesting those significant value-creation uplifts that we've talked about pretty openly in the past. And then, we'll begin working ourselves into the third prong of the strategy which is, I think in very simple terms is, doing whatever it takes to protect the met franchise, looking through the results of the optimization work that we're doing, coupled with what I think is a pretty good understanding of not only the domestic, but the global landscape and creating a sustainable long-term thermal enterprise. And then beyond that, it's whatever is left, we're going to have to figure out what to do with from a value-creation standpoint. So the details of that are yet to come. We have a very talented group of people that is working on this very rigorously. But that is essentially our three-pronged strategy, Brian.

Operator

Your next question is coming from Michael Dudas of Sterne Agee.

Michael S. Dudas - Sterne Agee & Leach Inc., Research Division

Kevin, as you've have been asked for a few months, maybe you can characterize maybe 2 or 3 upside surprises that you've witnessed through the operating infrastructure, reserve quality, positioning with Alpha that you've seen so far in the last 3 or 4 months?

Kevin S. Crutchfield

I think probably the most rewarding thing that we've seen so far is how receptive 7,300 people have been to this Running Right system. I mean the stories that come out of this have just been overwhelmingly positive. And look, we're more than building a dam, we're talking about a culture shift, and it's going to take some time. But so far, the feedback on that has just been, it's really been nothing short of extraordinary. But again, it does take time to get it fully, fully in place and operational. With Alpha, I mean it's been in place now for 5 or 6 years. And I still fundamentally believe we've only scratched the surface of what that will ultimately lead to in terms of its potential. I think some of the other positive surprises is, is from a value-creation standpoint, the more we dig, the more we find. We've gotten more constructive around what we think we can do in the area of strategic sourcing. I'm not prepared to talk about that a whole lot today because we're still digging. We think there are some extraordinary maintenance types of synergies as you move from preventative maintenance into predictive maintenance and look at the fleets that we have deployed across the suite of assets that there's going to be tremendous opportunity there. I think this optimization process is going to be a real winner for us too. And unfortunately, it takes time because we're in the middle of a transaction, we're converging systems and those kinds of things. So you need to get data to make your decisions with. But we think there's going to be extraordinary upside there. We see it in the preparation plants, Massey's plants weren't well run, but we see organic efficiency upside beyond probably what we talked about to date. So we feel very positive about that. So I think all in all, it's being a massive undertaking, and clearly, scale and scope, way beyond anything we've attempted before, but I think we're approaching it the right way. And it's going to take some time. But so far, so good. Anything you want to add to that, Kurt?

Kurt D. Kost

Yes, just one other thing in terms of future potential, very excited about some of the quality of the reserves in the Marianna mines and maybe in the Rowland areas that we'll be looking at developing and bringing on to new production in the 2013-2014 timeframe. So we're very pleased with some of the drill hole information that we've seen and the progression of developing the Marianna property.

Michael S. Dudas - Sterne Agee & Leach Inc., Research Division

Kevin, you mentioned some very strong turnover improvement. How would you characterize your skilled quality, the quality labor needs at Alpha as a total company? Are you very short, just a little bit short, long and please? And will that turnover rate lessen the burden on you to keep and maintain some of the higher-quality employees that you have?

Kevin S. Crutchfield

Yes, I think the turnover rate is a function of -- I mean, you tend do a big transaction. There's a lot of anxiety and there's a lot of uncertainty. So think that in and of itself was a piece of it. But also I think people are getting more comfortable with, they're hearing the words around what Running Right means. But now they're, also now they've got enough time to begin to see the actions that back those up. We did some pretty strategic wage synchronization that I think went over well. Synchronized, haven't synchronized the benefits yet, but have announced that we plan to do that early next year. I think that was a factor in it. Look, we're still short, something in the mid-300s, which is down pretty considerably from where it was when we first kicked this thing off. And the good employees that are talented and skilled are still hard to come by. So our focus is keeping what we have and keeping them trained and prepared for the future. But also through an active redhead program, building our own, and I think through this optimization process, too as we find opportunities to shut-in production that perhaps isn't strategic for us or doesn't make sense for us, we'll have the opportunity to redeploy folks. And so we'll continue chipping away at that with the passage of time and feel pretty good about where that's headed.

Michael S. Dudas - Sterne Agee & Leach Inc., Research Division

And my final question is, when you look at your export potential, what does it looked like 2011 total export shipments might be for the combined company? And are you seeing significant logistics, transportation savings with some of the export opportunities expansions? And is there -- could there be upside to that capacity that you have given the world needs our coal so badly?

Kevin S. Crutchfield

Our pace, I don't know. I don't actually have a handle on them total or the absolute number of exports that we'll do this year.

Frank J. Wood

We're probably approaching 15 million when you throw in thermal. So that current price you got about [indiscernible].

Michael S. Dudas - Sterne Agee & Leach Inc., Research Division

Fair enough.

Kevin S. Crutchfield

So when you look at the met side, I mean, we're on pace to export about 3 quarters of that, it's been pretty consistent, therms, since the transaction. And we've always reserved the right to move that or calibrate that based on what we see domestically versus internationally, but I think that's a reasonable proxy going forward. Clearly, what we got to is ramp up our efforts just given the environment here in the United States to take advantage of our infrastructure to move more thermal coal internationally. We've got a great network. You're seeing the Gulf still advantaged in a lot of ways relative to going off to the East Coast and we're doing everything we can to maximize that. You can see that actually in the shipments to date out of the country, the growth in the, the tons flowing out of the Gulf has been pretty prolific. So I think the export space has really become a strategic foothold now for those that have access to it. And I will see that pressure continuing in the near to midterm when there's clearly have a lot to talk about, port expansions and the addition of midstreaming and moving coal frankly, out of the United States through the lakes, clearly a lot of talk continues on the West Coast. So the export capacity has become a real strategic foothold here just in the last 2 or 3 years. And I don't really see that changing anytime soon.

Operator

Our next question is coming from Shneur Gershuni of UBS.

Shneur Z. Gershuni - UBS Investment Bank, Research Division

Just a follow-up to some of Mike's questions. You've owned the Massey assets now for a little over 5 months I guess. Your guidance suggests that you seem to have a better understanding of the assets today. Where do you see the opportunities as you move forward on the existing run rate, or the existing production assets with that expansion, can you exceed 30 million tons of met coal? And kind of where do you see costs trending all else equal as we go into '12 and possibly into '13 from a trend perspective?

Kevin S. Crutchfield

Yes, 5 months and 2 days to be exact, not that I'm counting anything. I think this optimization process keeps going back to, I mean, it's going to be a very strategic process for us. We continue to affirm everything we've said about the future rates around met. When you look at kind of where we're guiding to in '12 at a midpoint looking at, the tons we're already producing now frankly are going to wind up to existing transactions. So it will free up in '13, the potential to move some additional [indiscernible] coal into the metallurgical marketplace, which is again not an unusual thing at all. Some of the new mines that we've got going on, some of the optimization efforts that we think will expand sections or productivity or production out of existing mines. We feel very comfortable about the range that we talked about for 2013. We'd like to think that there's upside in that, I'm not prepared to go that far just today. But if you could think back to the three-pronged strategy we talked about, protecting and bolstering where we can. The met franchise is really the name of the game for us for the next few years. So you can expect us to focus on that. So we don't see any reason why that's not going to be plausible in the coming year. The question will be then I mean to the extent you can create a 30 million ton met franchise, how can you move the needle from there? And I think it's a little premature to get into that a whole lot today.

Shneur Z. Gershuni - UBS Investment Bank, Research Division

Okay. A follow-up question maybe if you can talk about MSHA for a little bit. The former Massey assets had some challenges with MSHA. Management kind of having an adventurous relationship with MSHA. Can you talk about where the relationship now? Is it improving? Have they cut also a little bit of slack or if you can just sort of walk us through how it's transforming.

Kevin S. Crutchfield

I think as people will think back now, we said that MSHA was not going to cut us any slack and they didn't. I think, MSHA's doing what they think is right and what we're going to do is demonstrate that we know how to run these operations, we know how to run them in compliance. And I would expect over time that you'll see the violation rate fall. The incident rate continue to trend down, not as a function of MSHA backing off, but as a function of the fact that we're doing the right things. Maybe again, that's going to take some time. You can't turn this thing on a dime, but we've already, just the early signs out of this 5 months have been very, very positive in that regard. Alpha operations have typically -- we experienced a violation rate of something in the order of 0.5 to 0.6 per inspector day, where Massey's have been in the 0.8 to 1. I would expect to see that fall over time as we continue to emphasize that we're going to do the right thing here because it is the right thing to do. So I think it is, I think MSHA has a fair degree of respect for Alpha. I don't think I'm going to lie in saying that. But what we're going to do is just make their job easier in some ways, not harder than any of the others, they're just going to look a little harder to be able to find something to right. So they haven't backed off at all, as evidenced by the 2 PPOVs. But that gives us a platform to say that we're going to run this thing the right way, and if we can't, we just won't run them.

Shneur Z. Gershuni - UBS Investment Bank, Research Division

Okay. One final set of questions. You talked about in the past about negative free cash flow mines and the challenges related to some NYMEX contracting. Has there been any developments on that end? Have you been able to close out some of those contracts or if you can just give us an update on that, that would be great.

Kevin S. Crutchfield

Paul's a little closer to that, and I'm going to let Paul handle that one.

Paul H. Vining

Yes, I'd say that it's an ongoing effort in terms of managing the, primarily the OTC positions that the Massey book had that pretty much extends through '12 and a little bit into '13. We'd probably book out on the order of about 2 million tons or thereabouts, covering shipments both for this year and next year. In some cases we work for some of the counterparties, actually to price adjust to bring quality down that better suit some of our surface operations and create some value. So we've been really working it hard and continue to work it hard, and had a lot of cooperation on the other side of the fence.

Operator

Our next question is coming from Andre Benjamin of Goldman Sachs.

Andre Benjamin - Goldman Sachs Group Inc., Research Division

First question is around your reduction in Appalachia thermal volumes for 2012 and how much of that cut was driven by weaker demand outlook versus rising cost pressures given the wide range? Could you maybe speak a little bit to what would drive to the upper versus the lower end. And does that guidance fully reflect your view on the potential impacts to Alpha from CSAPR?

Kevin S. Crutchfield

Well. Part of this is really a function of balancing what we kind of see unfolding as the supply versus the demand picture. Part of it is giving consideration to what we think would be subject to optimization in 2012. And look, we have the ability to toggle out of the other direction under the right set of market circumstances. But we don't see that existing right now anyway. I think, however, with stockpiles having been, they're falling now back through kind of that magic 150 million ton level, we are in the shoulder season and are moving into where our output will start to see some additional activity there in the coming months. But this regulatory environment here in the United States whether it's CSAPR or MACT or collectively the train wreck as we call it, has created a fair amount of opacity in the marketplace and people are making decisions. Just looking at burn rates over the last year, kind of September year-to-date this year versus last year. The coal is off a little bit, gas is up, marginally, oil's way off, new trough. And some of that, this is long shot, think of the economy, but again I think some of that's a function to what we're seeing in the regulatory environment and with the economic slowdown, there's a little more inventory that's got to get burned off. But it's nice to see the overall stockpiles falling back below of 150 million tons. So hopefully, we'll see some activity, some picked up activity next year. But our goal is to balance our production with what we anticipate to be the perceived demand, and not try to force it into what is already a tedious market.

Andre Benjamin - Goldman Sachs Group Inc., Research Division

So if CSAPR goes through as its currently proposed with, should we expect a change in your views? Or is it already in there?

Kevin S. Crutchfield

I think it's in there for now. I mean long term, we got to assess what we think ultimate CSAPR is going to look like. There's been a fair amount of blow back as everybody's seen around CSAPR. There's been something like 45 different petitions filed to either stop it or modify it materially in some ways. So I think it remains to be seen exactly what's going to get implemented in 2012. But we continue to -- as we talked about at our Investor Conference back in, whenever that was several months ago, I mean we talked pretty openly about what we thought the potential of, not particularly CSAPR. Well, it wasn't CSAPR at the time, but what the train wreck set of regulations could mean for the domestic coal business. And I think we were pretty forthright in what our views were there. But what we've done as a result is alter our marketing strategy to ensure that we're aligned with folks that are going to be continuing to burn coal and removing our focus off of some of the others that potentially are on.

Andre Benjamin - Goldman Sachs Group Inc., Research Division

And then a similar question on the cost guidance. How much of the range is driven by just a mix issue with your met versus thermal volumes versus demand or effectiveness of productivity improvement efforts?

Frank J. Wood

Yes. There's a lot of things that go into that mix. I mean obviously, volume is a big determinant of our cost. So as our cost, as we move below the midpoint of a range, let's say, that will tend to push the cost towards the higher end of the range. Obviously, also the mix of met versus steam as we've seen this year also tends to increase our cost generally. So we try to bake that into the cost guidance. I think the other wild card that's sort of in the cost guidance, we tried to incorporate into the range is the degree into which we use purchased coals, which we will use them fairly consistently overtime. And then secondly, what those purchased coals cost because they're a volatile component of the cost. But we think we've baked in all the relevant factors. And in addition, we do expect to start to realize some of the effect of synergies and optimization on the cost mix as well as we go through 2012.

Kevin S. Crutchfield

I think as we go through this optimization process what will necessarily happen is, I mean, there's principally, there's no secret, it's principally our costs, Eastern thermal and so what you'll do is you'll move your cost structure down for your thermal portfolio. But as you reduce that portfolio, met becomes even a bigger player in that so it's a competing constant factor in what the resulting cost structure is and the specifics could be.

Operator

Our next question is coming from David Gagliano of Barclays Capital.

David Gagliano - Barclays Capital, Research Division

I was just wondering, you mentioned the regulatory environment continuing to slow things a bit. And my question is how much of your 2012 volume targets are dependent on improvements in things like regulatory, in sequencing, regulatory, things like that? And can you break that down between met and thermal?

Kevin S. Crutchfield

If anything, we have projected for 2012, it's not subject to what we have affectionally refer to as the permatorium, for example. We feel pretty good about what we already have permitted and in place now for several years. So there's nothing that's in 2012, but it's contingent upon any sort of regulatory relaxation or need.

Operator

Our next question is coming from Jim Rollyson of Raymond James.

James M. Rollyson - Raymond James & Associates, Inc., Research Division

Kevin, just circling back to your comments about met qualities from earlier. If we look at the 39%, you've got booked for next year, I guess assuming the midpoint, maybe a little bit of color on what the other 61% just in terms of qualities. What's booked? What's open? So we can kind of think about that from a mix standpoint?

Kevin S. Crutchfield

I'm sitting here looking at Paul. Hoping he can provide some color there, Jim.

Paul H. Vining

Now I'll tell you, we've got 11% committed and there's another portion there that's committed and priced, another portion that's committed and nonpriced. But we, given that we're knee deep, sort of, in a lot of our negotiations domestically here, we're not really in a position to try to break down qualities and the types of coal because it really isn't something we want to have out there.

Kevin S. Crutchfield

And it tends to get out ratably too, it's not like there a portion of the year where it's taking mid-vol rating season, and then you do a low-vol rating season and then a high-vol rating season, it tends to move pretty ratably through the course of the year.

James M. Rollyson - Raymond James & Associates, Inc., Research Division

I just didn't know if you have particularly sold some negotiations over there, but I understand. On the buyback, you guys obviously have continued to run through that pretty well during the quarter. Just kind of curious given that your stock’s roughly around where you averaged in buyback for the third quarter, how aggressive you want to be on the remaining $500 million?

Kevin S. Crutchfield

Yes, it's conversation that it's ongoing with our board, and we got a meeting coming up here in a few weeks, plan to continue to have ongoing discussions around that as we indicated. We still have $500 million left. And I can guess what I'd say is, we'll evaluate the purchase of our shares, just like any other financial decision. But we continue to believe that the intrinsic value of Alpha is very good at these levels. I don't want to foretell any additional buying. I don't want to cut off any thought there we have in mind because we haven't had a discussion with the board. Suffice it to say that we believe it represents a very, very good value or we're trading early.

James M. Rollyson - Raymond James & Associates, Inc., Research Division

Helpful. And Frank, share count today post all the buybacks so far?

Frank J. Wood

Yes, well, let me think, I don't really have an exact number. The weighted average obviously for the third quarter for diluted purposes was about 226 million. It'll be marginally below that because of the pace, because a lot of shares we bought back were toward the end of the quarter. So it only reflected to a limited extent in the, but I don't have an exact number for you, Jim.

Kevin S. Crutchfield

We can follow up. We can get an answer for you.

Operator

Our next question is coming from Brett Levy of Jefferies & Company.

Brett Levy

And most of my questions have been answered. In terms of like the rate at which is the $220 million to $260 million of synergies come on, is that a straight line? Have you got some amount of that sort of baked into the current numbers? Just give a sense as to sort of when that rolls into the P&L?

Kevin S. Crutchfield

That's a good question. I think we've talked about it in terms of kind of $150 million run rate for '12 building up to that crescendo of $220 million to $260 million by mid-2013. Part of it is discovering what the art of possible is, and we think we got a very good handle on that. Now it's putting execution plans in place to go harvest those. So some, for example, like the efficiency gains on the preparation plant, some of that is just a change in operating methodology and some of it requires capital investment of that which is just an operating change will be harvested pretty quickly, and that which requires some capital will take a little time to get the money spent and to get the infrastructure put in place. So I see no reason whatsoever that we won't hit the numbers that we've talked about. The goal would be to comfortably exceed them, consistent with our track record at Foundation, for example. So that's kind of the glide path that we're thinking about in terms of the synergies. And of course, on top of that, you've got the optimization activities and the capital allocation process that we've instituted to ensure that capital is being expended wisely.

Brett Levy

And then the other one is a broader situation question. And there's been a lot in the press about more natural gas percentage of power generation in the United States by 2020, less coal, the regulatory environment that drives that. Can you guys talk about why you feel that thermal coal is a more defensible position than maybe some of those articles indicate?

Kevin S. Crutchfield

Well, look, we've been in a battle with natural gas now for several years, and we've clearly lost some market share to natural gas. I think the regulatory environment is such that it's not a clear path to build natural gas, but to the extent you have to make a decision that's probably the only decision you can make in the current regulatory environment. I think where we are now in terms of losing additional market share is you have maybe, it gets nipped around the edges. But I think the amount of change that's occurred is largely it, beyond again just some tangental nipping around the edges because you have to look where the gas is, where the pipes are, or where the gas burners are and where the population that needs the additional electricity is located. And I think that's, they've got a whole lot of left there to do. But what's clearly happening in this gas environment is it's placing a ceiling on particularly Eastern coal, what that's going to be priced for. So we'll, I don't know what it's going to look like long term. Clearly, the current administration through their regulatory approach, regulatory fiat, whatever you want to call it, is focused on picking winners and losers. And they certainly don't want coal to win. But at the end of the day, we've got a good asset portfolio, and I think we can prune it appropriately and end up with a world-class met franchise, sustainable and durable thermal franchises. We continue to think about the strategic implications for the company and the future.

Operator

Your next question is coming from Lucas Pipes of Brean Murray.

Lucas Pipes - Brean Murray, Carret & Co., LLC, Research Division

My first question is kind of a follow up on your thermal coal guidance for 2012. The lower volumes, what is that a function of? Are you throttling back production across your portfolio? Or are you taking off some high-cost mines to get the volumes to the new range?

Kevin S. Crutchfield

As I mentioned earlier, some of it's a function of matching what we perceive as demand with our supplies so that we'd dispatch appropriately. Because the last thing you want to do is try to force tons into a marketplace that doesn’t really want them. Some of it is a function of this optimization process, potentially a slightly skinnier, Eastern thermal footprint than what we thought originally, which is a function, it's the environment that we face. And we could continue to throw out targets, meaningful targets if we wanted, but our goal is to throw out targets that we think makes sense and that are achievable and makes sense under the current market environment.

Lucas Pipes - Brean Murray, Carret & Co., LLC, Research Division

That's helpful. And just on the cost side, if I look at the $70 to $75 per ton for 2012, could you kind of give us a cost bridge. How you get there from Q3 cost down to those levels next year?

Frank J. Wood

Yes. Well, Q3 is a little bit above the upper end of that range on an adjusted basis of about $75 to $81. So if you go to the midpoint, I guess you'd be going for about $75 to $81 down to $72.50 which is roughly $3. I think a lot of it interrelates with some of the items that we sort of played a little bit this year. I think we anticipate some level of better productivity, which will have an impact on the cost, along with the turnover in some of that sort of thing. The percent of sales will remain relatively the same. So I think a lot of it's really related on really the productivity. Productivity and maybe overtime to somewhat the mix of the properties. The longwall operations will have some more positive effect in 2012 than what they've had in 2011, as we get more stable production out of Emerald. Although we're guessing a little bit, also purchased coal probably won't be quite as much a driver as it was this year.

Lucas Pipes - Brean Murray, Carret & Co., LLC, Research Division

Could you give us maybe a number for the amounts, purchased coal you had in the third quarter and what the cost was of that?

Frank J. Wood

We got, I think in the guidance table, the 3 million to 4 million tons a year is what we normally guide to and basically, what we've doing is in that range.

Kevin S. Crutchfield

And the purchased coals for us are as much an enabler of arbitrage as, if anything. We could store, I think we've hit a high of, in excess of 6 million tons one year, I think it was in 2005. So I think it's probably always going to be in that 3 million or 4 million range at a minimum that market circumstances, if I went back and. Our purchased coal prices are really a function of what's the prevailing market conditions as much as anything. We back and we buy for different reasons. But they'll oscillate along with the market generally speaking. But we think we can create additional value through our blending capabilities by introducing these purchased coals into the mix.

Lucas Pipes - Brean Murray, Carret & Co., LLC, Research Division

Then just my last question really quickly, there's repeated chatter about you selling some thermal assets. Can you maybe give us an indication of what the interest is in Central Appalachia for thermal assets at the moment.

Kevin S. Crutchfield

Well, look, I think the level of interest is high. All we're willing to say today is we have a process, we want to be very thoughtful about the process and approach we take. We're focused on what I said earlier, which is the met franchise and a durable, sustainable thermal franchise. And to the extent there's anything left as we go through that process then we'll be subject to other value creation types of exercises that as we might deploy at the time. But we got to work our way through the process and what we'd do is pledge to keep you posted as we do work our way through that.

Operator

Our next question is coming from Mark Levin of BB&T Capital Markets.

Mark A. Levin - BB&T Capital Markets, Research Division

Hey, gentleman, just more macro-related question. Yesterday at the McCloskey Conference down in Florida, there were some discussion that U.S. met exports could come in 10% to 15% next year, just given sort of the way that the macro is shaping up. Just curious, Paul, your perspective on that as you kind of see what the U.S. met export situation could look like, speaking on a more macro level 2012 versus 2011.

Paul H. Vining

Well, to be honest with you I haven't -- didn't have anybody down there, don't know the context of the discussion. But if I look at '12 compared to '11, I'm still pretty optimistic we're going to hit or exceed the volumes we saw this year. I think the first quarter of this year, we were just building momentum and there's a country at least and really started to hit strides, second, third quarters so, I don't see things backing off in '12 relative to total tons. Now they may move around, maybe a few less tons go into Europe and a few more tons going elsewhere in the world. But I still see a lot of opportunity.

Operator

And our final question is coming from Meredith Bandy of BMO Capital Markets.

Meredith H. Bandy - BMO Capital Markets Canada

I just wanted to go back and ask a little bit more on the improvement you've seen in the Massey operations. You mentioned the legacy -- the incident rates are declining. Have the seen any improvement in the inspection hours and violations? I know you've gave the, Kevin you gave us the 0.8 to 1. Is that a previous number for legacy Massey? Is that the current, has there been improvement there?

Kevin S. Crutchfield

Yes, that's a previous kind of run rate for the legacy Massey operations, and it's trended down slightly, although I wouldn't say enough to report on.

Kurt D. Kost

We haven't seen a significant decrease in, or violations per inspection day. The main metric that we're focusing on right now, obviously, is the injury rate and that rate is definitely trending in the proper direction.

Meredith H. Bandy - BMO Capital Markets Canada

Right. And have you seen, like, is the violations per inspector day are the same? Like, have the inspector days also have been the same? Or have you seen any improvement there?

Kurt D. Kost

The gross number of inspection days per month have decreased, and I guess on one hand, the S&S or non-S&S citations per inspection day haven't really decreased, but the number of the severity of the citations have decreased. We've seen a significant drop in the number of D orders on a monthly basis, so that's another positive trend that we are proud of.

Meredith H. Bandy - BMO Capital Markets Canada

Okay. And if you said you speak with, when you talk about getting the mines off PPOV, what does that entail? What do you need to do to get a mine off PPOV?

Kevin S. Crutchfield

It's a pretty prescriptive process, and I think can articulate a reason as well, but you have a 90-day cycle to demonstrate from a safety perspective violations as well as your, some safety incident rate to be able to demonstrate why you should be taken off of PPOV. So you have very discrete criteria you have to meet to be removed from the PPOV, and I don't want to say anything about how those mines are tracking. The tracking period actually didn't begin, was it October 1?

Kurt D. Kost

October 1, for 90 days.

Kevin S. Crutchfield

Yes, so we're just 32, 33 days into it now. So we put in place what we believed to be a very robust plan for these mines to improve and I'll just leave it at that for now.

Operator

Thank you. At this time, I'd like to hand the floor over back to management for any closing comments.

Kevin S. Crutchfield

We want to thank you again for your interest and ongoing support of Alpha, and we look forward to updating you in the future on our progress around the integration and achievement of synergies and value realization for our shareholders. So thank you very much, everyone, and have a great day.

Operator

And this concludes today's teleconference. You may disconnect your lines at this time. Thank you, all, for your participation.

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