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Executives

Paul Blalock - Head of Investor Relations

Walter J. Scheller - Chief Executive Officer, Member of The Board of Directors, President of Jim Walter Resources and Chief Operating Officer of Jim Walter Resources

Robert P. Kerley - Chief Accounting Officer, Vice President and Controller

Daniel Paul Cartwright - President of Canadian Operations

Michael T. Madden - Senior Vice President of Sales & Marketing

Charles C. Stewart - President of Walter Coke Inc, President of Walter Minerals Inc, Chief Operating officer of Walter Coke, Inc. and Chief Operating Officer of Walter Minerals Inc.

Richard Allen Donnelly - President of Jim Walter Resources

Michael Griffin -

Analysts

Andre Benjamin - Goldman Sachs Group Inc., Research Division

Wes Sconce - Morgan Stanley, Research Division

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

Brian Yu - Citigroup Inc, Research Division

Timna Tanners - BofA Merrill Lynch, Research Division

David Lipschitz - CLSA Asia-Pacific Markets, Research Division

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

Lance Ettus

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

Paul Forward - Stifel, Nicolaus & Co., Inc., Research Division

Mitesh Thakkar - FBR Capital Markets & Co., Research Division

Michael Goldenberg - Luminus Management, LLC

David E. Beard - Iberia Capital Partners, Research Division

Mark L. Parr - KeyBanc Capital Markets Inc., Research Division

Shneur Z. Gershuni - UBS Investment Bank, Research Division

J. Christopher Haberlin - Davenport & Company, LLC, Research Division

Walter Energy (WLT) Q1 2012 Earnings Call May 3, 2012 9:00 AM ET

Operator

Welcome to Walter Energy's First Quarter 2012 Earnings Call. [Operator Instructions] I would now like to turn the meeting over to Mr. Paul Blalock, Vice President of Investor Relations. Sir, please begin.

Paul Blalock

Thank you, Elan. Good morning, all, and thanks for joining us today. This call is being webcast live over the Internet, and a recording will be available and archived on our website.

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

Joining me on today's call are Walter Energy's CEO, Walt Scheller; and Chief Accounting Officer, Robert Kerley; as well as other members of the management team, who will be available for Q&A. Walt?

Walter J. Scheller

Thanks, Paul. Good morning, everyone, and thank you for joining us. As we always do, I'd like to start today with a brief report on safety, which always comes first at Walter Energy.

U.S. operations reduced the total reportable injury rate by 16% in the first quarter. In our Canadian operations, the reduction was 5% compared with the year ago.

Across the entire Walter community, we strive to ensure a safety culture for our employees and in the communities where we operate. In that regard, I am also pleased to share with you that just recently, on April 20, the Chief Inspector of Mines from the Ministry of Natural Resource Operations in British Columbia awarded our coal mine the Edward Prior Safety Award for 2011 as recognition for Brule's dedication to the safe operation of all aspects of its mining operations.

Turning now to our results. First quarter met production of 3 million metric tons was the best in Walter's history and represents a 23% increase from the 2.4 million metric tons produced last quarter.

Just one year ago, prior to the acquisition of Western Coal, Walter produced 1.5 million metric tons so compared with last year, met coal production has doubled. Of the 3 million metric tons produced this quarter, 80% was hard coking coal, and clearly, we are off to a solid start to achieve our 2012 production target of 11.5 to 13 million metric tons.

Walter is also focused on reducing cost, and in the first quarter across all of our properties, the cash cost of hard coking coal decreased 12% to $116 versus $132 per ton in the fourth quarter last year. In the U.S., cash cost fell 7% and in Canada, cash cost for hard coking coal decreased 14%. While these cost reductions are a solid start to the year, we anticipate even further progress as we optimize our existing operations and mature our start-up projects.

It is also important to mention that Walter's focus on enhanced met production and reduced costs is occurring at the same time that global met markets are stabilizing. We are beginning to see signs of strengthening demand for our hard coking coal, as well as improved pricing.

While I believe that global met markets on a year-to-date basis can certainly be described as choppy, over the past few weeks there have been some positive signs.

Improvements in global steel pricing, reductions in steel inventories and the tightening of met supplies have led to increased global prices and have reversed the declining trends that I know many investors had feared.

Recent reports indicate that global steel utilization hit 81% in March and steel production in the top 10 producing countries was up 10% month-over-month.

In Europe, while the market has remained spotty, our customers' products continue to be in high demand, and concern over economic uncertainty has been reduced. In South America, steel production is increasing but currency issues remain a factor. In Asia, our customer relationships remain strong. Demand is returning, and we see renewed requests for additional shipments.

Walter's focus on long-term supply contracts continues to serve us well. We are jointly marketing our suite of products on a global basis to our diversified mix of customers, and we continue to work closely with them to fulfill their customer-specific needs.

I am also pleased to report that in early April, we contracted a shipment with a strategically important new customer at slightly above second quarter benchmark prices.

This sale was a combination of our Mine Nos. 4 and 7 coals shipped to an Asian buyer familiar with our high-quality coals. As compared with fourth quarter, Walter's contract pricing in the first quarter for hard coking coal decreased 7% to $226 per ton and was slightly better than we'd projected about a month ago in our first quarter outlook issued on March 26. However, as we indicated in that outlook, met coal sales of 2.4 million metric tons in the first quarter would be unchanged from last quarter.

Switching now to operations. We made solid progress in the first quarter. I would like to address a few key highlights. Recently, Rich Donnelly and his team in the U.S. received MSHA approval for new ventilation planned for Blue Creek Mine No. 7 in Alabama. Since then, mine production has improved significantly, and the longwalls have been operating within normal parameters.

Also the E2 panel has now completed its mission and was an important contributor in driving strong first quarter production. The new E3 panel will now optimize its production over time, and the mine will benefit from reduced operational complexity.

At Mine No. 4, we are in the second year of relatively short longwall panels and have several moves planned for this year, including a move in the second quarter.

Moving on to Canada. We had a solid quarter in hard coking coal production and improvement in costs. Dan Cartwright and his team are maturing these operations, and we are investing for the future.

At Wolverine, hard coking coal production was 400,000 metric tons, and as I mentioned before, cost per ton decreased about 14%.

At the Willow project, production was limited in the quarter and costs were impacted by the scheduled wash plant outage that was necessary to upgrade its ability to process hard coking coal. The upgrade was successfully completed, and during the quarter, we saw improving trends on a month-to-month basis. We also moved Willow from a contractor-operated mine to an owner-operated mine. And while we were successful in retaining 90% of the workforce, we did incur some duplicate costs during the quarter.

As many of you know, both Brule, a PCI mine, and Willow share a common wash plant. To date, Willow has primarily produced PCI coal. However, over its life, Willow is projected to produce almost half of its production in premium low-vol hard coking coal, which is similar in quality to Mine No. 7 in Alabama. In the coming quarters, Willow is anticipated to tap the high-quality, low-vol hard coking coal seams. The wash plant upgrade was successfully completed, which will allow for the processing of this low vol hard coking coal as we move forward.

At Brule, production of PCI was solid in the first quarter, and you may have already noticed that we provided enhanced cost detail this quarter to provide greater insight into PCI cost. Dan Cartwright and his team in Canada are pushing hard to complete mine development operations, improve drilling efficiencies, utilize new trucks and shovels and execute on a complex mining plan.

In summary, Walter Energy safely mined 3 million metric tons of met coal in the first quarter, our best in history. Hard coking coal costs declined in both the U.S. and in Canada, and in the coming quarters, we aim to sell more coal, further reduce costs and improve our profitability.

Now I'll stop to allow Robert Kerley to further discuss our financial results, and then I'll provide some additional comments before we begin taking questions. Robert?

Robert P. Kerley

Thank you, Walt. To focus on the financial results for the quarter, although sales tons were flat, I should highlight that our first quarter 2012 financial results, when compared with the fourth quarter of 2011, showed a reduction in revenue, net income, fully diluted earnings per share and EBITDA, all primarily due to lower contract pricing and a loss in our equity investments.

On a positive note for the quarter, we reduced our cash cost per ton on hard coking coal by approximately 12% overall.

First quarter 2012 EBITDA was $144 million, lower than the fourth quarter of 2011 by $63 million. This decrease was primarily driven by approximately $46 million in lower pricing combined with an approximate $13 million swing in the impact of our equity investments.

The first quarter of these factors impacted revenues and both impacted net income and fully diluted earnings per share. Another factor impacting our financial results specific to Canada PCI was the higher cost layer of inventory from fourth quarter of 2011, which rolled into the first quarter financial results as that inventory was sold.

As we move through the quarter, our production costs have improved, and that improvement is anticipated to benefit our results in the second quarter of 2012 as that inventory is sold.

I would also like to highlight a few other noteworthy items. The tax rate in the first quarter was 17.6% as a result of the geographical mix of our individual international income and losses and the differing geographic effective tax rates that such income and losses are subject to. We currently anticipate an effective tax rate of approximately 18% for the full year of 2012.

Additionally, the first quarter of 2012 was the last quarter of purchase price accounting refinement related to the Western acquisition. As a result of final refinement around the purchase accounting for Western, we have modified certain balances and related financial results for 2011. These modifications were only related to the final refinement of the purchase accounting and had an approximate $14.4 million favorable impact on retained earnings and no impact on EBITDA for the year ended December 31, 2011.

As a result of the above, first quarter depreciation and depletion of $67 million is a reasonable quarterly estimate for 2012, adjusted for changes in production.

Lastly, as mentioned, hard coking coal comprised 80% of first quarter production, and I would point out that the cash margin for hard coking coal is $110 in the first quarter. The breakout of Willow from our overall PCI results in Canada also demonstrates that PCI cash margin, excluding Willow's limited production, was $29 per ton.

Willow was impacted by an approximate 2-month planned upgrade at the processing plant. This resulted in minimal production during those 2 months, and the bulk of the operating costs for those months went directly to cost of sales versus being absorbed into inventory and resulted in an approximate $20 million period expense when compared to the expected financial results post-upgrade.

If we back out the impact of the $7 million loss on our equity investments and the impact of the shutdown at Willow of approximately $20 million, on a more normalized basis, our diluted earnings per share would have approached $1.

I will now turn it back over to Walt.

Walter J. Scheller

Thanks, Robert. First quarter results clearly demonstrate that met production at Walter is improving, met costs are decreasing and the global environment for hard coking coal, which comprised 80% of first quarter production, is improving. No other coal company has a met focus like Walter Energy, and in my view, the strong margins we generate on hard coking coal will continue to make us a one-of-a-kind coal company.

I'm also pleased to share that we are making good progress integrating and operating as one company throughout the Walter family.

Regarding senior management, I expect the team to be completed in the near future and in particular, I have some internal developments to announce.

First, Tom Lynch who has a solid track record at NRG Energy and IBM has joined us as head of Human Resources. Also, Carol Farrell, who has served in various financial roles within the Walter organization and is very familiar with the coke business, has recently taken over as President of Walter Coke. And Chuck Stewart, the former President of Walter Coke, has moved into a new role to oversee project development for Walter. Chuck has assumed responsibility for the development of the Aberpergwm mine in Wales and has already made significant progress on the place with this important and interesting anthracite project.

In addition, Chuck will manage the Belcourt-Saxon partnership with Anglo American in Northeast British Colombia, which is a large development in the Peace River basin. Finally, he will lead the development of the new Blue Creek Energy Mine No. 1 in Alabama.

I should also mention that recently, the Alabama legislature passed new incentive tax legislation impacting new coal mine developments like the Blue Creek Energy project, and the governor signed into law a new provision which has significantly reduced the overall cost of this new mine. As you may recall, this mine will be developed in the Blue Creek seam here in Alabama with which we are very familiar. These coal reserves were part of the Chevron transaction that we completed last year.

In addition, we will complete the development of a new terminal in Mobile from the property we purchased last year, providing us additional shipping capacity.

Lastly, today's results clearly indicate that Walter is making solid operational and financial progress. Our focus on safely growing our met production this year is beginning to pay off. We are on track to reaching our 2012 production target of 11.5 million to 13 million metric tons.

Longer term, Walter's current met operations in the U.S., Canada, and the U.K. have significant room for further growth, and when combined with our strong project pipeline, Walter Energy has the potential to produce more than 20 million metric tons annually by the end of the decade.

Thank you for listening. The team and I will now be happy to take your questions. Operator, please open up the Q&A.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question today is from Andre Benjamin from Goldman Sachs.

Andre Benjamin - Goldman Sachs Group Inc., Research Division

My first question. I appreciate that you're starting to make some progress in some of your operations in Canada, and you have some, if not aggressive, but ambitious goals of continuing to reduce those as you go to the end of the year. Just wondering how -- I guess, what the pace of improvement you're anticipating. Do you expect all that to accrue in the second quarter or is it something that we should think will happen steadily through the course of the year?

Daniel Paul Cartwright

This is Dan Cartwright. I'm the President of Canadian Operations. If I could, I'd like to make a few just introductory comments I think that help frame what we're doing for the year in Canada that will be helpful here. During the first quarter, we got off to a good start at being the best-in-class in Northeast British Columbia coal business. And our goal is to lay the foundation for a sustainable continuously improving performance. The things that we had to accomplish in the first quarter and get complete and behind us had to do with Willow, with completing the preparation plant that we got there, as well as some of the other construction that we had, and the biggest piece that we had was converting early from a contractor-run operation to a company-run operation. And we did achieve a number of these things that we had across our platform. Brule, Walt mentioned the Safety Award that we won. That's a very prestigious award of British Columbia. We reduced our hard coking coal results from Q1, 14%. Our Wolverine team achieved that. I mentioned the early conversion from contractor to company. Our prep plant now allows us to do hard coal -- hard coking coal processing at Willow. In Brule, our production costs, which are a precursor to the cost of sales that we published, were reduced from Q4. Our throughput over the Falling Creek Connector Road improved from Q4 to Q1 from 1,900 to 2,500. And our first powered trailer that's going to allow us to haul double trailers, essentially doubling our payloads, is now being perfected on the road. So we've got a number of things in process for the first quarter. And then the systems, and I think that's what you're getting to, that we're putting in place that are really going to give us the sustainable improvement over the long term, involved the things that I mentioned in last month's call: mine planning, performance management that measures our execution plan and how well we're doing on a daily basis of performing that mine plan, reliability-centered maintenance, enhanced cost management tools and an integrated supply chain management improvement process. So there's a lot that we have to get complete and behind us even still in the year, but in answer to your question, we are -- we will see sustained improvement through the year, but it's going to be a slow but steady improvement as we put these fundamental things that I mentioned in process.

Andre Benjamin - Goldman Sachs Group Inc., Research Division

That's helpful. And then I guess on the demand side, if someone could comment on what you're seeing in terms of the differences between demand from Europe and Brazil versus Asia. And then in terms of the pricing for the Canadian operations, are you seeing any pushback on the differentials you're being forced to take on some of the PCI sold under China?

Michael T. Madden

Yes, this is Mike Madden, Senior VP of Marketing. Well, on the demand side, we're actually seeing an uptick, not on a pushback right now. We've gotten locked in on a benchmark for all of our high-grade met coal, and on PCI we also achieved in the benchmark numbers of the 150s, so that coal is moving very well into Asia. Demand is good. Europe, we're seeing -- actually we're actually seeing a couple of customers in Europe now coming back for Q2, asking about additional cargo. So overall, we're seeing a pretty good market out there developing right now.

Operator

Our next question is from Wes Sconce from Morgan Stanley.

Wes Sconce - Morgan Stanley, Research Division

This one's for Walt. Could you discuss the Blue Creek project a little bit? There were some headlines that this is going to be a $1.2 billion project. I'm wondering if you could quantify some of the offsetting development revenues or tax breaks that might be associated with it. And I take it that the net outflow is going to be some number less than that $1.2 billion. Is that the right way of thinking about it?

Walter J. Scheller

Yes, it is. And I'm going to turn that question over to Chuck Stewart since he's going to be in charge of the project moving forward. Chuck?

Charles C. Stewart

Like Walt said, I'm Chuck Stewart, new Senior VP of Project Development. Yes, this project has got several things that offset it. And I think the timing of the governor's press release sort of makes it sound like this is a somewhat new project. And as you know, we've been working on this development. It's the last large block of Blue Creek reserves in this state or in the country. And we've been working on this for several years. The acquisition of the HighMount gas company, which has wells in the area; the Mobile River Terminal we purchased last year to have throughput for this coal; the acquisition of Chevron last year, the North River mine, to give us the reserve base we need has all been taking place over several years. And our whole capital structure, capital expense plan going forward, has kept this project in line. We've built this around it. In the next couple of years, you'll see us slowly ramping up our capital spend. It will be about 2015 probably before we get into spending the majority of the capital. And by that time, we'll see some of our major projects that are currently in development in Wales and in Willow Creek starting to reach maturity. So we'll see the spend drop off at those 2 while we take on the capital spend at this operation. As far as breaking out the cost, we're estimating probably $600 million in CapEx for equipment and shafts and slopes at the mine, about $400 million in capital development for the underground operation to get us to the longwall stage. And during that time, you're right, we will have coal that's being mined offsetting that. I don't have the exact figure -- between $100 million and $200 million, probably in revenue generated from those coal sales. In addition to that is the large tax benefit we'll receive from this. And that -- we'll start to see that even as we make our capital purchases in the next year or 2.

Wes Sconce - Morgan Stanley, Research Division

I appreciate it. And then maybe as a follow-up for Mike. Is the interest you're seeing from Asian mills for your Alabama coking coals a direct result from the labor disruptions in Australia? And are your discussions progressing for more spot-type business to -- and more towards term contracts?

Michael T. Madden

Actually, the business we locked in, in Asia is not spot. It's actually a term contract for 3 years, and it is clearly predicated in that, that benchmark pricing would apply. So we're not subsidizing that coal at all. And I think that's mainly being driven somewhat by the labor issues in Australia, but definitely more so on further diversification out of Asia.

Wes Sconce - Morgan Stanley, Research Division

Great. And you mentioned you're not taking -- you're taking benchmark. Does that mean that the mills are eating a freight differential?

Michael T. Madden

Most definitely, yes, because the freight from Mobile into Asia right now is probably in the $20.

Walter J. Scheller

Wes, I should follow up on the tax incentive. That will allow us to recapture approximately 50% of the capital invested in the project. So if the capital results in about $1.2 billion, we will be able to recapture about $600 million of that over a 20-year period.

Operator

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

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

Can you talk a little bit about, I guess, developments for the rest of the year in Alabama? You mentioned Mine No. 4 and the longwall moves, including the one in the second quarter. But given the strength in the first quarter, I guess not completely offset by sales, you've got to go through production versus sales for the next couple of quarters given just your operational expectations for this month?

Richard Allen Donnelly

This is Rich Donnelly, President of Jim Walter Resources. Just talk quickly about 4 and 7. 7 Mine, as you know, we've just completed the E2 panel. E2 is the panel that caused us all our troubles last -- most of our troubles, anyway -- last year. The first quarter benefited from the operation of 3 longwalls. As we go forward at 7, we'll be back to our traditional 2 longwall operations. So the 2 existing longwalls we'll be ramping them up to try and make up that difference. Both of them are operating very well right now. We'll continue to try and increase productivity. The E3 panel particularly is into the zone where E2 ran into troubles last year. The new equipment's performing very well. We don't see any real issues with it. So right now, we're pretty positive about it. As far as 4 Mine's concerned, the mine's running well. We do have several short panels, so throughout the year we've got several longwall moves. We'll be running that mine in the 2 million-ton range, similar to what we did last year. Right now, on both fronts, we look to be in pretty good shape.

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

And on the inventory side?

Michael T. Madden

This is Mike. On the inventory side, right now, if we look at our sales book, we're probably neck to neck. We're a little bit ahead on our production. And as I said earlier, we are starting to get some calls from some of our traditional customers about additional cargoes for the quarter. So we're looking at that as well.

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

Mike, are those additional inquiries to the ones you would traditionally start for July 1 signings? Are they the same guys just coming in early or are those different guys?

Michael T. Madden

I'm sorry. Can you repeat that again?

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

Your traditional discussions in your South American, European customers for volumes that go out July 1, these are the same customers that are coming in early and asking for more or these are other existing costumers that have volumes going to them already this year but might not be part of those typical July 1 conversations?

Michael T. Madden

Well, these are customers who have given us their lifting schedules for the April through June. And now they're coming back inquiring as if they could increase it. So they actually want to pick up more coal in the quarter.

Operator

And our next question is from Brian Yu from Citi.

Brian Yu - Citigroup Inc, Research Division

I know you guys had talked about cost earlier, so I was hoping if you could put those comments relative to the cost target you'd set out in the last quarter earnings call, $100 for U.S. mines, $130 for Brule and Wolverine and $180 for Willow Creek? Do you feel like those are still achievable targets for this year?

Walter J. Scheller

I'll answer that one. What we said was that we would get the Wolverine and Brule into the $130s. And we still think that is still our target and we still anticipate getting both those operations into the $130s this year. And we still believe that we will get the U.S. operations into the $100 range this year.

Brian Yu - Citigroup Inc, Research Division

Okay, great. And then the second one is with customers coming back for more tons. In the press release, you'd built up about 500,000 tons of inventory. How do you see that getting worked down during 2Q or maybe perhaps during the second half?

Michael T. Madden

Again, this is Mike. We're looking at it, I guess the best way is to say, carefully, because we feel that Q3 will have another price bump and we don't want to lock in additional tons at a price differential where we think we can gain in Q2. And I believe the momentum is there, and we've always said that we thought in Q3 and Q4 we'd see an uptick, and we still feel confident about that.

Brian Yu - Citigroup Inc, Research Division

So that means you will probably work down less, maybe just a couple hundred thousand tons, in second quarter. I think those relate to some timing issues, right, from Q1?

Michael T. Madden

Yes. I think that you've got to bear in mind now that the terminal is got a limit today on how much coal it can put out the door. When we come into September period, we will have another vessel loader in operation, so we'll be able to load 2 vessels at a time. Today, we're limited to one, and that's in Mobile, so. And again, vessel schedules, it's not a perfect world. We try and schedule them as best we can, but you're always going to find some congestion cropping up.

Walter J. Scheller

The other thing is, as we said, we're going to be moving the 4 Mine longwall in this quarter, and it's an extended move, so we will naturally see 4 inventory drop in this quarter.

Operator

Our next question is from Timna Tanners from Bank of America.

Timna Tanners - BofA Merrill Lynch, Research Division

I wanted to ask -- just 2 things left. And one is in the expected strength you talked about in the second half of the year. Can you talk a little bit more about your met market view? And then secondly, there has been some talk about higher cost producers shutting down. Can you talk a little bit more about anything you're expecting on that trend in terms of more your competition, I guess?

Michael T. Madden

Well, we still feel and I believe the market is definitely driving that way right now that the second half you're going -- you're definitely going to see some improvement coming on demand as well as pricing. Obviously, this momentum is going to have to continue to drive that, but we feel confident it will. If you look at the steel capacity utilization numbers just for the Q1, you went from January to March, up 10%. That's pretty significant. And if that continues on that kind of a pace, we are going to -- we're definitely going to see an uptick in demand. As far as mines shuttering in, I really don't know if I could comment on that because I don't know the cost structure really of all of those competitive mines.

Timna Tanners - BofA Merrill Lynch, Research Division

That's fair. I guess on the steel mill utilization, a lot of that was China. So China just had a really tough winter in the first 2 months. Is there anything else you're seeing that would drive more the second half? I mean, seasonally speaking, the third quarter is tough in Europe and tough here in the fourth quarter. So just wondering if there was anything more specific that you could point to.

Michael T. Madden

I think we saw a definite pickup in South America also in the end of Q1. And again, parts of Europe are doing a lot better than other parts and they're -- those are really where our customers are located. Also even when you see a downside, they're going to continue to take the hard coking coal, the high-quality stuff, so I don't -- I'm not concerned on that really right now.

Operator

And our next question is from Dave Lipschitz from CLSA.

David Lipschitz - CLSA Asia-Pacific Markets, Research Division

Quick question for you on the difference between high-quality and low-quality coking coal. Do you see that spread continuing to widen? Or do you think as demand picks up, we'll see that start to narrow? How do you see that playing out over the next year?

Michael T. Madden

I think if you look at our products, the low vol, mid-vol type, I think those deltas will start to narrow. I think where you'll still see some lag will probably be on the high-vol side, and that's going to be driven on the thermal market primarily. A lot of thermal coke coal can go either thermal or met, and right now, there's a lot of pressure coming on the high-vol met.

David Lipschitz - CLSA Asia-Pacific Markets, Research Division

Okay. And then my follow-up question is on carryover tons in terms of, do you have any in the second quarter? And sort of how much contracted are you already for the second quarter and for even the rest of the year, if you'll give us that?

Michael T. Madden

We've got about 650 of Q1 -- well, it's actually a mixture. Most of it is Q1 into Q2. And it's about evenly split, half hard coking and half PCI.

Operator

Our next question is from Lucas Pipes from Brean Murray, Carret & Co.

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

Quick question about your U.S. costs for the first quarter. I believe you had about 400,000 tons of inventory in Alabama at the end of 2011. So that implies that maybe just like 1.1 million tons or so from this quarter -- sorry, the first quarter production flowed through your P&L and gave you the cost advantage. And if I were to kind of back it out, I come to maybe $5 to $10 per ton lower for the costs. Is this the right way to look at it?

Robert P. Kerley

This is Robert Kerley, the Chief Accounting Officer of the company. Not really. You almost have to look mine by mine. So our No. 7, it sells and ships as soon as we can get it to the port. Our No. 4 is where really the build-up in our inventory lies. And again, as we talked about, that comes in handy this quarter as we have our extended longwall move and we'll be selling some of that inventory this quarter. But you can't look at it just as if everything is exactly the same.

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

Great. And in terms of Mine No. 7, you previously expected that about 1/3 of the increase is going to come from that mine. And do you still feel pretty comfortable about those targets?

Robert P. Kerley

Yes, we do. Very much.

Operator

Our next question is from Lance Ettus from Tuohy Brothers.

Lance Ettus

I just had a question about you've built up inventories. What's the kind of limit you think that are -- that you can -- I guess the physical limit you could have on inventories?

Richard Allen Donnelly

Oh, well -- I mean, I can -- this is Rich Donnelly. At the coal mines, we've got a pretty good amount of space. I mean, I don't know that there is a limit. If we're willing to move the coal around, I mean we've been able to handle it pretty well. So you're talking about a considerable number there. In Mobile, we're limited to 0.5 million tons of inventory. I mean, 500 million tons of inventory down there -- 500,000 tons. But at each of the mines, we've got a lot of space, so I mean we can push it around and do a lot of things with it. We don't like to do it, but we are able to do it. So there's -- at each of the mines, we could probably keep a considerable number.

Walter J. Scheller

One of our goals for this year also was to develop more inventory for our Alabama operations. Last year, we had virtually no inventory throughout the year at the port, and that resulted in about $25 million in demurrage charges. And part of our goal this year is to make sure that we keep enough coal at the port so that we can minimize those demurrage charges as well.

Operator

Our next question is from Jim Rollyson from Raymond James.

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

Walt, there's been a lot of questions about inventory, and I guess one way maybe to get to -- what everybody is hoping to ask is you guys have, obviously, you just mentioned, wanted to keep a little bit of inventory just to make life easier in dealing with timing differences, getting rid of demurrage, et cetera. When you think about this full year 11.5 million to 13 million tons of production, which you're nicely on track for -- congratulations -- where do you think sales shake out in relation to that? I mean, do you think at the end of the year, you have built up a couple hundred thousand tons of inventory to give you that flexibility? Or is the market starting to get outlook a little bit better to where you think you're going to actually be closer to matching sales versus production?

Walter J. Scheller

I would hope that we would build inventory slightly above sales, so a couple of hundred thousand tons above what our production is.

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

That's very, very helpful. On the pricing front, historically, when we were just Walter stand-alone, the No. 4, No. 7 mines used to sell kind of on average sell their coal pretty much right around the benchmark price, assuming you guys didn't contract ahead or behind whenever the benchmark was actually set. And as I kind of look at the actual numbers this quarter, Canada clearly came in at the benchmark numbers or a little above, I assume, because of carryover tons. And the U.S. side looked a little bit light relative to benchmark. Is that because of just the mix with the West Virginia mine in there, operations in there, or were you getting just a little bit of discount? Just how do we think about that going forward for the hard coking coal side of the business relative to whatever our benchmark assumptions should be?

Michael T. Madden

Jim, this is Mike. Yes, it's definitely driven by the mix. Obviously, the West Virginia and the brokerage coal that we sell pulls down the average, but we can safely say that the 7 coal always gets benchmarked. The 4 coal today -- and it's all predicated on demand at the time -- is anywhere from $2 to $3, $5 differential. And the Wolverine generally sells at about the same level as the 4 coal.

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

Okay, that's very helpful. And last little follow-up. On the thermal side, it's not clearly a core focus of the growth going forward, but you've to date been generally making positive margin there and it looks like all in on a consolidated basis this quarter, it was a bit of a negative margin. Kind of how do you think about that business going forward over the next 2 or 3 years?

Walter J. Scheller

Well, the negative this year -- this quarter was because we had a longwall move at North River. And North River, when we got the North River operation which only had a limited amount of coal left in that mine and that mine will play out over the next couple of years and that coal is all contracted. But with the -- it almost doubled our thermal production for the next couple of years. And with that mine being down for part of the quarter during the longwall move, it greatly impacts the cost on the thermal side of the business. So those tons, as I said, are already contracted at price. So we're not being overly impacted by the downturn in the thermal market, but as we roll forward, we have everything or almost all of our tons contracted from the thermal market for this year, and clearly, as I said, half of that production goes away over the next couple of years.

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

Yes. So it's more of a temporary cost issue?

Robert P. Kerley

Yes.

Operator

Our next question is from Paul Forward from Stifel, Nicolaus.

Paul Forward - Stifel, Nicolaus & Co., Inc., Research Division

I think Chuck talked about Willow Creek over time, reaching maturity over a few years. But I was just wondering if you could talk about now that you've got the plant built and that's out of the way, in modeling Willow Creek's growth over the next few quarters, I think you had 120,000 tons this quarter. How does that recover to a normalized rate this year and next year? And when do we -- how does the split go between PCI and the hard coking coal from Willow Creek?

Daniel Paul Cartwright

This is Dan Cartwright again. We were -- the 120 course reflects the planned outage that we had while we were doing the work. In April, we've seen our tonnage come up to the 80 to 90 range, and we see it, it will go up and down. If you remember, we're still under development there. So as we develop out around those crop areas -- outcrop areas and do the testing, of course, there's oxidation issues that we've got to definitively determine to determine the seams that we have identified as hard coking coal will indeed be able to be shipped as hard coking coal. So this year, we're saying that we're going to be in that 80-to-90-a-month range with some variation, with about 1/3 hard coking coal, about 2/3 PCI. The development should be complete towards the end of this year into the first quarter of next year. And then we would look at then ramping it up to the 1.8 million clean level, about, in 2013 and the mix over the long term there of the reserve would be about 50-50 hard coking coal to PCI.

Operator

Our next question is from Mitesh Thakkar from FBR Capital.

Mitesh Thakkar - FBR Capital Markets & Co., Research Division

One question. When you look at your volume growth over the next several years and the CapEx need, how comfortable you are with your present liquidity and how do you think about ramping up those projects if you want to at a faster pace. Would you -- basically, would you need to generate additional liquidity for that?

Michael Griffin

This is Michael Griffin, the Treasurer of Walter. We believe that Walter has ample cash flow internally generated from operation over that time frame and as the mines roll off. So as Willow decreases in CapEx spend, Blue Creek coal will increase over that time. And so we do not expect to have to generate additional liquidity from the market. But if we chose to, the opportunity does exist for us to be able to borrow money in the bond market.

Mitesh Thakkar - FBR Capital Markets & Co., Research Division

Okay, great. And if you think about Willow rolling off and the new project coming in, how should we think about CapEx going forward for '13 and '14? I don't need a firm guidance, but just so if you can provide us some color on the moving parts, that would be great.

Michael Griffin

Well, basically, it will be flat because as projects roll off, other projects will roll in. We consider about a $200 million base CapEx level for maintenance and then other projects roll in and out.

Operator

Our next question is from Michael Goldenberg from Luminus Management.

Michael Goldenberg - Luminus Management, LLC

My questions have been answered.

Operator

[Operator Instructions] Our next question is from David Beard from Iberia.

David E. Beard - Iberia Capital Partners, Research Division

Just to follow up on the CapEx question, the $200 million maintenance. I seem to recall it appeared at a time that number may be higher. Can you just maybe address that or what is in the maintenance CapEx?

Walter J. Scheller

The $200 million maintenance CapEx is really about $150 million for current operations and we're looking at another $50 million as the Western operations start to get a little age on them. It will be about a $50 million maintenance capital for the Canadian operations. Our current operations have about $150 million maintenance capital. We're looking over the next several years. The last couple of years, we've said that we'd spent about $450 million in growth and maintenance, and we're looking at maintaining somewhere plus or minus 10% of that number over the next several years to develop our projects. And there's really not much opportunity. These projects are big enough that there's not much opportunity to accelerate these projects because of the permitting and just development time. So these projects kind of time themselves out in terms of their capital needs and development.

David E. Beard - Iberia Capital Partners, Research Division

Okay. And just to switch to the new mine development or the billion-dollar mine development. Was the production level there thought to be around 3 million to 4 million tons or are you thinking higher at some point?

Walter J. Scheller

It will probably, as a one longwall mine, it will be somewhere between 2.5 million and 3.5 million or 4 million tons, somewhere in there. It's going to be like a Mine No. 4.

Operator

Our next question is from Mark Parr from KeyBanc.

Mark L. Parr - KeyBanc Capital Markets Inc., Research Division

I really appreciate all the color that you've given this morning. I don't have any additional questions right now, but I just wanted to congratulate you on all the progress that you're making and best of luck for the second quarter here with the longwall move.

Operator

Our next question is from Shneur Gershuni from UBS.

Shneur Z. Gershuni - UBS Investment Bank, Research Division

Just a couple of quick follow-ups to some of the earlier questions, as most of my questions have been exhausted and answered. Starting on the cost side of the equation. You sort of gave some color about kind of your guidance is kind of on an average basis. Would you be able to give us your kind of your targeted exit run rate for both the U.S. and for Canada, kind of like where you expect to be on 12/31 in terms of cost per ton for both regions?

Walter J. Scheller

Well, I guess based on the information we've given to date, my expectation would be in the U.S., we would be in that $100 range and in Canada, we would be in the $130s, excluding Willow. And Willow, Willow is going to be a little higher than that exiting the year, probably closer to $180 even as we exit the year but then moving down next year.

Shneur Z. Gershuni - UBS Investment Bank, Research Division

There's not a scenario where you think that the mine, the U.S. operation can dip below $100?

Walter J. Scheller

Yes. As we look into next year again this year, we had multiple longwall moves at Mine No. 4 that are driving the overall costs at 4 and 7. As we move into next year, I think there is the opportunity for that to continue to go down.

Shneur Z. Gershuni - UBS Investment Bank, Research Division

Great. And a follow-up question on the increased demand. I recognize there's the issues with Australia and so forth, but can you sort of give us a flavor of where the demand is coming from? Is it Europeans that are asking for more? Is it the Brazilians that are asking for more? Or it's really this incremental demand coming just from Asia?

Michael T. Madden

Yes, this is Mike. Actually, to be frank with you, we started to see improvements in March prior to the force majeure issue in Australia. And right now, I would say that the 2 regions coming in with the demand are Asia and Europe, but I do expect that we will start seeing the same coming from South America.

Operator

And our final question today is from Chris Haberlin from Davenport & Company.

J. Christopher Haberlin - Davenport & Company, LLC, Research Division

I just wanted to see, as we look forward to Q2, Q3 are you limited at all in your ability to increase sales, either infrastructure or poor capacity? I know you mentioned adding a ship loader at Mobile. How does that impact your capacity to export when that kind of comes into play?

Michael T. Madden

This is Mike. Well, we've been in the process of renovating ship loader #1 down in Mobile now for about a year. And that will come into play around the September time frame. What that will allow us to do now is be able to load 2 vessels at a time. We are not the only customer today out of McDuffie so when the berth is occupied today, it's occupied. Now we'll have the option that if it is occupied, we can probably bring our ship into the other berth. So it'll definitely enhance outbound loading at McDuffie.

J. Christopher Haberlin - Davenport & Company, LLC, Research Division

But prior to that coming online, are there any limits with, as far as construction goes, with adding that ship loader? Will there be a shutdown at the port at all that might hurt volumes in Q3?

Michael T. Madden

No. There's no anticipated outages other than a customary dredging that takes place 2 or 3x a year, but that's generally only a short period of time and usually scheduled when the terminal has some idle time coming up. No, we don't anticipate any outages at all at McDuffie and actually, the loading rates for the vessels through April have been looking very good for us, actually.

J. Christopher Haberlin - Davenport & Company, LLC, Research Division

Okay. And then second question. Costs at Brule, those were up in the quarter. Can you just talk about what caused costs to go up there and kind of what steps are being taken to kind of get down into that $130s range and what kind of time frame you're looking for to get down there?

Robert P. Kerley

Well, Chris, this is Robert Kerley again. So those costs are really related to the prior quarter. We had a higher cost layer in inventory that flushed through this quarter. That higher cost is primarily driven by volume production and so as we go through this, the rest of this year, we will see -- we're anticipating volume to increase, costs to start dropping. We're already seeing some benefits there.

J. Christopher Haberlin - Davenport & Company, LLC, Research Division

So we should see kind of improvement here as we move through the...

Robert P. Kerley

Yes, that's what we're already seeing indications of and we're anticipating it to impact Q2 favorably as well.

Daniel Paul Cartwright

And this is Dan Cartwright. As I tried to mention in some of my earlier comments, that the precursor to cost of sales is cost of production, and we've already seen those come down almost 10%.

Operator

And I'm showing no further questions at this time, sir.

Walter J. Scheller

Thank you very much, and thanks for listening today. That concludes our call.

Operator

Thank you. And this concludes today's conference. You may disconnect at this time.

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