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Alliance Holdings GP, L.P. (NASDAQ:AHGP)

Q2 2012 Earnings Call

July 27, 2012 10:00 a.m. ET

Executives

Brian Cantrell - SVP and CFO

Joseph Craft III - President, CEO and Chairman

Analysts

Praveen Narra - Raymond James

Garrett Nelson - BB&T Capital Markets

Chris Haberlin - Davenport & Co

Wayne Atwell - Global Hunter

Operator

Good day ladies and gentlemen and welcome to the second quarter 2012 Alliance Resource Partners L.P. and Alliance Holdings GP earnings conference call. My name is Erica and I will be your coordinator for today. (Operator Instructions) I would now like to turn the presentation over to your host for today’s call Mr. Brian Cantrell, senior vice president and chief financial officer. Please proceed.

Brian Cantrell

Thank you Erica and welcome everyone. Earlier this morning we released 2012 second quarter earnings for both

Alliance Resource Partners or ARLP and Alliance Holdings GP or AHGP and we will now discuss those results as well as our outlook for the remainder of this year. Following our prepared remarks, we will open the call to your questions.

Before beginning, we will start with a few customary reminder. First, AHGP’s only assets are its ownership interest in ARLP, our comments today will be directed to ARLP’s results and outlook unless otherwise noted. In addition, please be aware that some of our remarks may include forward-looking statements that are subject to a variety of risks, uncertainties and assumptions which are contained in our filings from time to time with the Securities and Exchange Commission and are also reflected in today’s press releases from the partnerships.

All these forward-looking statements are based on information currently available to partnerships and those with their general partners and management, if one or more of these risks or uncertainties materialize or if our underlying assumptions prove incorrect, actual results of the partnerships may vary materially from those we projected or expected. In providing these remarks, neither ARLP nor AHGP has any obligation to publicly update or revise any forward-looking statement, whether as a result of new information, future events or otherwise.

Finally, we will also be discussing certain non-GAAP financial measures. Definitions and reconciliations of the differences between these non-GAAP measures and the most directly comparable GAAP financial measure are contained at the end of the ARLP press release, which has been posted on ARLP’s website and furnished to the SEC on Form 8-K.

Now that we are through the required preliminaries, I’ll start this morning with a review of the partnerships operating and financial results for the 2012 quarter end period. Then turn the call over to Joe Craft, our President and Chief Executive Officer.

It was noted in our release earlier this morning, ARLP once again posted strong results for both of 2012 quarter end and year to date. Looking first at the top line, ARLP posted record revenues in the 2012 quarter of $529.9 million, an increase of 15.7% compared to the 2011 quarter and $973.5 million for the first half of 2012 or 10.5% higher than the 2011 period.

Growth in coal sales revenues during the 2012 quarter was led by record coal sales pricing and volumes. Improved contract price realization at the Illinois Basin and increased sales from Northern Appalachia into the high price metallurgical export markets drove total average coal sales prices higher in the 2012 quarter to a record $59.17 per ton sold, an increase of 5.5% compared to the 2011 quarter.

High Illinois basin sales volumes from the Warrior and newly acquired Onton and the Northern Appalachia from the start-up of longwall production at Tunnel Ridge as well as increased brokered sales volumes, pushed coal sales volumes up 9.8% compared to the 2011 quarter to a record 8.7 million tons.

For the first half 2012 higher sales volumes from the River View and Tunnel Ridge mines as well as the acquisition of the Onton mine more than offset lower sales into the export markets, driving total sales volumes to a record 16.5 million tons, an increase of 6.8% compared to the 2011 period.

Average coal sales prices also increased to a record $57.19 in the 2012 period, rising $2.08 per ton sold compared to the 2011 period. On the strength of record revenue, ARLP also reported record EBITDA of $155.5 million in the 2012 quarter, an increased of 6% compared to the 2011 quarter. compared to the 2011 period, however, EBITDA year to date fell slightly to $287 million due to the passthrough of losses related to ARLP’s investments in the White Oak development project and the impact on margins from lower export sales into 2012 period I mentioned a moment ago.

As anticipated, higher DD&A related to the start of longwall production at Tunnel Ridge and the passthrough of White Oak losses contributed to lower net income in the 2012 quarter which declined 2.8% compared to the 2011 quarter. For the 2012 period, these factors along with reduced export sales volumes and revenue combined to drive net income lower by 7.8% compared to the 2011 period.

Turning now to costs, ARLP’s total segment adjusted EBITDA expense increased to $40.23 per ton sold in the 2012 quarter. Costs in the Illinois basin were impacted the most by lower coal recoveries and difficult mining conditions at Dotiki as this mine continued its transition into the West Kentucky number 13 coal seam and in addition, the acquisition of Onton number 9 mine.

Regulatory actions continued to burn results in central Appalachia as the loss of the production unit at both our Dotiki (ph) and MC Mining operations contributed to higher segment adjusted EBITDA expense per ton in the 2012 quarter.

In northern Appalachia, higher segment adjusted EBITDA expense per ton reflects the increased cost of coal purchase item at Mettiki complex, higher cost per ton of initial longwall production at the Tunnel Ridge mine, as well as the impact of difficult mining conditions at Mountain View as this mine experienced significant sandstone intrusions during the 2012 quarter.

Looking at costs for the end of 2012, for our Illinois basin and Central Appalachian regions we expect production in the second half of the year to be consistent with the first half and segment adjusted EBITDA expense per ton to be comparable to second-quarter levels. In northern Appalachia, we expect costs over the balance of the year to improve significantly by approximately 30% per ton as production for the Tunnel Ridge longwall builds over initial start-up level and mining conditions at Mettiki improve as the sandstone role that impacted production and costs in the 2012 quarter is now behind us.

Based on our currently anticipated production and sales mix, total segment adjusted EBITDA expense per ton of the full year 2012 is expected to be approximately 3% to 5% higher than 2011. I will wrap up my comments this morning with an update on our liquidity.

During the 2012 quarter, ARLP approached the bank markets to replace its expiring revolving credit facility and restructure its then existing $300 million term loan. Market reception was strong with roughly $1.1 billion in demand allowing us to expand our bank group, priced the new $700 million revolver at an attractive 165 basis point initial drawing spread and replaced the old term loan with a new $250 million term loan.

These new facilities improve ARLP’s liquidity to approximately $626 million at the end of 2012 quarter. Our balance sheet remains strong and we believe these new facilities provide ARLP with sufficient liquidity and flexibility to execute our current plans and position us to quickly take advantage of additional opportunities that may arise in the future.

With that, let me turn the call over to Joe for his take on the second quarter performance, our perspectives on the coal markets and a review of our outlook for the balance of the year. Joe?

Joseph Craft III

Thank you Brian and good morning everyone. It is no secret that the times have been and are still tough in the coal sector. And the markets are weak and the challenges are many. We can't forget however that our industry is still expected to mine a billion tons in 2012, and even more in 2013.

The world continues to rely on coal today and coal will continue to be the fuel choice for most of the electricity produced around the globe, and we believe that demand for U.S. coal has hit bottom, and supply and demand is closer to being imbalance and better times are ahead. The question remains just when.

With the kind of misery for many in our industry, I feel fortunate that our partnerships have been able to manage through this recent downturn and still be able to deliver record results. As Brian just reviewed, during the 2012 quarter, ARLP posted record EBITDA, sales volumes and revenue. We also significantly improved our liquidity with our new bank facilities.

Operationally we continue to effectively execute ARLP's growth plans. We completed the acquisition of assets from Green River Collieries in April, adding the Onton number nine mine and approximately 40 million tons of reserves to our Illinois basin portfolio. Onton performed as expected in the 2012 quarter and we believe their addition will further enhance our already strong Illinois basin market position.

We also began longwall operations at Tunnel Ridge in mid-May, increasing production from this mine to nearly 300,000 tons in the 2012 quarter. As we work through the typical start-up issues at the new coal mine, we currently expect production from Tunnel Ridge to reach 900,000 tons in the third quarter and 1.2 million tons in the fourth quarter of this year. In 2013 as we continue to ramp up production, we are now expecting Tunnel Ridge to produce approximately 6.2 million tons on the way to an annual run rate of 6.5 to 6.8 million tons in 2014.

In addition, ARLP continued to move full speed ahead with our development projects at Gibson South and While Oak. Recently, our marketing team successfully reached agreement for the sale of approximately 5.6 million tons over a six-year period starting in 2013. With these new agreements since the beginning of the year, ARLP has secured new coal sales commitments for deliveries through 2018 of 27 million tons plus or minus 10% depending upon customary customer generating requirements.

ARLP has now essentially sold out in 2012 and has commitments for approximately 90% of anticipated sales volumes in 2013 based upon current production levels plus the previously discussed increased production expected at Tunnel Ridge.

Recently hotter weather patterns, rising natural gas prices, strong export thermal sales and supply reductions by other coal producers gives us hope that better days are ahead for the coal markets. We still are concerned, however, about a weak U.S. and global economy. We expect to ship the last 70,000 tons on our high-priced export contract in July. We are in negotiations to continue shipping into the export metallurgical market but cannot predict if, or when, shipments will resume. Due to this uncertainty, we have assumed in our guidance that we will not ship additional met tons this year.

We’ve adjusted our anticipated production and sales mix for the balance of 2012 accordingly. Based on results to date and adjusted expectations we now expect full year 2012 coal production, sales volumes and revenues near the lower end of our previous guidance ranges, reflecting the strength of our contract position and customer relationships, as well as increased production from Tunnel Ridge and the addition of Onton, we continue to target 2012 EBITDA and net income near the midpoint of previous guidance.

For the 17th consecutive quarter, the Alliance boards elected to increase distributions to our unitholders. For this quarter, the cash distributions were increased over the first quarter of 2012 by 3.7% at ARLP and by 4.5% at AHGP. Compared to the 2011 second-quarter, the announced distributions represented 15.2% increase for ARLP and a 19.7% increase for AHGP.

The board’s decision to again provide unitholders with a strong distribution increase was based upon ARLP’s year-to-date performance, expectations for another year of record EBITDA in 2012 and confidence in our ability to execute our growth strategy. Results like these don't just happen, and I want to recognize all the men and women that work at Alliance Coal, they are responsible for these results and have positioned us to not only manage these challenges but to execute on our strategy, meet and exceed customer demand and deliver long-term value to our unitholders. And they are the best.

This concludes our prepared comments. We appreciate your continued support and interest in both ARLP and AHGP. And now with the operator’s assistance we will open the call to your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from the line of Praveen Narra with Raymond James.

Praveen Narra - Raymond James

You guys have actually been able to book some coal (indiscernible) thus far, speaking to your star relationships and operational reliability, can you give us an idea of what prices were coming in that, is it comparable to all contracts, it is higher, lower, basically how should we think about coal pricing going forward?

Joseph Craft III

It’s mixed obviously, but I think as we’re looking -- at this moment in time, as we look into 2012, we would be expecting revenues on a per ton basis comparable to what we see in 2012.

Praveen Narra - Raymond James

And then I guess just in thinking about – your proximity to rivers, could you give us a bit of color on how does getting the coal out to the market, and I guess what percentage of your coal is delivered – we are thinking about 15% to 20%, is that about right?

Joseph Craft III

Now we have essentially River View and Onton around the river as well as Tunnel Ridge. I think the river issues are talking about a more for West Kentucky operations, we are watching that, we haven’t had any disruptions yet but we are keeping an eye on that.

Praveen Narra - Raymond James

And then you guys have had couple of regulatory issue at two mines, are these back up and running and are there any steeper (ph) issues on the horizon?

Joseph Craft III

Now in Central Appalachian operations we had idled two units. So we’ve basically modified our work schedule to work seven days a week on a 6-3 work schedule to try to maximize efficiency and costs. But we are having to sort of focus on. Essentially three units at each mine as opposed to what we would prefer as 40 units at each mine. And that’s been our biggest challenge. We continue to have as much help as we want from the government. So I can’t say that we are always through those things.

Praveen Narra - Raymond James

Last question from me. Regarding the guidance on income and EBITDA where range was unchanged, you guys were little bit lower but the income – the volumes and revenue little bit lower there but income and EBITDA were in line. Should we say this is a reflection of better than previously expected costs?

Joseph Craft III

As Brian mentioned, with Tunnel Ridge ramping up, we should see our Northern App costs – I think we are projecting about 30% decrease in the first half I believe. So you’re going to see – we would – depending on, if Tunnel Ridge hits their tonnage projections and we should see improved cost primarily driven by Tunnel Ridge’s production.

Operator

Our next question comes from the line of Garrett Nelson with BB&T Capital Markets.

Garrett Nelson - BB&T Capital Markets

I’ve got to say it’s really pretty remarkable how you guys continue to execute quarter after quarter under these market conditions. So congratulations on that. I was just wondering if you could talk about changes in market demand that you have seen for Illinois basin coal in recent quarters. I know you mentioned exports but are you seeing more of your Illinois basin coal travel into the Southeast or being used as a blend? Are you seeing an increase in demand from any specific regional markets over the last few quarters?

Joseph Craft III

Not really. I think that we feel like for 2013, 2014 we will. We think that with the central Appalachia production falling and gas prices expected to rise, we do expect that we will see increased demand for the reasons you just mentioned. But looking back, we haven't actually seen any movement in that regard.

Garrett Nelson - BB&T Capital Markets

And then I was hoping you might be able to provide some insight into productivity metrics at your Illinois basin mine, not just the sales and cash numbers that we can see but maybe tons per man-hour trends or some of the steps you’ve taken to maximize efficiencies from this mine?

Joseph Craft III

Essentially we have had issues at Dotiki where we are transitioning from the nine seam to the 13. So we have had some production loss there and productivity issues. We do anticipate – we feel that the 13 seam is going to be very favorable once we can get there. So we do expect improved productivity out of Dotiki as we look forward. Beyond that, I think our operations are running pretty consistently. And the only issue that will affect productivity either plus or minus is conditions.

Sometimes conditions are good and we get high productivity. And sometimes we find some not totally challenging but just some route conditions or whatever that might impact production in a negative way. But overall the Illinois basin seams are pretty consistent and our mines do have a pretty consistent to reliable tons per man hour across-the-board conditions and regulatory impacts being the exception.

Operator

Our next question comes from the line of Chris Haberlin with Davenport & Co.

Chris Haberlin - Davenport & Co

I was hoping that maybe you could kind of give us a little bit of color around your customers’ inventory positions just given the recent heat. Are you starting to see inventories come down and then kind of as a follow on, how do you see different inventories by different basins position? What basins are best positioned and what basins kind of have the most inventory?

Joseph Craft III

I think to answer your first question, the burn obviously has improved. I think John craved for a rain dance in the last quarter – not a rain dance but a heat dance, I think it worked. But so the burn has been up for our customers and thus they have been able to reduce the inventories. I think overall inventories are still high at a higher level. So we don't see a lot of new activity in the marketplace. So I think we would expect that because of the supply side to demand supply balance will be more imbalanced hopefully by the end of the year because it needs to be a little more supply to come off the market in Central App, I think will happen.

I think that Central App has been the highest and then you’ve got Power River basin are the two highest, I think Northern App and Illinois basin are better positioned, but even their inventories are higher than normal. I think that’s the current situation. I think the real issue is that I think that creates uncertainty is what’s been happening in Europe with the debt issue there, the euro and then what's going to happen our own country as we have this election season and we are playing around with whether we’re going to have this fiscal cliff occur or not with the tax increases and sequester, which will definitely impact GDP.

So some people believe that everything will get delayed a year and whoever wins the presidency will be with it next year without any major impact. And others believe that the politicians will go off the cliff here and create all kinds of consternation. So that's the one area of concern is what the economy is going to be that would impact, what the inventories would be. And until I think we get clarity you're not going to see utilities go out and start committing tonnage. And then obviously the other is the natural gas prices, as to whether you’re going to see $4 gas in the fourth quarter of this year $4 gas, some time in the next year or the following year.

Chris Haberlin - Davenport & Co

On pricing, just given the significant supply cuts across the industry, would you anticipate seeing pricing start to return due to the supply cuts or would you need to see demand really come back and inventories get back down to maybe more normal levels before pricing would start to return?

Joseph Craft III

I think the biggest catalyst of price increase would be natural gas prices and return back to coal. I think absent that if demand is stable, I think pricing will remain to be stable. I think that’s going to be the key as to how fast utilities that moved away from coal over the last 18 months would move back into coal, if you start to see gas prices moving up.

Chris Haberlin - Davenport & Co

And on that given the recent rebound in natural gas prices, are you starting to see any switching back to coal specifically in the Illinois basin?

Joseph Craft III

We haven't lost that much in Illinois basin. I think the first switch back will be at the Power River basin. And then I think the second will be as those plants that moved away from Central App and they are going to come back for Illinois basin. So I think that's where we're going to get the improved market condition is when – and there are certain utilities today at $3.50 gas that are definitely looking to burn the Illinois basin coal. So whether they switch or they didn’t switch and whether that demand, it’s a hard question to answer as to whether its replacement percent will up its gas prices, but we are projecting that Illinois basin will grow anywhere from 10 million to 20 million tons over the next 12 to 18 months.

Operator

Our next question comes from the line of Wayne Atwell with Global Hunter.

Wayne Atwell - Global Hunter

This is sort of an industry question. Do you have any idea on how much capacity is going to be closed permanently over the next 6 to 12 months?

Joseph Craft III

I think our projections go to 2015, so I don't know over the 6 to 12 months period. And I think we were at – what was it 37 – I can’t give you precise number. I can’t remember right off the top of my head. But it’s in our last presentation and hopefully it’s still on our website as to what our particular guidance is. If not, you can call Brian and he can give you the exact number. I read so many projections on that, I am afraid which one is ours or other people’s.

Operator

We have no further questions at this time. I will now turn the call back over to Brian Cantrell for any closing remarks.

Brian Cantrell

Thanks Erica. Well, it looks our results for the large part are speaking for themselves. We want to thank all of you for joining us today. To learn more about our record results this quarter and what should prove to be another year of impressive results for our partnerships, as always we appreciate your continued support and interest in both ARLP and AHGP. And we look forward to updating you on our progress on October. Thank you.

Operator

Thank you for your participation in today’s conference. This concludes the presentation. Everyone may now disconnect. And have a great day.

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