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Executives

Brian L. Cantrell - Chief Financial Officer of Alliance Resource Management Gp, Llc, Principal Accounting Officer of Alliance Resource Management Gp, Llc and Senior Vice President of Alliance Resource Management Gp, Llc

Joseph W. Craft - Chief Executive Officer of Alliance Resource Management GP LLC, President of Alliance Resource Management GP LLC and Director of Alliance Resource Management GP LLC

Analysts

Garrett S. Nelson - BB&T Capital Markets, Research Division

Wayne Atwell

Alliance Resource Partners LP (ARLP) Q2 2012 Earnings Call July 27, 2012 10:00 AM ET

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'll 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 L. 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'll now discuss those results, as well as our outlook for the remainder of this year. Following our prepared remarks, we'll open the call to your questions.

Before beginning, we'll start with a few customary reminders. First, since AHGP's only assets are its ownership interest in ARLP, our comments for 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.

While these forward-looking statements are based on information currently available to the partnerships and those of their general partners and management, if one or more of these risks or uncertainties materialize, or if our underlying assumptions prove incorrect, actual results for 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'll also be discussing certain non-GAAP financial measures. Definitions and reconciliations of the differences between these non-GAAP financial 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're through with the required preliminaries, I'll start this morning with a review of the partnerships' operating and financial results for the 2012 quarter-end period, and then turn the call over to Joe Craft, our President and Chief Executive Officer.

As noted in our release earlier this morning, ARLP once again posted strong results for both the 2012 quarter and year-to-date. Looking first at the top line, ARLP posted record revenues in the 2012 quarter at $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 realizations in the Illinois Basin and increased sales from Northern Appalachia into the higher price metallurgical export markets grow 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. Higher Illinois Basin sales volumes from the Warrior and newly acquired Onton mine, and in Northern Appalachia, from the startup of longwall production at Tunnel Ridge, as well as increased brokerage 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 of 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 revenues, ARLP also reported record EBITDA of $155.5 million in the 2012 quarter, an increase 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 past through of losses related to ARLP's investment in the White Oak development project and the impact on margins from lower export sales in the 2012 period I mentioned a moment ago.

As anticipated, higher DD&A related to the start of longwall production at Tunnel Ridge and the pass through 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 cost. 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 No. 13 coal seam, and in addition, the acquisition of the Onton No. 9 mine.

Regulatory actions continue to burden results in Central Appalachia as the loss of a production unit at both our Pontiki 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 costs per coal purchased by the 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 cost through 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 cost over the balance of the year to improve significantly by approximately 30% per ton, as production for the Tunnel Ridge longwall builds over initial startup levels and mining conditions at Mettiki improve as the sandstone roll 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 in the full year 2012 is expected to be approximately 3% to 5% higher than 2011.

I'll 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, price the new $700 million revolver at an attractive 165 basis point initial drawn spread and replace the old term loan with a new $250 million term loan. These new facilities improved ARLP's liquidity to approximately $626 million at the end of the 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 W. Craft

Thank you, Brian, and good morning, everyone. It's no secret that times have been and are still tough in the coal sector. The markets are weak and the challenges are many. We can't forget however, that our industry is still expected to mine 1 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 of choice for most of the electricity produced around the globe. And we believe demand for U.S. coal has hit bottom and supply and demand is closer to being in balance and better times are ahead. The question remains, just when? With a ton 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 No. 9 mine in 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 this 2012 quarter. As we work through the typical startup issues of 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 million to 6.8 million tons in 2014. In addition, ARLP continued to move full speed ahead with our development projects at Gibson South and White Oak.

Recently, our marketing teams successfully reached an agreement for the sale of approximately 5.6 million tons over a 6-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 customer generating requirements. ARLP is 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. And 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 with 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 have 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 represent a 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.

Now 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 execute on our strategy, meet and exceed customer demands and deliver long-term value to our unitholders. 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 operators assistance, we'll open the call to your questions.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from the line of Praveen Narra [ph] with Raymond James.

Unknown Analyst

You guys have actually been able to book some coal for the out week. You're thus far speaking to your strong relationships and operational reliability, could you give us an idea of what prices were coming in at? Is it comparable to old contracts? Are these higher or lower? Basically, how should we think about coal pricing going forward?

Brian L. Cantrell

It's mixed, obviously, but I think as we look at this moment in time, as we look into 2013, we would be expecting revenues on a per ton basis comparable to what we see in 2012.

Unknown Analyst

Okay, that's great. And then, I guess, just in thinking about the drought with your proximity to the rivers, could you give us a bit of color on how it is getting the coal out to the market, and I guess, what percentage of your coal is delivered on the river? We're thinking about 15% to 20%, is that about right.

Joseph W. Craft

We have, essentially, River View and Onton are on the river, as well as Tunnel Ridge. But I think the river issues are [indiscernible] more for West Kentucky operations. We are watching that. We haven't had any disruptions yet, but we are keeping an eye on that.

Unknown Analyst

Okay, okay. And then I guess you guys have had a couple of regulatory issues at the 2 mines, are these back up and running, and are there any foreseeable issues on the horizon?

Joseph W. Craft

Well, in Central Appalachian operations, we had to idle 2 units. So we are -- we basically modified our work schedule to work 7 days a week on a 6, 3 work schedule to try to maximize efficiency and cost, but we're having to sort of focus on essentially 3 units at each mine as opposed to what we would prefer as 4 units at each mine. And that's been our biggest challenge. We've continued to have as much help as we want from the government, so I can't say that we'll always through those things.

Unknown Analyst

Right, right. And I guess last question for me. Regarding the guidance on incoming EBITDA where the range was unchanged, you guys are a little bit lower, but the income -- the volumes and revenue which was a little bit lower there, but the income and EBITDA were in line, should we see this as a reflection of better than previously expected costs?

Joseph W. Craft

Yes. As Brian mentioned, with Tunnel Ridge ramping up, we should see our Northern App cost, I think we're projecting about 30% decrease at the first half, I believe.

Brian L. Cantrell

That's right.

Joseph W. Craft

So you're going to see, we would -- depending on the -- if Tunnel Ridge hits their tonnage projections, then we should see improved costs, primarily driven by Tunnel Ridge's production.

Operator

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

Garrett S. Nelson - BB&T Capital Markets, Research Division

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've seen for your Illinois Basin coal in recent quarters. I know you mentioned exports, but are you seeing more of your Illinois Basin coal traveling to 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 W. Craft

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 S. Nelson - BB&T Capital Markets, Research Division

Okay. And then I was hoping you might be able to provide some insight into productivity metrics at your Illinois Basin mines, not just the sales and cash cost numbers that we can see, but maybe tons per man hour trends or some of the steps you've taken to maximize efficiency from those mines.

Joseph W. Craft

Essentially, we've had issues at Dotiki where we're transitioning from the 19 to the 13. So we have had some production loss there and productivity issues. We do anticipate -- we feel that the 13 seems 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. So sometimes conditions are good, we get higher 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 seems pretty consistent and our mines do have pretty consistent, reliable tons per man hour across-the-board, conditions and regulatory impacts being the exception.

Operator

[Operator Instructions] Our next question comes from the line of Chris Haberlin [ph] from Davenport & Company.

Unknown Analyst

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 W. Craft

I think the answer to your first question, the burn, obviously, has improved. So I'm prayed for a rain dance as of the last quarter, not a rain dance but a heat dance, and I think it worked. But -- so the burn has been up for our customers, and thus, they have been able to reduce 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 the cause of the supply side -- that the demand-supply balance will be more in balance hopefully by the end of the year. Because it needs to be a little bit more supply to come off the market in Central App, which I think will happen. I think that Central App has been the highest, and then you've got Powder River basin, are the 2 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 that I think that creates uncertainty is what's going to happen in Europe with the debt issue there and the euro, and then what's going to happen in our own country as we have this election season, and we're playing around with whether we're going to have this fiscal cliff occur or not, with the tax increases and the sequester, which will definitely impact GDP. So some people believe that everything will get delayed a year, and whoever wins the presidency will deal with it next year without any major impact. And others believe that politicians will go off the cliff here and create all kinds of consternation, so that's the one area of concern as to 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, there's the natural gas prices, as to whether you're going to see $4 gas in the fourth quarter this year or $4 gas sometime next year or the following year.

Unknown Analyst

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 W. Craft

I think the biggest catalyst of price increase would be natural gas prices and the return back to coal. I think absent that, if demand is stable, then I think pricing will remain to be stable. So 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.

Unknown Analyst

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 W. Craft

We haven't lost that much in Illinois Basin. So I think the first switchback will be at the Powder River basin, and then I think the second will be as those plants that moved away from Central App and they're 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 again, there are certain utilities today at $3.50 gas that are definitely looking to burn Illinois Basin coal. So whether they switched or they didn't switch or whether that demand, it's a hard question to answer, as to whether it's replacement for Central App or if it's gas prices, but we are projecting that Illinois Basin will grow anywhere from 10 million tons 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

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

Joseph W. Craft

I think our projections go to 2015, so I don't know over the 6 to 12 month period. And I think we are at, what was it, 37 [indiscernible]?

Brian L. Cantrell

About [ph], really, yes.

Joseph W. Craft

I can't give you a 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 it's not, you can call Brian, and he can give you the exact number.

Brian L. Cantrell

We don't have it at our fingertips right now.

Joseph W. Craft

I read so many different projections on that, I'm afraid to say which one is ours versus other peoples.

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 L. Cantrell

Thanks, Erica. Well it looks like our results to a 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 in October. Thank you, all.

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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