Walter Industries, Inc. Q1 2008 Earnings Call Transcript

May.19.08 | About: Walter Energy, (WLT)

Walter Industries, Inc. (NYSE:WLT)

Q1 2008 Earnings Call

May 2, 2008 10:00 am ET

Executives

Victor P. Patrick - Vice Chairman, CFO, General Counsel and Secretary

Mark J. O'Brien - Chairman and CEO, JWH Holding Company, LLC

George R. Richmond CEO, Jim Walter Resources, Inc.

Mark Tubb – Vice President, Investor Relations and Strategic Planning

Analysts

Michael Gaugler - Brean Murray Carret & Company, LLC.

Jim Rollyson – Raymond James

Dan Mannes – Avondale Partners

James McCanless – FTN Midwest Securities Corp.

Mark Caruso – Millennium Partners

Wayne Cooperman – Cobalt Capital

George [Harlambides – Contras Capital]

Sam Martini – Cobalt Capital

Frank [Duplex] – Credential

Ted Kim – Diamondback Capital Management, LLC.

Charles Morris – Amiya Capital

Operator

Welcome and thank you for standing by. All participants will be able to listen only until the Question and Answer Session. [Operator Instructions] Now, I’d like to turn the call over to your host, Mr. Mark Tubb.

Mark Tubb

Thank you, Melissa. Good morning and thank you for joining us for Walter Industries’ First Quarter 2008 Earnings Conference Call. This is call is being webcast live on the internet and a recording of today’s call will be archived on our website for up to 30 days.

As you know yesterday we released our first quarter 2008 earnings and our outlook for the remainder of the year. We also provided information on our 2008/2009 Met coal Contract Settlements as well as in our recent Financing activity and separation strategy initiatives.

During this morning’s call, management will discuss forward-looking statements made in yesterday’s press release and may make these and other forward-looking statements. For more information regarding risks associated with forward-looking statements, please refer to the company’s SEC filings.

Here in today’s call, Walter Industries’ Chairman, Vice-Chairman, CFO and General Counsel, Vic Patrick, will discuss our business results, key developments and our consolidated outlook for the remainder of 2008. Jim Walter Resources’ CEO, George Richmond, will discuss our national resources and Sloss businesses. And JWH Holding Company Chairman and CEO, Mark O’Brien, will talk about our Financing and Home Building businesses. Once our management team has completed the prepared remarks, we will open the call to questions from our dial in participants. At this time, I’ll turn the call over to Vic.

Victor P. Patrick

Thank you, Mark, and good morning everyone. As Mark mentioned, last night we issued two press releases detailing our quarterly results and outlining the steps we’re taking to further the separation of our Financing and Home Building businesses from Walter Industries. The most important news we announced was our coal contract settlements. At Jim Walter Resources we settled much of our remaining 2008/2009 coal contracts to the average price up more than $315 per metric ton FOB Port.

As noted yesterday’s earnings release, our financial results for the quarter included several items that adversely impacted earnings and resulted in net income of a pending per diluted share. I will go into greater detail on these items as I discuss our full operating results which we’re very much in line with the expectations we gave you last quarter.

Natural Resources delivered $17.8 million in operating income in the quarter. And Jim Walter Resources sold $1.5 million ton to the metallurgical coal at an average price of $84.86 per ton on a short ton FOB Port basis.

Sales prices in the first quarter were established in the 2007-2008 contract season and were negatively affected by $9.2 million in demurrage charges. Sloss delivered on its dramatic increase in pricing and recorded $18.7 million in operating income. Together, our Natural Resources in Sloss segments delivered $36.5 million in operating income.

As I mentioned, the recorded results were negatively affected by several items in the quarter related to our non-core Financing and Home Building businesses. On an operating basis, our Financing and Home Building businesses performed consistently with our expectations.

Our Home Building business reported a $14.7 million operating loss. After adjusting for the previously announced $6.8 million in structuring charge and the $4.2 million non-cash charge for additional discount, normalized operating results for Home Building would have been a loss of $3.7 million, one million dollars below the year ago quarter.

The $6.8 million in structuring charge to Jim Walter Homes related to our decision to shut its 36 underperforming sales centers. This charge impacted earnings by approximately $0.08 per diluted share but improved the operating position of the company in today’s market.

The $4.2 million of additional discounts, or approximately $0.05 per diluted share, was recorded as an adjustment to the sales price of installment notes. This non-cash charge results from a significant increase in the discount required to transfer the assets to Financing at their estimated market value. We expect similar charges for the next three quarters as we build out the backlog of internally financed homes.

Financing reported at $6.7 million loss in the quarter, after reporting a $17 million charge related to the change in value of interest rate Sloss that no longer qualify for hedge accounting treatment. On a normalized basis, Financing would deliver $10.3 million in operating income, $300,000 behind last year’s first quarter, reflecting slower pre-payment speeds.

The $17 million pre-tax charge, or $0.21 per diluted share, was reported for losses on maturing interest rates Sloss that we had entered into as a hedge on a forecasted securitization of bombarded warehouse assets. The other availability of a residential mortgage securitization market led to our decision not to pursue securitization of the warehouse assets as we have in the past. As a result, the Sloss no longer qualify for hedge accounting treatment and the Sloss that would have been amortized over the life of the securitization has to be recognized in the quarter.

As noted in our separate release last night, we’ve taken several important steps aimed at preparing our Financing and Home Building businesses for separation from Walter Industries. Beginning May 1, 2008, Walter Mortgage Company will no longer finance customers of Jim Walter Homes and Jim Walter Homes is transitioning to a third party lender model to include loans under various government sponsored loan programs. Walter Mortgage Company will continue to service the existing $1.8 billion portfolio while aggressively pursuing service and expansion opportunities.

In addition, we amended our 2005 Walter Credit Agreement to provide an additional $250 million of credit availability. This action allowed the company to repay its mortgage warehouse borrowings and eliminate the company’s reliance on mortgage warehouse facilities and the mortgage bank securitization market. While this increases debt at the corporate level, it was a prudent measure to preserve the value of the investment and Financing business and its portfolio. We expect to have significant free cash flows over the next 12-18 months that will allow us to rapidly repay this incremental debt and provide ample liquidity going forward.

In a very difficult credit environment, the amendment demonstrates the strong support of our lenders and, importantly, pre-approves the separation of the Financing and Home Building businesses from Walter Industries. Mark will provide more details on these items later.

At this time, I will turn the call over to George to discuss Natural Resources and Sloss.

George R. Richmond

Thanks, Vic, and good morning. I would like to open by commenting on our safety performance in the period. At Jim Walter Resources, our [M shared {08:05}] reportable incident rate was 4.65, which was 33% below the 2007 national outcome. We continue to assess our safety performance and upgrade safety systems, including training, safety audits and risk assessment programs. Although we are pleased with our progress today, we will not be satisfied until we achieve our ultimate goal of zero accidents across all our businesses. We remain committed to operating safety operations in the world and as such continue to make safety our number one priority.

Turning now to our operating performance for the first quarter, we produced 1.6 million ton of coal at Jim Walter Resources and remain on track to achieve our previously announced pushed out range of 2.8 to 3 million tons.

Production at No. 7 Mine was slightly less than an average quarter as we were operating in the part of the longwall Tunnel with [? Inaudible ? {09:05}]. However, this was offset regular production output of one million tons at No. 4 Mine. Our four year Met coal prediction remains unchanged at 6.7 to7.1 million tons.

The incremental year over year volumes is related to the No. 7 Mine southwest 8 panel, which is scheduled to begin production in August and deliver approximately one million tons by the end of the year.

We have increased our full-year Met coal sales outlook to a range of 6.9 to 7.2 million tons, reflecting opportunities to sell, purchase, cold, to serve an existing coasters leading to bridge supply shirt for and the current in market environment.

Coal production costs were $48.47 per ton in the quarter, in line with our previously announced expectations. [Inaudible] goes to the prior year period as we continue to develop our No. 7 Mine expansion projects. As we said last quarter, we expect every production cost to decline once we start up the second longwall No. 7 Mine and return to a normal ratio of continuous miner tons to longwall tons.

Our expectations of coal production cost for the full year remains between $45 and $50 per ton. However, rising of material costs such as steel and energy could negatively impact production costs.

Metallurgical coal pricing in the first quarter was lower than expected due to rollover pricing from the 2007-2008 contract period. Triton also reflects $9.2 million of demurrage charges compared to $7.8 million in fourth quarter of 2007 and $2.3 million in last year’s first quarter.

Demurrage in the first quarter included $3 million resulting from delays of the Port with the remainder due to limited availability of No. 7 Mine’s coal. Although demurrage was high in the first quarter, we expect decrease in the second out for a number of reasons.

First, when the second longwall commences production at No. 7 Mine, we will have additional coal available. Second, the expansion of the Alabama State Docks is expected to unwind in the August timeframe. And finally, we have negotiated demurrage caps into many of our 2008/2009 coal contracts, which should limit our costs.

We continue to make very good progress in our No. 7 Mine expansion activities. Development of the Southwest “A” panel continues and we are confident the longwall will start in mid-to-late August.

Our 7 East expansion project also remains on track with development of the first tunnel provisionist plant. Start of the longwall is expected late first quarter, although the second quarter 2009 depended from the achievement of plant advance rate for the continuous mining sections. All of our infrastructure will be completed in this year’s third quarter, well in advance of the scheduled longwall [inaudible].

Sloss continues to perform well on posted record operating income of $18.7 million for the quarter, on the stretch of dramatically increased coal prices. Sloss’s pricing and production are expected to remain strong throughout the rest of the year. However, our raw material costs may slightly reduce margins over the course of the year.

Tuscaloosa Resources lumped over 93,000 tons during the quarter. Of produced [inaudible], 7,000 tons. Operating income totaled $1.2 million, which was impacted by escalating diesel fuel prices. From the contracts that’s been priced through the year end, we have already begun negotiating 2,009 contracts and expects significantly higher prices.

Kodiak sold 43,000 tons of coal and produced $20,000 in the quarter. Operating losses from Kodiak were approximately $4 million in the quarter, in line with the fourth quarter of 2007. While Kodiak may not reach our initial expectations to production, we believe we’ll be improving production of continuous strength in the metallurgical and thermal coal market this business can achieve profitability over the next several quarters.

Moving to the market, it’s reported in yesterday’s press release, we have recently settled 2 million metric tons of production of pricing accessible at $315 per ton FOB Port, more than $15 above the Australian benchmark. The reported prices that we are realizing reflect the continuing expansion of the global steel market, as well as, the [{14:14}]. Significant supply constraints remain and as a result, I expect strong metallurgical coal pricing to continue beyond the 2008/2009 pricing cycle.

I would also like to point out that the timing of the increases pricing could not be better for Walter Industries. As we continue the expansion of No.7 Mine with approximately one million incremental tons to be produced in the second half of this year from our Southwest “A” panel and production increase into operable annualized rate of 9 million tons then the 7 East longwall start of 2009.

I would now like to turn the call over to Mark.

Mark J. O’Brien

Thank you, George, and good morning everyone.

As Vic mentioned earlier, Financing and Home Building recorded $28 million in special charges during the quarter, reflecting weak credit and housing market conditions and charges related to the strategic actions we have taken. Excluding these charges, Financing income was essentially flat and Home Building income was down approximately $1 million compared with prior year period.

What is most important this quarter was the strategic actions we took to advance our strategy to separate Financing and Home Building from Walter Industries. And at the same time, preserve the value inherent in our Financing business and its portfolio of strong performing mortgage assets.

As you know, our Home Building business has improved its profitability dramatically over the past two years, all the while remaining a source of high quality, fixed rate mortgage asset. We’ll be accumulating these high quality mortgage assets which, in a normal course of business, we would have secured that. However, it is now apparent that the mortgage bank securitization market is not currently available and may not be available for some time. In addition, none of the supervised short-term warehouse facilities are capital constrained and are having trouble issuing commercial paper to finance these assets. As a result, they are dramatically reducing the availability of this credit.

Bottom line: Right now, you cannot finance the origination of mortgage assets short-term or long-term no matter what the quality. Despite the strong performance of our assets, we are being affected like the rest of the industry. At March 31, 2008, we had more than $330 million in mortgage assets securing $214 million in warehouse borrowings. This represents more than $100 million in equity trapped in these warehouse facilities. These warehouse facilities were scheduled to mature in July and October, and which is extremely difficult to renew under any reasonable terms.

Again, all of this is a by draw and believing that this market will not be back to normal in the near future. We paid off our warehouses, abandoned our efforts to securitize in 2008, and discontinued originating new mortgages. As a result, we were required to that the $17 million charge off the securitization hedge we had at plate. Going forward, we do not have and will not have securitization hedging.

We have stopped originations to eliminate our needs for future additional financing. Home Building is implementing a third-party mortgage financing model focused on government sponsored or insured mortgages. We have a backlog of approximately 900 homes or a plus or minus $80 million that we will build and finance over the next 6-9 months, but this is the limit of our future funding obligations.

Importantly, we extinguished our two mortgage warehouse facilities by amending our corporate present facilities to increase our corporate revolver availability. This remove the need for short-term liquidity necessary to finance existing warehouse assets and future backlog production. This positions us such that we are not dependent on the unpredictable mortgage financing market. The result: More than $400 million of mortgage assets will be unencumbered and unpledged to any borrowings. This represent significant value preserved for our shareholders. In addition, the new amendment to the Walter Credit Agreement pre-approves the separation of our Home Building and Financing businesses from Walter Industries.

So what about the future? On the Financing side, we have a very viable, strong stand alone company: A proven management team, a solid balance sheet, and significant stable cash flow. The servicing side of the business has a proven track record for improving portfolio performance and we believe it is a platform that can be leveraged to service mortgage assets for others. There currently is a very strong demand in the market for specialty financing and distressed mortgage loans. And the timing could not be better for us to expand and profitably grow this business.

For Home Building, the removal of our internal financing option essentially puts us at parody with the rest of the industry, as most of our home builders rely only on third-party financing. Having internal financing was a comparative advantage and we anticipate that there will be a transition period where our business adjust to not having this [19:51] but we have been encouraged by the percentage of our potential customers that may qualify for the various government sponsored loan programs.

Many potential customers will actually benefit from lower down payment requirements, lower interest rates and mortgage payments. Along with this, we see the opportunity to build bigger houses and move up slightly in price point. The new business model with introduced expense structure and comparatively low capital requirements has the potential to generate good returns and, as a result, add value in the marketplace.

To summarize, we believe these actions have positioned us to ease the separation of Home Building and Finance businesses from Walter Industries by year end while preserving the significant value in these businesses for our shareholders. With that, I’ll turn the call back over to Vic.

Victor P. Patrick

Thank you, Mark.

Before moving to Q&A, I want to comment on our business outlook. The business outlook section of the earnings release includes ranges for tons sold and operating margins for tons for our met coal and coke, taking into the account all of the key drivers we have provided.

For the remainder of 2008 in particular, the timing of incremental met coal production and sales volumes, as well as, the changing base of pricing will cause significant variation between periods. The sales volume and operating margin ranges provided reflect our estimate of the overall impact of these issues. Also, in establishing these ranges, we’ve incorporated reasonable contingencies for risks.

Summarizing our outlook for 2008, our record coal contract pricing for the 2008-2009 contract year, coupled with our strategic actions in Financing and Home Building, now have us very well positioned for the remainder of the year.

First, our pricing and performance outlook for the remainder of the year have us extremely confident that we will report record earnings in 2008. And second, we have cleared the runway to finalize our separation strategy before the year end. Looking ahead for 2009, we expect a continued strong pricing along with increased met coal production. We’ll lead to even higher earnings and significant increases in cash flows.

Now that we have completed our prepared remarks, we’ll open the call for questions.

Question and Answer Session

Operator

Thank you. At this time we’ll begin the Question and Answer Session. [Operator Instructions]

Our first question comes from Michael Gaugler, Brean Murray Carret.

Michael Gaugler - Brean Murray Carret & Company, LLC.

Morning, everyone.

George, something in your comments caught my eye: Demurrage caps, can you provide any details, say a per ton range, at cost-wise?

George R. Richmond

Yes, at this time, I prefer not to when we fund the release. I still expect over a million tons contract pricing to be settled so I’m not quite finished. We will not see the $100,000 a day number no more. We are going to share some of the risks with our customers. I’d rather wait until we finish our negotiations.

Michael Gaugler - Brean Murray Carret & Company, LLC.

Okay. One more question on the natural resource segment. You’ve got some longwall moves coming up, correct?

George R. Richmond

Correct.

Michael Gaugler - Brean Murray Carret & Company, LLC.

How’s that looking in terms of getting set up and ready to go and what kind of timelines are you looking at?

George R. Richmond

The No. 4 Mine is that one longwall move but we added the longwall equipment pre-installed so we had no delay. The next longwall move, we got a new set of longwall shield to finally total the result the problem a few years ago. And provided the delivery is on schedule, we should also have the longwall pre-installed and expect no longwall delay. The No. 7 longwall is in early in the third quarter and again, the development is in good shape so we should be a normal tight delay of 10-12 days.

Michael Gaugler - Brean Murray Carret & Company, LLC.

Okay, sorry, got another follow up. Should you mention longwall shields, the 7 East expansion, are those going to be shield that are to be rebuilt in your yard or are they going to be new shields?

George R. Richmond

The 7 East expansion, we’ll have two sets of shields throughout operation and they’re actually the shields that are operating at No. 4 now. And the second sent the shields out, we’ll operate the 7, Southwest “A” panel. Both sets of shields are being overall in the last year or so.

Michael Gaugler - Brean Murray Carret & Company, LLC.

Okay. I got a question on Home Building, but congrats George on the pricing. That was just phenomenal.

With regards to the Home Building segment, I was wondering do you anticipate any further financial changes associated with the separation of those assets that could generate any type of significant additional charges or do you feel that you’re pretty well set up now to spend those assets without any more messing as to future quarters?

Mark J. O’Brien

As we mentioned on the call, Michael, there are about 900 houses in backlog that will require our financing. We have to meet our obligations and there will be charges. We’re expecting charges to the discount yield adjustment somewhere to those we had in the first quarter again, but that’s the extent of it.

Michael Gaugler - Brean Murray Carret & Company, LLC.

All right, guys. Thanks and congrats on the pricing.

Operator

Our next question comes from Jim Rollyson, Raymond James.

Jim Rollyson – Raymond James

Good morning, gentlemen.

I’d also reckon to congrats George on the pricing. You kind of gave really good detail by quarter of expected sales and operating margins per ton. Can you give us a little detail? I mean, you haven’t gotten in to ’09 but the 8 to 8.5 million tons you’re looking for, how much of that is now priced and do you know what the average is so far? Just trying to get a sense for how this runs through into next year.

George R. Richmond

Jim, I’m not going to go quarter by quarter, but let me just try and put the first half. Between what we settled at the first batch, the 135, and what we settled at the second batch of what we expect to settle in the next two weeks, there’ll be 3.3 million short-terms for the first half. And we expect the outreach price to be slightly over $200 a ton FOB Mine site short-term.

Jim Rollyson – Raymond James

Okay, very helpful. If you might give us your thoughts on how you see pricing kind of rolling into the next year fiscal contracts, given what you guys see with your market intelligence. $315 issues the number today, is that go up or down or kind of what your broad thoughts there?

George R. Richmond

I’m not sure I can tell you a little broad today but I can just give you a few of the basics. There will continue to be a shortage at the steel industry stage warranties of high quality coal. If you look around at all quality coal, you don’t see any new significant production or infrastructure coming on. On the other side of it, there are significant projects in demand that are going to require metallurgical coal. In Brazil, for example, the Brazilian steel industry used to be a 30 million ton industry. It’s gone to 50 or 60 million tons. And this is all drawing board plans so as of today, we can’t say we’re just going to be down a bit. There are some articles out there that talk about maybe $275, but I don’t think anybody has got a clear picture. But we’re absolutely confident it’s going to be extremely strong based on the supply and demand.

Jim Rollyson – Raymond James

All right. Last question: Obviously, this suggests that you’re going to generate a lot of free cash flow over the next couple of years. Any thoughts broadly with what you guys plan to do with such free cash?

Victor P. Patrick

Well, one of the things we’re going to have to look at is repaying the debt we put on. We’re going to have to look at continuing organic kinds of projects like George has done with the 7 East project, which is obviously very beneficial. We’re going to have to look at acquisitions and we’ll have to think about ways to return money to our shareholders in the form of dividends or stock repurchase. We’re going to have to look at all of those as the occasion permits and just tee those up and try to figure out what the right thing to do is when we have that issue.

Jim Rollyson – Raymond James

Excellent. Thank you.

Operator

Our next question comes from Dan Mannes, Avondale Partners.

Dan Mannes – Avondale Partners

Morning everybody.

Couple of follow up questions: First on Home Building and Financing. Can you briefly talk about, maybe I missed this, what are your commitment levels for funding the homes already in backlog?

Mark J. O’Brien

Dan, about 900 houses and $80 million in volume. Obviously, there’ll be some cancellations to that but that’s what we’re looking at at the end of the quarter.

Dan Mannes – Avondale Partners

And that’s already committed to be financed? $80 million?

Mark J. O’Brien

Yes.

Dan Mannes – Avondale Partners

Okay, perfect. Have then given the reduction of activity in Financing, are there going to be further headcount reductions or is that included in the $6.7 million charge you took this quarter?

Victor P. Patrick

The ones for ’08 are included in the restructuring charges. We’ll have to look at the business as we go forward. That depends in large measure on what the pre-payments and that kind of thing are.

Dan Mannes – Avondale Partners

Okay. Then moving quickly to the coal side of the business. Can you talk a little bit about the, I know you guys priced the $2 million at the attractive rate of $315, when you look at the 1.1 million you’re currently negotiating and the $600 that sort of still open, can you give us any thoughts on current dynamics or any changes from the $315 already priced? Or by just assuming that, we’re probably in good shape?

Victor P. Patrick

I think we’re in good shape on the 1.1 million.

Dan Mannes – Avondale Partners

And then lastly, on just other sort of mining things, you talked a little bit about Kodiak and improving performance. When you said it would be, it sounded like you mentioned operating income positive over the next couple of quarters, are you saying that it’ll get there or are you saying it should be there already in the next quarter or so? And then just talk a little bit about what the output could be from that unit.

George R. Richmond

Let us expand on it. As you know, we’ve been monitoring very closely. We had a few issues but the mine to be profitable, it really needs two continuous miner sections. We have not been willing to put the second continuous miner section until we improve performance on the first one. And also, we need to spend some capital. Not a lot but some capital to improve some equipment but we really needed to hit some targets on the production before we’re willing to do that.

Today, we have seen fairly significant over the last month or so, improvements in production. It’s not for a long time, but we take that and double it by two. The production starts to look pretty good. But one of the major change is I don’t think we’ll ever get to the production level we expected but also the market is changing so dramatically. The coal we sold in the first quarter was into the steel market at $60 a ton. We have recently sold some of that coal into international met markets at approximately under $150 a ton. So the grand dynamics of this business is dramatically changing.

Dan Mannes – Avondale Partners

That actually brings up a follow up. As you look at Kodiak and maybe to a lesser degree, TRI, could you give us a little bit more color on what the opportunities are? I mean, that $150, is that a TCI and is that something that can continue? And then I guess a similar question on what the opportunities is out of TRI.

George R. Richmond

It’s actually [inaudible]. It got some issues with high quality coal as well. And we’ll just have to production, we’ll continue, I’m pretty much in that quality coal once it steps into the market, it could go on for a while.

Dan Mannes – Avondale Partners

Okay, and then same question for TRI and what the opportunities are.

George R. Richmond

Within negotiations on TRI, most of our production is sold out for the year. So, I really don’t want to talk about where we are in negotiation but needless to say, the [inaudible] for steam coal’s gone close to $90 a ton. So we’ve seen a dramatic improvement in steam prices as well.

Dan Mannes – Avondale Partners

And can that be realized this year or are we talking about for forward periods?

George R. Richmond

That would be 2009.

Dan Mannes – Avondale Partners

Great. Thanks so much for the comment.

Operator

Our next question comes from James McCanless, FTN Midwest.

James McCanless – FTN Midwest Securities Corp.

Good morning, everyone.

Mr. O’Brien, I’ve got a couple of questions for you. The first one, I guess, is just understanding how going forward Home Building is going to obtain mortgages for their customers? Is it going to be a thing where they work with political banks, etc, or the customer’s going to wholly responsible for bringing their own financing to the table?

Mark J. O’Brien

No, Jay, we will principally be an origination arm probably for government-sponsored loans, mostly likely, FAJBA; some of the state sponsored programs. We will organize some central processing and do it much the way the traditional Home Builder does it. Although, we won’t use our own funds at this point. We would basically table fund all of the closings. We will not encourage, but certainly not discourage either, that customers bring in their own financing that’s from its local bank. That’s fine, provided if the economics have it right for us.

James McCanless – FTN Midwest Securities Corp.

Okay, and then my second question is that since you don’t have the competitive advantage of internal financing anymore, is your intention or your thoughts continue the business as a on-your-lot business or potentially look at, since you talked about going to bigger houses, etc. getting back into the subdivision business?

Mark J. O’Brien

No, I don’t think we want to get into the subdivision basis given the capital requirements. On the other hand, we still enjoy a particular advantage in the on-your-lot business, given that we have an organized workforce that’s been doing this for six years and as you can imagine, building on your lot is not easy. So, we have a fairly unique niche in the marketplace so I think we’re going to stay there. It’s a capital efficient market. I actually think that in many cases, bringing more traditional government sponsored financing will be an advantage. Obviously, the credit enhancement of the government, whichever government, is superior to the oldest model of the business model we have run. We will by definition eliminate some of the poorer credits that we had traditionally been able to finance. On the other hand, there’s a fairly robust second home market and that kind of thing that is financeable through some of these government programs that I think could pick up the slack. I don’t want to however minimize the change in the process. It’s significant and the transition period will be a bit tedious.

James McCanless – FTN Midwest Securities Corp.

Okay, and then my final question: If you look at the amount of revenues that the company is bringing in, etc, is the potential for a spin off still there or is it more a thing of potentially a sale of the business? How are you thinking about that part of it?

Mark J. O’Brien

We haven’t eliminated anything but I think it’s important to understand that while when we talk about our business segments, we tend to put Home Building and Financing in one bucket and Natural Resources in another. I don’t think you should be predisposed to believe that those have to go together. Pretty clearly, the Financing business with these unencumbered assets is a much different business model than the one that requires additional financing. At the point, the Financing business, as it exists right now, wouldn’t require any further financing. And then if you look at the Home Building business, its financing requirements as it moves to a third party financing model, those financing requirements are fairly limited.

So I think we now have an opportunity to do more things in the disposition of those two assets than we have hitherto for.

James McCanless – FTN Midwest Securities Corp.

Okay, great. Thank you.

Operator

Our next question comes from Mark Caruso, Millennium Partners.

Mark Caruso – Millennium Partners

Good morning, guys.

Just wanted to circle back on pricing. I was hearing recently that spot pricing is formatted in the $400 a ton range. I want to see if that is accurate and then I wanted to circle back as far as the calendar goes, where you stand as far as customers, because I’m trying to remember if Europe or Brazil negotiations in June and then sort of how the calendar plays out since we just had the Australian benchmark in April?

George R. Richmond

Let’s start off with the calendar year. Most of Europe is the April 1st March period and South America is mainly July to the end of June. The $400 I have not heard of. I have heard of some stock business in the $350 range but some of it has been stretched. As of today, I know very little term business with long-term customers who are above our $315. It wouldn’t shock me to see some individual spot businesses go fairly high prices and over the next 12 months when the term business is done, we’ll all see some very, very high distressed sales prices.

Mark Caruso – Millennium Partners

And then George, when you’re talking about ’09 and I realize this is probably more winded to the back half of ’09, but you mentioned significantly higher prices. I’m just trying to gauge when people in general have discussions about 2009, is it sort of in line with the $315 or the benchmark, or is there a discount to the benchmark because I know the issues in Australia to your point hasn’t really shown that it’s really going to unwind this year. So I’m wondering where pricing is right now and in conversations.

George R. Richmond

For next year’s business, I don’t think we’re willing right now to give you a variation, give you brought down from the $300. However, I believe that most customers that have settled off continue to settle are still short of coal. And traditionally, with no guarantees, that will drive early settlements for the 2009-2010 business. Not a guarantee but sure to just tend to bring those negotiations forward.

Mark Caruso – Millennium Partners

Do you think it’s safe to say that a wide range is sort of mid-$200s around $300? Is that a fair wide range as far as where negotiations could be?

George R. Richmond

I’ll just say I’ve seen those types of ranges in different articles. I’m really not willing to comment on where I think it is today.

Mark Caruso – Millennium Partners

That’s great. Thanks again, guys.

Operator

Our next question comes from Wayne Cooperman, Cobalt Capital.

Wayne Cooperman – Cobalt Capital

Hi, guys. How are you?

I had a couple of questions, some of which are mostly answered. Just to be clear, you haven’t said when you’re going to split up the company but you expect to do it by the end of the year. And it sounded like from your last comments that you would not expect that you needed to infuse capital into the Financing or Home Building segments to effectuate that. Is that accurate?

Victor P. Patrick

Yes.

Wayne Cooperman – Cobalt Capital

All that’s accurate?

Victor P. Patrick

Yes, I mean, obviously we got to work on marginal details but on broad terms, that’s completely accurate.

Wayne Cooperman – Cobalt Capital

Okay, I know you’re not going to tell me what the met coal price is for next year but—

Victor P. Patrick

Yes, yes. Well, keep trying on that one.

Wayne Cooperman – Cobalt Capital

I read the same publications as everybody else and talk to the same people. You guys have good production numbers though, increasing in ’09 and ’10 on met coal. Could you talk about just longer terms, is that a stable runway? Do you see the ability to increase production beyond that? Do you have any desire to increase production beyond that or you think where you are now keeps the market in good balance?

George R. Richmond

Well, that’s a stable runway with our existing plans. However, we obviously, on a daily basis, explore every opportunity internally we can to improve productions above those levels, but until we come up with some definite plans, we’ll use that as a stable runway.

Wayne Cooperman – Cobalt Capital

So I guess you’re saying you have the resources to go beyond that. Is that something you would consider doing or do you think you’ll kind of upset the market if you put—?

George R. Richmond

No. 7 expansion, from a hoisting capacity point of view, gives us some upside hoisting ability. However, we have to figure out how to mine more coal out the ground. The No. 4 Mine is somewhat hoist limited so we’d have to explore ways to increasing the hoisting without improving the ability to produce more coal in the ground. But we do look at those things on a daily basis.

Wayne Cooperman – Cobalt Capital

All right, great. I mean, we got some pretty mind boggling numbers for ’09. If you assume met coal prices stay somewhere where they are.

Victor P. Patrick

Well, that’s the math.

Wayne Cooperman – Cobalt Capital

Okay, last time I checked up on my calculator, it was broken.

Operator

Our next question comes from George [Haralambides with Contras Capital].

George Harlambides – Contras Capital

Good morning, gentlemen. Could you just explain to us how much tonnage is open for pricing met coal for ’08, ’09 and ’10? Thank you.

George R. Richmond

Well, when we complete the next 1.1 million tons over the next weeks, basically ’08 will be sold out. There’ll be a little bit but basically it’ll be sold out. But ’09, again, when we completed that bid, that 1.1 million ton, when some of it flows into ’09, there’ll be a little bit over 5 million tons available for ’09. And ’10, it’s all of available.

George Harlambides – Contras Capital

Thank you much.

Operator

Our next question comes from Sam Martini, Cobalt Capital.

Sam Martini – Cobalt Capital

Hi guys. Sorry for the duplicative questions. Just a couple of follow ups. In my recollection, you’re 50/50 Japanese and Brazilian fiscals. Is that about right?

George R. Richmond

It’s actually Europe and it’s a little over 50% into Europe versus Brazil.

Sam Martini – Cobalt Capital

I’m just trying to understand, in terms of the pricing strategy, if I were to make it really simple I would say that in coming into July, we would have some percent of our production open and coming into April, we would have some percent of our production open and that would roll each year, except it seems like we sell coal throughout the year albeit not on a US fiscal but we sell it forward into these fiscals well in advance of settlements. Can you just give a little bit of the approach to pricing in such a tight environment, how you think about looking forward if we just roughly said you do 8 million tons next year at the low end and that’s sort of would be 4 and 4 on each fiscal, when you would expect those to be kind of locked up? I know that coming into this very strong fiscal ’09, we sold some in advance of the settlement and I’m just trying to get a better handle on the strategy behind the pricing dialogue with your customers.

George R. Richmond

Yes, you’re right. It’s actually we don’t sell it over the year, going from year to year. It swings a lot and when we actually do sell it, it seems that way. Sometimes the settlements fold fairly quickly in the October/November timeframes. And then, some years it goes into February. But what is fairly common though is whenever we start negotiations, they do conclude relatively fast. The timeframe, for example, the 2 million tons we’ve just settled, has occurred in 6 days.

But looking at the available tons for 2009, which some of it will start in April 1st and some of it will start in July, I would suspect today that that will probably settle in the last quarter of this year versus the first quarter of next year, purely because there’s a shortage of coal and customers like to lock in volume as quick as they can.

Sam Martini – Cobalt Capital

That’s really my question. So, let’s say, your expectation would be it’s “A” and by the beginning of Q4, you’re going to be negotiating for this 5 million tons and hoping you’ll think you’ll end the year locked up. You’re not going to wait ‘til next April to be signing this?

George R. Richmond

It takes two to tango. My best guess today is because I expect a shortage of high quality coal next year but a lot of the customers will want to tie up early versus later. And certainly, we’re willing to do that. We think it’s the right time of the marketing season for us to maximize prices.

Sam Martini – Cobalt Capital

I’m not sure I got this right but you said about 3-3.5ish or $200 short of the mine for the first half of ’09. Was that right?

George R. Richmond

I’m saying over the next few weeks, we will have expected to settle 3.3 million tons in the first half of next year at prices of the mine slightly over $200 at short-term.

Sam Martini – Cobalt Capital

Okay, then just a couple of housekeeping questions. On capital required to continue to grow these productions, if you said it already I apologize, but could you just say what you think you’ll be spending this year and next?

George R. Richmond

Most of the capital for the expansion is completed this year and that’s a little over $52 million for the 7 East expansion.

Victor P. Patrick

That $52 million includes the $10 million in the first quarter.

George R. Richmond

Yes, and that’s the 2008. There’s a little bit into the first quarter and after that, without new projects, will revert back to a normal run rate which is in the $40 million range.

Sam Martini – Cobalt Capital

Okay, and then just finally on freight. Any big changes in freight cost from mobile to the mine.

George R. Richmond

The guidance we’ve given out takes into account what we expect for the year including fuel adjustments, etc. which is in the $13-14 range.

Sam Martini – Cobalt Capital

Okay, and I think Mark said earlier that one of the priorities would be to reduce debt. The debt sits currently at about $260 million. It’s reasonable cost. Is that not right? Do you think that being a debt-free company is—?

Victor P. Patrick

Well, you have in addition the $220 million from the refinancing of the mortgage assets. Then you have the potential for the incremental $80 million that Mark talked about for the commitment to internally fund the backlog. So that incremental debt could take you like maybe be a high priority for use of funds.

Sam Martini – Cobalt Capital

Okay. Thank you guys very much.

Operator

[Operator Instructions]

Our next question comes from Frank [Duplex], Credential.

Frank Duplex – Credential

Just a follow up on the last question about capital spending. Can you give us an overall number for 2008 and 2009 at this point, estimated?

Victor P. Patrick

2008, on total basis, we expect to be between $140 and $150 million. $51 million of that relates to 7 East. In 2009, that will come down considerably as we’ve got the 7 East done, so we’ll be back in a more of a maintenance kind of level.

Frank Duplex – Credential

And maintenance is kind of the $90-100 million level. Is that said?

George R. Richmond

I think from a maintenance level, that’s the high. We’ve traditionally been in the $40-45 million range for replacement equipment unless it’s a year when we buy a separate longwall shield which happens every maybe 4-5 years, which is about $40 million. The only think I warned you about is mining equipment have increased so it’s obviously inflation factors there.

Frank Duplex – Credential

And it looks like the 2008 number is up a little bit maybe from prior guidance. What do you attribute that to?

Victor P. Patrick

That’ll be the shields.

George R. Richmond

As we mentioned earlier, we replace the set of longwall shields this year. They usually last about 10 years but we approached them about 18 months ago. And we also traditionally lease our longwall shields under a long-term lease where the suppliers supplies components and repair rebuilds. That lease is up this year so we’d have to replace the shields for all the longwalls. That’s this year but that’s not our annual costs. This contract was about 6 years.

Frank Duplex – Credential

Okay, thank you.

Operator

Our next question comes from Ted Kim, Diamondback.

Ted Kim – Diamondback Capital Management, LLC.

Hello, I have two questions. First related to the additional mortgage debt and secondly pricing outlet. But on the first one, you spent the $220 take out the warehouse buy-ins and probably spend another $80 million for commitments on the backlog. When you funded that $300 million, should we think of it as you having an offsetting asset, $300 million of mortgages?

Victor P. Patrick

The increase in the mortgage assets, they were financed at an advanced rate. We repurchased a higher value than we spent to refinance it. We got $300 million back in assets for the $220 million. We put on an additional debt. And in the Financing business we will see the same level of financed interest income that we saw. For the financed business, the warehouse debt is no longer there and so you won’t see that debt expensed in the Financing business. On the other hand, you will see an increase in corporate revolver debt and that will essentially offset.

Ted Kim – Diamondback Capital Management, LLC.

So if you were able to separate the business, the Home Building one way or another, let’s say tomorrow, would that $220 million of debt probably come off your balance sheet right away and somebody else would be funding the other $80 million? Or would you expect that to stay with you even if the businesses were separated?

Victor P. Patrick

The debt is corporate debt and in the absence of some structure that would have that go with the Financing company, it would stay on the corporate balance sheet.

Ted Kim – Diamondback Capital Management, LLC.

But if you were to separate the businesses, presumably you would get value for the $300 million of offsetting assets?

Victor P. Patrick

Well, the short answer to that is yes but if it went off in the form of a spin off, our shareholders would see the value in the spun off shares in that form as if were in the form of a sale, then there would be cash coming back in and you could see the value in that sense. So, I’m not going to predict which one that is but the short answer is yes, but the form of that can be very different. And the effect on the Walter balance sheet could be very different depending on how that all structures out. At the end of the day, as the management team and as the Board of Directors, we have to assure that both sides of the business are properly capitalized whatever we do.

Ted Kim – Diamondback Capital Management, LLC.

Sounds like the form of it may be unpredictable but at the end of the day, we can be confident and comfortable that there is offsetting value here.

Victor P. Patrick

But the value didn’t go preserved for the shareholders. In fact, that’s the whole point, that in this difficult market conditions where there was a possibility of losing value for the shareholders and you’ve seen those kinds of transactions all around the market, what we did was done to preserve that value and assure that our shareholders would get the benefit of that in some fashion over time.

Ted Kim – Diamondback Capital Management, LLC.

Okay, and secondly on pricing, Estrada CEO was out yesterday making a very bullish comment on pricing, I think met coal pricing in particular, and they’re talking about trying to get $360 for the balance of their contracts, based on 60% they contracted. Mostly interesting, talking about expecting no decline for next year or next two years. I guess two questions relate to that.

First is, do you have any thoughts on if that’s possible at all, given what you said earlier about you thought $315 is kind of a high water mark and potential at least for having no decline at all for next year?

George R. Richmond

I didn’t mean to say that was a high water mark. We’re early in the stage given where the market is, I think there’s potential up, there’s potential down in this strong market. And I think at this stage, roll over pricing is one of the options as well as some of percentage down and some percentage up. I really can’t comment on the $360 extracting some good coal and likewise often get the top of the range in the market.

Ted Kim – Diamondback Capital Management, LLC.

I guess that BHP’s best guidance, as it seems to be, that we should expect a big drop off next year, maybe going back to $150. Do you see that as remotely possible given the supply and demand fundamentals you see or does that just seem way too conservative?

George R. Richmond

In my opinion, I think that’s way too conservative.

Ted Kim – Diamondback Capital Management, LLC.

Okay, and a follow up to the earlier question that someone asked you about contracting strategy for ’09 volumes. You said you probably look to start doing that in the fourth quarter. I guess my question is, it seems like waiting until after the BMA settlements has worked very well for Estrada in the past and also this year, and being kind of the last person to contract. Why wouldn’t you wait ‘til next April/May? Let BMA do it, let Estrada do their work, and kind of leverage those efforts to get the maximum price possible? It seems like if you wait for Estrada you would get a better pricing. You did it two quarters before they do. Just the industry generally.

George R. Richmond

I think if we take a long period of time, every year we try and assess where we maximize pricing. Some years, the $125 year where we got $127, I believe we’re the first to settle and we got the highest pricing. We always consider that and when it’s the time to go to maximize pricing. All I would say about in the fourth quarter of this year, I think with the shortage, I think the customers would probably want to go earlier than later. However, we’ve also taken in account where we benefit the most and some years they probably better go up to Estrada. Some years, maybe when the market’s a little weaker, market’s going go first. So, we’ll have to assess all that.

Ted Kim – Diamondback Capital Management, LLC.

Would it be possible to have a contract pricing term that you get perhaps you see in the year end where if you would to agree to someone to a contract in the fourth quarter, you give them the certainty and exchange for that you agree on your price which is kind of a floor price and the charge off if anybody else settles significant volumes at a higher price, you get kind of a catch up on the pricing? Has that been done in the industry at all?

George R. Richmond

Yes, but some of that been done in the past and it is always an option. For example, you settle early and then you get a right to match one of the Australian. That is always a possibility.

Ted Kim – Diamondback Capital Management, LLC.

Okay, thank you very much.

Operator

Our last question comes from Charles Morris, Amiya Capital.

Charles Morris – Amiya Capital

I just got another question on pricing. You guys must be getting bored but I’ve been hearing that maybe some of your competitors who have find coking coal contracts at lowest prices, $130, around those levels, have been sort of verging on those contracts, fighting it in courts, maybe paying some of that and then just going for the higher prices given how tight the market is. Is that anything that you would potentially consider so your lower price contracts for this year were—how do you think about that?

George R. Richmond

Maybe some people attempted to renegotiate but regarding remitting, we do not. In the business, it’s call price measuring. And our customers are long, long-term customers and we have customers that when the prices go down in general will keep paying the higher prices and vice-versa. And I think for all involved, that is the best way to do business.

Charles Morris – Amiya Capital

Okay, excellent. Thanks.

Mark Tubb

Any more questions, Operator?

Operator

At this time, there are no further questions, sir.

Mark Tubb

We would like to thank you all for participating and thank you for your continued interest in Walter Industries.

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