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Alpha Natural Resources, Inc. (NYSE:ANR)

Q2 2008 Earnings Call Transcript

July 29, 2008 11:00 am ET

Executives

Ted Pile – Director of Corporate Communications

Michael Quillen – Chairman and CEO

Kevin Crutchfield – President

David Stuebe – VP and CFO

Analysts

Shneur Gershuni [ph]

Pierce Hammond [ph]

Ojai Ballantine [ph]

John Hill [ph]

Luther Lu [ph]

Jim Rollyson [ph]

Mark Paul [ph]

Mark Lenema [ph]

Jeremy Sussman –Natixis Bleichroeder

Michael Doris [ph]

Justine Fischer [ph]

Operator

Good day, ladies and gentlemen. My name is Dorie and I will be your conference operator today. At this time I would like to welcome everyone to the Alpha Natural Resources Second Quarter 2008 Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question and answer session. (Operator instructions) Thank you. Mr. Pile, you may begin your conference.

Ted Pile

Welcome everyone and thank you for participating in Alpha Natural Resources Second Quarter 2008 earnings call this morning. As always, we appreciate your interest in our company. We'll start this morning's call with prepared remarks from our Chairman, Mike Quillen and from our President, Kevin Crutchfield, and we'll follow with Q&A with Mike, Kevin and our Chief Financial Officer, Dave Stuebe.

During this call and webcast, Alpha management will make some forward-looking statements. Actual results may differ materially from these statements and these statements should be considered in the context of the risk factors contained in the press release we issued this morning and which is posted on our Web site and in our Form 10-K and other SEC filings which you can also access through the Investor Relations section of Alpha’s Web site.

As a reminder, a replay of this call will be available several ways, either by telephone with the number and access code appearing in this morning’s earnings release or by logging on to our Web site at www.alphanr.com and also as a podcast available in the IR section of our Web site as well.

I’ll turn it over to Mike now.

Mike Quillen

Thanks Ted. As always we'll start with safety, and this is not an easy discussion this quarter because of an accident that took the life of (inaudible) underground mine in Pennsylvania on July 11. Experienced Foreman Bill Pardee was preparing to move the feeder to a conveyor while its electrical cable had apparently fallen across the tram lever, which caused the feeder to move when it started trap him against the (inaudible). Bill leaves behind a wife, a daughter, and many friends and our deepest thought and condolences continue to remain with him as they have since the accident. This happened in the mine that was recognized last year with a notable safety award in which it had excellent safety performance in a very low inspection citation rate so far this year. This shows that we can never let our guard down. We are not going to loose our diligence, our priority on safety and this is a grim reminder where we continue to put our primary focus. Prior to this (inaudible)mine and preparation plans had upheld our ongoing our record of continuous improvement in safety with injury and loss time rates and continue to be well bell last year and substantially better in fact 46% better than the industry wide benchmark.

Moving on, I trust most of you have had the opportunity to see through the press release we issued this morning. The three months ending June 30 for new milestone in Alpha's history with a record high set for everything from coal revenue to per share earnings to EBITDA. But the real story behind those numbers is what makes us a unique and that's the ability of our people to react swiftly and may inflate to dynamic shares in demand especially in the international spot market, but also domestically. We are certainly optimistic about the future but equally impressed with how the Alpha folks, (inaudible) blending an optimization operation or responding in real time. We saw that in the first quarter and we stepped it up in the second quarter with metallurgical sales comprising 44% of our total sales volumes. I believe that's a new high as well for any one quarter.

What's especially noteworthy is that we came in 2008 with relatively little plan net production that had not already being committed. But by Alpha production with coal purchases and applying our blending of optimization expertise, our team continue to produce met coal for spot tenders. In fact, we still have nearly 400,000 tons of met coal left for spot opportunities this year with current market prices now substantially north of $300 a metric ton at the port. In the second quarter, in total we landed 3 million tons of made commitments that began shipping in the second quarter and strays through the first half of 2009 at an average weighted price between $300 and $305 a metric ton at the port. That's about $250 net back to the mine short turn.

Also as we mentioned in our news release this morning, we settled about 2.7 tons of thermal coal for delivery this year and next at a weighted average price of over $102 a ton. These are the primary reasons why our EBITDA target for this year is in the range it is, which is $490 million to $540 million on approximately 30 million tons of sales. Even at the bottom end of this range, that's more than double our EBITDA last year. As we contract our remaining 10 million tons of caped mass production plan for 2009, we see the market remaining very strong for hard coke and coal next year. We not only expect prices to hold up, but also plan to yield some upside in line with trends in several regions for our market transactions.

Any unexpected disruptions to coal supply sets us an adverse ruling of the chambers Valley Field [ph] appeal, our weather conditions such as those seen in Australia at the beginning of this year could propel prices even higher next year. Even this morning we saw reports from both China and Indonesia citing critical shortages – coal shortages of a critical nature. For 2009, we expect EBITDA in the range of $1.7 billion to $2.1 billion, which would be about equal to our revenue number from last year.

I want to turn it over to Kevin now, I'll come back wrap up the call with some comments about our plan merger with the Cleveland-Cliffs organization.

Kevin Crutchfield

Thanks Mike. On the operations side, we had a solid second quarter. Production was up from last year in both our surface mines and in our company deep mines by a combined total of about 300,000 tons or more than 4%. Overall produced and processed tons were flat though because contract production in plant level purchases trailed last year. Purchase coal volumes were quite high at 1.5 million tons versus 870,000 tons in the second quarter last year as we maximized our blending operation to service the active spot market for metallurgical coal, which paid off handsomely on our income statement.

As you saw in this morning's news release, we experienced continuing cost pressures in the most recent quarter, although, we still successfully pushed our unit margins up by 130% to almost $22 a ton, far and away their best level ever. Three components accounted for the lion's share of the unit cost differential from last year and also from the first quarter of this year. Escalating steel and diesel fuel expenses combined with the cost we incurred in the second quarter from boosting employee incentives and our recognition in retention program accounted for almost two-thirds of the sequential increase in Alpha's mine costs, and more than half the increase from the second quarter of last year.

Also we had the impact of sales-related cost Royalty payments and coal severance taxes that rise as price realizations rise. We believe the trends in diesel, another supply cost are going to moderate. At the end of June, we had hedge positions in place for close to 70% of our remaining diesel fuel need for the balance of 2008 with about 35% of our anticipated needs now hedged for 2009. And rag [ph] prices has been fallen recently to around $3.60 a gallon. Also we locked in base steel roof control pricing for the balance of this year. Initial implementation costs of our employee incentive and retention program are mostly behind us too. This program was our way of showing our people how much we value their contribution in loyalty to Alpha, and recognize the vital role that they have in creating value for you, our shareholders'. The program has also helped curb turnover, which is what we had hoped.

So, we feel better about cost pressures moderating in the second half of this year. For 2008 as a whole, we think our per ton cost for produced and process coal will be in the range of $56 to $57 as compared with $54.65 year to date. We also believe purchase coal unit cost will for the fully probably be $4 or $5 higher than they were in the second quarter. We are now half way through 2008 having produced $105 million in free cash flow, which consists of $179 million of cash from operations and less CapEx of $74 million. We've got very strong ahead of us including as you know an exciting combination of forces with Cleveland-Cliffs.

Mike has a few comments to make about this.

Mike Quillen

Thanks Kevin. We've had the opportunity to talk with many of our investors both on the road and telephone discussions since our June announcement with Cleveland-Cliffs two weeks ago. We listened and we truly appreciate the feedback and comments. The number one question most people have, is this good deal for Alpha and its shareholders'? First Alpha management and the Board of Directors firm belief it is or neither of us would have endorsed it. We have run through many, many different analysis and scenarios to reach to that conclusion and considered a number of other potential deals as you will be able to see for yourselves when the proxy is filed.

Second, this makes strategic sense because it combines two market leaders and businesses that closely parallel on another, met coal and iron ore. Not only is it a steel raw material story, it's a grown story. Alpha will have emerging launch platform to continue our growth in combination with Cleveland-Cliffs and our appetite is consolidated of the coal industry has not changed, which spread to come out as merger with a very strong cash flow of profile and aggregate and a solid balance sheet with significant capacities continue to execute on our strategic plan with a pro forma ratio of about one times debt to EBITDA in 2008. We our Board reviewed a number of strategic opportunities and options to build shareholder value. The merger with Cleveland-Cliffs is attractive because it enables shareholders to gain a significant stake in the future's success by leading diversified mining in natural resource company, in addition to getting an immediate premium in cash when the mergers (inaudible).

We'll be happy to take your questions now and because of the transaction process we are involved in and the communications restraints we have to abide by, we'll take questions relative to our financial performance and outlook but we are limited what we can say about the merger agreement with Cleveland-Cliffs until the proxies are filed. Operator?

Question-and-Answer Session

Operator

(Operator instructions) And you first question comes from the line of Shneur Gershuni [ph]. Go ahead, sir, your line is open

Shneur Gershuni

Hi, good morning, guys.

Mike Quillen

Good morning.

Shneur Gershuni

I guess I'm going to leave the Cleveland question to another [ph] Q&A –

Mike Quillen

Hello, Shneur. Operator?

Operator

All right. It looks like we've lost them. Go ahead Pierce Hammond [ph], your line is open.

Pierce Hammond

Great, great results guys.

Mike Quillen

Thanks, and our people get the credit for that, Pierce.

Pierce Hammond

Couple of questions. First chambers, can you provide an update there, you mentioned chambers earlier and then how you see in permitting unfolding in Central Appalachia?

Mike Quillen

There's really nothing new to report on chambers. What we are as an industry, it's anticipated that their case will be heard in the fore said [ph] court of appeals has not issued a date when they'll actually start hearing that. In fact the other – in fact may be in this morning another case may have gotten in front of it, but we expect that we will hear something out this fall. We expect that it will be overturned. What our hope is, is that there's clarity in the decision so the industry can look forward and be back in this process again because we went down this path a few time. However, there is certainly a probability out there, there will not be definitive answer, and there will be additional law suits filed by environments groups for that chambers decision. We continue to monitor how that would effect our mining going forward, and as we said previously it's not something that's going to eliminate a whole lot of tons, but it is going to increase the cost of mining on our surface mine primarily due to having to hold our burden further distances than from the valley fields that we may anticipate today. Really nothing new as far as timing. It's still anticipated to be out this far.

Pierce Hammond

And then with the jump in cash costs across the industry, where would you peg the marginals ton cash cost, mine in Central Appalachia. What would that number be? Would it be $65 a ton, $70 a ton?

Mike Quillen

I'm afraid, your cost just not depend a little bit, one way you are located to what the quality is in terms of BPU and sulfur. But what we've seen it's really given us a lot of confidence for the base load business in the United States in the thermal big in time. In that we've seen almost a doubling in the price of steam coal in the last say 6 months or so. So, there's – now an attracted margin on the staying side, it really we have as an industry being able to enjoy over the last several years despite we have being making money of the met coal and not make an adequate return on your investment on steel [ph]. Again you still probably is what we see the prices moving forward there able to get a margin even at those numbers. So, there's not going to be a lot of current terms eliminated because of pricing, and we don't see that number coming off in the foreseeable future particular being from now through the end of '09. So, I think you are still going to see turns going there. For a variety of reasons, we don't see a whole lot of production increase coming on when that's primarily labor related, but we are beginning to see. I'm sure other companies will discuss this drop off in the delivery date zone, mining equipment both surface mine and underground, we are seeing extension zone underground miners out, an additional 4 months from where they were. We are seeing, for example, (inaudible) trucks 240 tons trucks being very limited in the availability over the next 18 months. A lot of excavs [ph] going offshore because of the US dollar and the activity offshore. So, we really don't see any significant increase in production, but at those prices I think we can still play in this steam and then make a margin.

Pierce Hammond

Thank you very much.

Operator

All right, sir. And we have Shneur Gershuni back in queue. Go ahead, sir, your line is open.

Shneur Gershuni

Hi, can you hear me now, guys?

Mike Quillen

Yes, we got you.

Shneur Gershuni

Okay. Good. I don't know what happened there before. I guess I just wanted to ask a couple of quick questions, I won't touch the Cliff questions but just I'm looking at your captive net production. With respect to your production this year and with respect to your production next year and so forth. I guess one of the first assumptions I would like to make is, can I assume that basically everything that you have on the purchase onside for met coal?

Mike Quillen

No. That won't exactly be accurate. What we do, we certainly do buy some met coal, we buy some marginal met coal and because of the higher quality of our hard coke and coal can carry some maybe coal that wouldn't necessarily make it on standalone. We also will purchase steam coal to put against existing steam commitments and free up particularly our (inaudible) coals in southern West Virginia and in Virginia that has coke characteristics in sales. And we can watch it a little bit harder and put them into the metallurgical business. So, I don't have a break down, and actually that's really a moving target how we do that. But at least a significant percentage of that would also be staying.

Shneur Gershuni

Okay. And then if I look at where you are at right now, I mean did you met coal run rate for this year on a production basis I mean should we be thinking of it that your basically producing 3.3 million tons of met coal because you are substituting some steam from the other side, and therefore you are running 12 million ton phase right now, or you running at less than that level?

Mike Quillen

Our company mines purchased – process now what on contract. It's going to around that 11 million to 12 million tons just standalone. So, really there's some offset because they at a lot of times we are extending that out a little bit. But the majority of that's going to be company kind. I don't have that right in front of me as far as the break down. But the other thing we do is with our stocks [ph] – certainly produces out there that if you are not billing [ph] I'll make an open number, but if you are not doing say 2 million plus tons in the export market, it's very difficult to address out the different where you could through a (inaudible) Again we are servicing in 17 countries. We have agents around the world. We have an experienced met sales. If you are already selling say half a million tons, it's an opportunity for us and coal producers to acquire those turns and put them into the metallurgical market. But overall the vast majority of the (inaudible) that are going there right now are our company controlled of course [ph].

Shneur Gershuni

Okay. I noticed that your production guidance for year is a bit higher and so forth. They (inaudible) run rate. Is there's some new production you are bringing on line or you improving your productivity in some areas that's going to straighten more production out? And also are you shipping as much as steam as possible that currently uncontracted that has high vol [ph] characteristics in that market as well?

Kevin Crutchfield

Shneur, this is Kevin. What's going on with the volume surge next year is we've got a couple of things happening. We've got a couple of surface mines they are going to enjoy particularly favorable mining ratios next year. And that's a temporary time [ph], we'll see kind of – we worked back to normal levels in 2010 and beyond. So, we are getting a bit of a surge there. We are bringing on some new deep mine capacity, some of that we've talked about before EnC9 and Deep Mine 41, normal replacement mines that sort of thing. But until some of those other mines exhaust we are going to experience a bit of above their, and we are also bringing on some new contractor production that it's faded off a little bit over the last 6 months and we are going to restore that to more normal operating levels. I think what you can expect is that in 2009, we are going to experience a surge up to the 28 million ton range. But you probably expect to see that back off a little bit in 2010 as some of these mines do exhaust themselves. And then your second question was are we continuing to so throw as much coal in the met market as we can, sir?

Shneur Gershuni

Yes.

Kevin Crutchfield

Can you hear me? I want the second part of your question again.

Shneur Gershuni

Yes. You basically you saw some uncontracted steam coal for 2009 and 2010. I mean was your plan basically to ship some of that into the met coal market if possible?

Kevin Crutchfield

I mean we continue to try to optimize our portfolio to take advantage of what's going on in the market. And the first thing we've got to do is take care existing customer commitments. But in the past we had talked about it, the 40% range was probably our theoretical match, but as we've continued to blend and optimize more to our purchase optimization programs we've been able to tweak that. And I think the last quarter was about 44%. Yes, I mean we've tried to take advantage of the marketplace where the best margin opportunities are available but yet take care of all of our customers as well.

Mike Quillen

As you can see, Shneur, we've got a pretty good gap on our forecasted purchase program for 2009 between 3 and 5. So, it's a little early to tighten that number down. We obviously are raising it for this year. We saw it happen this year on the low end of purchase goal and now we are moving towards the higher end of purchase goal. And it'll be reflected on opportunities in the market.

Shneur Gershuni

Okay. Great. If I can just have one last follow-up question. Just with respect labor availability, you weren't seeing as much turnover due to some of the incentive programs. I was wondering if you can talk about the general labor availability in the region itself? Are you seeing the surging demand quite off a little bit or (inaudible) places in other mines as well or will this a constant pressure for the next couple of years?

Mike Quillen

I think it's very, very tight particularly on the underground side. We started to experience prior to our employee appreciation program, a movement back from last year where it somewhat moderated back towards the higher teens area. After our program, we've had some divisions come – reduced as much as 60% and turnover in company-wide were down about 20% since our program went it and turnover. But it's extremely tight out there particularly for your skilled positions and especially for your licensed foreman supervisors. We all see that change at anytime probably in the next decade really is just – with what's going to move out of the industry because of age, and some of the expansion plans – excuse me that's been talked about within the industry. We think this is going to be a tremendous strain on labor availability for the foreseeable future.

Kevin Crutchfield

And Shneur, I would add that I think the production stats from the various regions in the United States bear out what Mike is saying very well. In the phase of doubling, tripling, quadrupling of coal prices. And you say what you want on a region by region basis, some are down, some are up a little up. But it's been especially in Central Appalachia, it's been largely inter-lactic [ph] supply base. I think as Mike says, this problem is going to continue to persist for a good while.

Shneur Gershuni

Is it fair to say though that if some your competitors and friends in the neighborhood start matching your incentive type programs or possibly exceeding them that you could have turnover tick up of again given the outlook that you've described the labor availability?

Mike Quillen

This is going to (inaudible) of course that's all already happened, and I have met with people – as we would react to whatever – and it's going to vary a little bit by region to region. I think the benefit fact is not all that different between particularly amongst the majors and the large independents, and therefore it becomes how you treat people, how they feel about your company, how you operate your safety programs. And the core, I mean very large core is going to stay with you. Obviously, if an employee has an opportunity to move from an evening shift to a day shift job or he can get a opportunity much closer to home because he's driving. Those two factors are very difficult to overcome with any benefit program. But the majority of them will work for you because they like the company probably rated higher than the benefit package.

Shneur Gershuni

Great. Thank you very much.

Operator

Your next comes from the line of Ojai Ballantine [ph]. Go ahead, sir, your line is open.

Ojai Ballantine

Yes. Good morning. My question was if the current deal that was announced this morning of Forting [ph] to be taken over by Tekamingo [ph]. Does this change the face of the North American met coal industry in your view in terms of the distribution or is it simply the linking up of two companies that were already jointly on? That's my first question. And secondly, could you comment a little bit of what the multiples on the deal? It seems that that was around for between $700 and $800 a metric ton for met coal, which seems much higher than the proposed Cliffs consideration for your metallurgical coal?

Mike Quillen

We of course got the release only an hour or so, and we have not had a chance yet to deal into the metrics but we actually have some people working on that right now to break it down into variety of different parameters that we would look at to compare it. As far as impact on the production side because the way the ownership was between Elk valley and Forting [ph], it's probably not going to have a significant impact I think on the supply side. Going into the marketplace, I think it's more everybody analyzing the financials. So, it is – that's kind of a unique deal because of this existing ownership structure which they had. So, I'm not sure if that is a perfect way to evaluate for a company's worth even though we will study and then compare it where we do our evaluations. But just haven't had a chance here. I'm it's been a waterfall of announcements this morning from China and Indonesia, their problems and then the fire at Nippon Steel is going to take out the coke ovens over there, and it's just been analyze of news this morning, and then that one came in right at the end which I just didn't have a chance to digest just to get prepared for this call.

Ojai Ballantine

Okay. That's fine. And just my second question is, would you say that the current spot number that you were quoting for or I guess even realization for thermal coal and met coal being north of the 300 bucks a metric ton? Are those indicative of where you see the contract market in 2009?

Mike Quillen

Apparently right now, we currently think that that's an indication as see it. Certain events could cause that number to even move forward because the supply/demand is so tight that you get another negative return on the production side and there will be more pressure on that price to move forward, and when we look at walk enforces those down, there's limited things. We just don't see any significant supply side (inaudible) Australia in excess of where they are in 2009, certainly recognize that there's limits on what's going to come out in the United States on a port wise basis in terms of total volume. A (inaudible) demand stayed relatively in line with the projections that we see there. This is not a lot other than something happened at the overall economic steel business around the world that changes there. So, yes, we are very confident that those number are very raise able now, and potentially have opportunity to go higher.

Ojai Ballantine

Okay. Thank you.

Operator

Your next question comes from the line of John Hill [ph]. Go ahead, sir, you line is open.

John Hill

Great and congratulations on a stand out result to everyone.

Mike Quillen

Thank you, John.

John Hill

I guess just a follow-up on Shneur's question. Just how representative in terms of specs are we on that $250 a ton net business recently signed out, and obviously you had similar price business that you did in first quarter of which you are talking about and to talk about some of the specs on that material. So, how representative is that $250, and I guess I would ask the same question really about the one or two on the thermal side?

Mike Quillen

On the met side, actually the second quarter the specifications were probably a little less than what our norm would be and less than what our domestic product that we contracted for in November of last year. So, that was not what I call our super quality coal by any stretch of imagination that would be on the lower end, not as first – more resembled what the Australians shipped and what we historically have sent out of the United States, they are around the six. That would be from a lower end of the premier coking coals that we have ability to sell and obviously as you can see in our (inaudible) we can take our hard coking coal that has fresh fluidity, strong coke strength and blend with it to meet the customer specification which he is will to accept and pay those number for. And so, that demonstrated in our volume going out as we – we don't have a coke (inaudible) far the lot where we make additional tons rightly doing it by blending, and it's because those specifications have actually lied below that. Overall, the same side that's primarily 0.5% or around 1%, actually a little bit higher than 1% stain coal left and falling on the average somewhere around 11.12 sulfur and 12.5 to 12.7 Btu.

John Hill

Great. Thanks for the color. And one subject which I suppose is a relative minor one, but haven't got a lot of play in all but the headlines is Gallatin (inaudible). Could you just provide us an update of what's going there and how we are progressing?

Kevin Crutchfield

Yes. John, it's Kevin. We continue to ramp up Gallatin. And I think as we indicated in the last quarter's discussion we had some startup issues that we continue to work through and establish the Gallatin facility as running to this sort of standard that we expect. What we have done is decided at least for the time being to hood off on building up a second kiln until we have a clear picture on the fact that we can run this thing and operate the factory. I think we'll go ahead and do that but we able to push that into 2009 as opposed to initiating that project this year. But it is showing significant signs of stabilization in running the way we expected the two able to (inaudible)

John Hill

So, no new negatives, just you are working through the same issues?

Kevin Crutchfield

Yes, I mean it goes to show, yes it involves processing which we are actually pretty good at in the own aspect of mining and sales and that sort of thing that it is a new business, of course and it's just taking a little while – a little longer than we had initially anticipated to get our arms around it. But we see light at the end of the tunnel. I think it's going to fine.

John Hill

Great perspective. Great results. Thanks everyone.

Operator

Your next question comes from the line of Luther Lu [ph]. Go ahead, sir, your line is open.

Luther Lu

Yes. Good morning, guys. Great results.

Kevin Crutchfield

Thanks Luther.

Mike Quillen

Thanks Luther.

Luther Lu

I want to ask you in terms of the guidance, what kind of a macro assumption did you use for 2009?

Kevin Crutchfield

Did you mean in terms of quality? Not sure I understand.

Luther Lu

For the EBITDA guidance of 1.7 to 2.1. (inaudible) what kind of macro assumption in terms of price assumption you use?

Mike Quillen

We are not going to give that out, yet. You can do some calculations of that again. We are talking about around almost 13 million tons of met coal is what we are looking at in the 2009 forecast. And the reason we don't be that specific about that is certainly negotiations are going on right now. We are on July talking about a lot of businesses that's going to be active on April 1st, and it's a little bit premature for us to put a number out on the wall. But now the numbers that we show that now are not unreasonable to think of as a base. We just factored additional opportunity out there, and the negotiating season as we've said in other public forms is already started at the international paper here much earlier. We are actually here now in the United States. So, that's going on. We'll see what is (inaudible). I think what most companies would do both on steam and met, you got to layer in some time to (inaudible) you have, and maybe not put everything out to contract this early in the year. We did that last year in the domestic business, and certainly left a lot of money on the table for our US met coal. So, we've got a plan going forward now on how we are going to do that and that number is going to be say starting in the range you are saying, but we don't yet know what the cap is on that.

Luther Lu

Okay. And just want to get a sense of the market. How many million tons of steam coal do you think is being switched into the met market this year and how many more is going to be switched into the met market next year?

Mike Quillen

I don't know. I don't think anybody would know that number particularly, I mean it's primarily going to be specific coals coming out of known scenes [ph] and know geographic regions like from south West Virginia and southern West Virginia, little bit in Pennsylvania. I think the one that probably could change the magnitude of that number is how much of the Pittsburgh aid actually gets moved over and then is it met coal or is it PCR. So, that's the statistics. It’s hard. I don't think it's irrational to think which is probably an extra 10 million to 20 million going export that could – that would normally may be steam going forward but a lot of that's going to come back to how much we can squeeze out of the ports in the United States for '08 and '09. But I know somehow we could come out of that number.

Luther Lu

Okay.

Mike Quillen

It is there and there's no question between that we are seeing right now, met exports and thermal exports are up about 50%, plus 55% through June and imports are down 6%. So, you are seeing significant impact on these coast pricing because of that even though, you got 1 billion ton steel industry or 100 million ton met and industrial side, you are seeing a lot of imports from – thermal going in demand. Then they actually (inaudible) another 13 million, 14 million tons of (inaudible) this year exports are an impact.

Luther Lu

Okay.

Mike Quillen

I would need to ask very hot summer and then it's going to come away and it will be in good shape.

Luther Lu

Okay. One more question. You said – Kevin you mentioned that you hedged roof port for the second half of the year? But I saw the fuel producers keep on passing the surcharges. How do you manage hedging that roof part?

Kevin Crutchfield

And that's good point, Luther. We actually hedged our diesel for the back half of the year. There's really no instrument to hedge other than just a physical position. Your steel associated with roof support. We've locked in the base supply contracts. That doesn't absorb you of receiving surcharges in the – from time to time. And those continue to bounce all over the board. Our sense is that we might we see some moderation for the second half of the year, but it's probably a little too early to predict that.

Luther Lu

Okay. Great. Thank you.

Operator

Your next question comes from the line of Jim Rollyson [ph]. Go ahead, your line is open.

Jim Rollyson

Hi, good morning guys. Great quarter. Mike, thoughts on – if you look at the thermal markets and you look at the met coal markets, which one do you think has the most sustainability in your opinion?

Mike Quillen

Quite interesting question. I want to answer that philosophically. Even the (inaudible) can be finite with that. Then I'll say steel, and the reason I say that is if you look at over 20 years, you look at history, you've seen on the steel side coming back to the met side, you've seen up and downs over the years. We are seeing the longest run of positive pricing on steel that we've probably ever see. But when you look – historically at the steel side it's pretty much grown 1.5% to 2.5%, electricity demand every year is pretty much been a US market, but we are seeing strong pull from international side. So, I think as far as predictability, you don't see the demand than much more consistent. It's like a straight line on steam. And you are going to see some up and down in the met as you go forward, and both of those statements are based on not a material change in the supply side on either one of those products that would count that I think. Basically, you are just going to see the demand is going to be economic driven and the supply is going to be constrained by the issues we continue to talk about.

Jim Rollyson

Excellent. Thanks for that answer. Your incentive compensation program, which obviously hit the SC line this quarter. Is that an ongoing thing, can we expect SG&A to stay at higher levels or there's some onetime things in there?

Mike Quillen

There's a variety of different programs but I tell you that's the amount of dollar spent than we have any regrets upon. In fact we hope that all of our employees max at and then we had a about $10 million (inaudible) $4 million that was stock award which is a onetime, and then we safety bonuses, attendance bonuses. We have production bonuses tied into that. So, those are ongoing. But the big chunk of that, in this quarter and then you'll see significantly less for the next. But we don't approach [ph] by that. I hope we max out on every one of those because if anybody deserves reward in this market it's our employees.

Jim Rollyson

Absolutely. And then just lastly. Are you guys expecting the converts to get converted?

David Stuebe

This is Dave. We don't have any expectations that's a whole, we will convert those until a term of those instruments.

Jim Rollyson

Okay. Thanks guys again. A great quarter.

Mike Quillen

Thank you.

Operator

And your next question comes from the line of Mark Paul [ph]. Go ahead, your line is open.

Mark Paul

Okay. Thanks very much. Good morning.

Mike Quillen

Good morning.

Mark Paul

I'm relatively new to this industry, and I was wondering Mike if you or one of your team could comment on potential bottle necks. I know you had mentioned availability of docks phase and rail infrastructure. With the export momentum as strong as it right now, is the infrastructure available to grow that much more heading into next year?

Mike Quillen

Not really. I mean when you look at the non-coal ports basically Baltimore, Hampton Roads and Mobile. They have 9 ply capacity, but what we are seeing versus that say in the 90's is we are shipping a variety of different coals, and when you have a ground storage phase or rail capacity that – you are using that for different qualities. You lose storage phase and it cuts your capacity to do the remarkable quantities of different qualities of coal going out. When you are doing just one, for example, TTA [ph] which we own 42% of, we are just doing one product out there. We could probably push 20 million tons through that facility, which we have done in the past. But practically now, we are moving up – we are in 12 million, 13 million, we might get that up and we can reduce the number of shipments quality. Quality is going out there, but it's limited what we can do and all ports are like that. You go back to the hay day [ph] when we were doing I don't know close to 100 million from the whole of United States and you got a situation where Charleston did some. Some of the smaller ports tried to handle it up like most of those handling facilities have done a way. Now it's pretty much mandate of the Hampton Roads, Baltimore and Mobile and they – we are going to pull [ph] as I think as an industry to get some more out of that, but there's defiantly a maximum that's going to go out of there without some infrastructure capital improvements.

Kevin Crutchfield

Mark, did your question relate also to the supply side constraints or just the export constraints?

Mike Quillen

I mean certainly I would be interested in talking about that as well. But it just seemed like from a near term perspective – I mean if you don't have the docs capacity, you don't have the rail capacity, I mean you could end up making some big piles of coal outside the mine, but no where to push them?

Kevin Crutchfield

I think the general consensus was that '08 we might hit the 60 million to 80 million was the initial number of exports. Based on the numbers Mike gave out a few minutes ago, we are on pace to peg 80. I wouldn't see – I wouldn't be surprised to see go beyond that. I think the conventional wisdom is that we can probably optimize this thing without a whole lot of additional CapEx that about may be 100 million tons of export but anything beyond that is going to take some substantial capital expenditures, perhaps even new ports to go much beyond 100 million tons.

Mike Quillen

A interesting phenomenon that lot of people don't think about that we have to monitor is starting actually right now through about say late September or October you have a significant amount of container freight coming into the United States moving itself into the interior for Christmas going to the Wal-Mart and (inaudible) and home depot and toys. And that takes up capacity in the pipeline. It will push in coal freight trains in the other direction, but rail roads got (inaudible) a couple of years ago. I think they are probably going to do a better job this year keeping that pipeline open going in both directions but then we add to coal project where they were raising the tongue. So, there are some infrastructures issues out there that to be managed. But I expect the railroads are very cognizant and working on plans for that right now. But it is a fact that there's going to be more water coming down the pipeline from containers over the next three or four months than we would add to the year.

Mark Paul

Okay. All right, that's really helpful. If I could ask just one more question, and this is strictly a theoretical one. I was just curious, your company has done such a good job being able to market it's blending technology or utilize blending technology to maximize the value of your coal assets. I was wondering if you could a little bit about what having tentacle [ph] available to you would – what theoretically could that do from blending perspectives as far as further enhancing your asset base?

Mike Quillen

I think specifically don't go to that asset but let me try theoretical. We take out of those coking coal from anywhere whether we purchase or out of mine or get an acquisition. It's the base load coal that has strong coking characteristics, we can't stretch [ph] a little bit further, in particular if you take a mine that's been historically run for steel company for 5 or 6 years and you can keep those coals into the main market for, and actually you avail an opportunity for that. You – that's something our people are actually doing. And we look for those opportunities all the time.

Mark Paul

Would you say that the 44% that you are running at right now is fully optimized or there is more upside to that?

Mike Quillen

I have answered that question. Last year I've been wrong. So, I'm not going to say anymore if it's optimized. We blended – the cap before is 38, then we said 40 and then we hit 44. So, the market is out there. Our people going to try and find a way to do it but we certainly want to say that we are going to, on our existing contracts and in particular our same customers, of course those comments which will be made and we are (inaudible) we are going make those commitments and fulfill them.

Mark Paul

Thank you very much for the color. Congratulations on the great results.

Mike Quillen

Thank you.

Operator

And your next question comes from the line of Mark Lenema [ph]. Go ahead sir, your line is open.

Mark Lenema

Hello.

Mike Quillen

Hello, Mark.

Mark Lenema

Hello. Thought I dropped you. Hitting the wrong button on the phone. Regionally, you’ve commented that you don’t have any production at risk because of permitting issues other than just tracking it a little bit more. Can you comment on what you see around the Central Appalachian region, how much production could be at risk?

Mike Quillen

We (inaudible) don’t have a number on that. We, like you, monitor what other people are seeing and our experience in the industry. So there is going to be some impact. Obviously a lot of the – the reason we can do it and others don’t have some of the opportunity is we are mining a lot of re-mining areas where we’ve got whole high wall and areas that we can dispose off material. If you are in – certainly we’d like to have some virgin property to mine where we have a real process but most of the places we mine we have whole mining around us that we can take the dirt. We can't put it into valley field. We can take it to an old high wall and cover that. So, it gets kind of specific to the ones that will be restricted partially will be the ones that are mined and operated that don’t have anywhere other than and barely fields to put it in because when you break over burden from an area of this scale I mean depend on the percentage of say sand stone it’s going to be 20% to 35% more material to dispose off and you – if you put it back, right against where you took it out of so, that our advantage is. We have old mining spots to put it on. And everyone that’s in that situation will see it increase in cost. It may not lose as much. If you are on a very big mountain top and you don’t have anywhere to put it, that’s going to get to be a bigger issue.

Mark, this is Kevin. (inaudible) add a little additional color to what Mike said.

Kevin Crutchfield

When you think of Central Appalachia, let’s just leave is isolated for a moment, think of it as Nevada 240 million ton basin, my numbers might be a little stale, but nearly half maybe 45% of that comes via surface mining. And it is – if you are in the surface mining business and chambers is not overturned I mean it’s just a matter of time before you are going to have issues, but what we are seeing is it’s just going to provide a constraint on production because you have to change the way you attack these reserves basis in a way that is sub optimal compared to the way we used to do it. So I think near term, you are not going to see much of a production shortfall, but what it does is this creates the prospect – you know it’s going to take longer to get permits and instead of a might be 6 million ton mountain top permit, it might – you might have to turn it into a 4 million ton mountain top permit or something like that. So I think long term what we’ll do chambers is not overturned is just going to place some additional constraint on Central App production.

Mark Lenema

Okay. Thanks for that. And on some of the other calls in the industry this earnings season, there has been a lot of discussion about PRB back selling as is some of coal out of Central App in the east in general gets exported. Are you seeing any of that sort of activity?

Mike Quillen

(inaudible) we are not seeing much of that. I think maybe some of that going up in west of the Mississippi river up in the Great Lakes, in the Midwest, and probably maybe some of the coal that would come out of northern or central that should go in that direction might be back filled but I think – we really have been seeing a significant increase in western coal in the last year coming into our markets.

Mark Lenema

Thanks very much guys.

Mike Quillen

Thanks Mark.

Operator

Your next question comes from the line of Jeremy Sussman. Go ahead, sir, your line is open.

Jeremy Sussman –Natixis Bleichroeder

Hi, good morning, and congratulations.

Mike Quillen

Thank you.

Kevin Crutchfield

Hi.

Jeremy Sussman –Natixis Bleichroeder

I guess first question given your ownership in DTA you probably have a better sense than most on the export situation. So where could we see total exports next year say both met and thermal and I mean can we get to the – can we get to maybe the 100 million ton level in the next couple of years?

Mike Quillen

I think that’s kind of practical limit we see in the infrastructure right now, I don’t think there is going to change a lot from ’08 to ’09. Nobody to my knowledge has announced any great expansion plans on port capacity maybe Norfolk Southern is working on some things that appear five and six but nothing really dramatic. You go back a year ago, we were talking about spending capital dollars make DTA an import facility. So, there is physical opportunity to do that. Just a matter of making that commitment. And maybe this thermal market will drive some of us that are port owners to look at that. But I don’t see that changing in ’09 to specifically answer your question.

Jeremy Sussman –Natixis Bleichroeder

Great. And then I guess on met coal, two things. I guess, first, you obviously indicated that negotiations are – have been ongoing, are quicker than –earlier than normal this year. So, in terms of I guess how do you see that playing out in the light – in terms of the U.S. buyers, U.S. steel buyers versus international steel buyers given that the U.S. guys are likely going to have to absorb a much higher increase? And then the second thing would be, in terms of the near term risks to pricing I mean do you see a slowdown in China as being a bigger risk or say more supply let’s say out of Australia?

Mike Quillen

On that first one, certainly the U.S. coke producers and steel companies did a good job last year getting the business closed in before we saw this dramatic run up because of the events in – with the snow in China and the rain in Australia. So that will have obviously a (inaudible) if they look at their ’09 calendar year business. But it’s going to be a different year, there is no question about that. Normally they do get their business done before the international consumers get real active, but that’s not going to happen this year just by what we are seeing today. I mean we know that the internationals are here, they are interested. They are looking for April ’09 business, which will push the domestic guys to also start thinking about theirs earlier than the fall. So, from our side, it’s going to be a better situation to have more competition early in the year rather than having tow different negotiating session like we have historically had with the domestic guys in the (inaudible) – in the international. Some times if there comes a timing issue, this year everybody is going to be after the tons.

On the China question, now really the way we look at it right now, we see a Pacific basin an Atlantic basin and certainly if China were to significantly move away or particularly turn around, become a exporter instead of an importer, that would eventually have an worldwide impact and eventually we would see Australia tons coming back to the Eastern Europe and the Atlantic basin. But right now I guess if we were going to have to worry about something we would be more be concerned if there was an economic downturn in either western Europe, significant downturn in Western Europe or say South America, Brazil in particular, will probably have a more immediate impact on us than in China. But China certainly is (inaudible) grow. They are going to – they (inaudible) direct commodities worldwide on everyone.

Jeremy Sussman –Natixis Bleichroeder

Okay, well thank you very much for the color.

Mike Quillen

Thank you.

Operator

And your next question comes from the line of Michael Doris [ph]. Go ahead, sir, your line is open.

Michael Doris

Gentlemen, you have done a great job answering the question. I am all set. Thank you very much and good luck with the transaction.

Mike Quillen

Thanks Mike.

Operator

And the next question comes from the line Justine Fischer [ph]. Go ahead, your line is open.

Justine Fischer

Hello.

Mike Quillen

Hello Justine.

Justine Fischer

Hi. The first question that I had is a follow-up to the question of PRB coal back selling and another coal company that also reported this morning noted on their conference call today that they are not really seeing that much increase from eastern utility buyers of thermal coal and that the activity has slowed down. So, I am wondering, first of all, what you guys are hearing from the utilities on the – on just enquiries generally right now. And then second of all, are you guys hearing any commentary from the utilities to the coal companies saying – to the eastern coal companies saying well if you guys sell your coal abroad, we’ll just go buy PRB coal because it sounds like some of the coal companies are saying well if you guys don’t buy our coal at high prices we’ll just go and export it. So, are you hearing any of that type of retaliatory – for lack of a better term – commentary from the utilities.

Mike Quillen

Let me go back to the first one and I can't say we are seeing any significant – now what happened and maybe that’s what the – and I don’t know who (inaudible) within on this call and I am not sure who talked this morning, we’ll see that later, but there was a flurry of solicitations came out in say February, March range. And awful lot of people came out at one time and probably inordinate amount and I think that’s when you saw the pricing move from the say $45 to $55 range up into the $90 to $100 range people are seeing in the marketplace today. So maybe we are not – at one time there, we probably got 10 or 12 solicitations. We all responded to them. But they are still normal. I say they are normal activity. I am looking at that (inaudible) a little bit un-normal where this is – we are at a normal season when contracts run out, people back out looking for us. so, I mean I don’t – my gut feeling is I don’t see any real difference in what we are seeing other than that flurry that came out – when the prices start to move, everybody came out at one time there, but a lot of those didn’t react and now they are still out in the marketplace looking for tons. In any negotiations you are going to have people take different tactics I mean whether are quoting the NYMEX or ARA or whatever you are doing or whether – but I haven’t – on any of our sales call I have not heard one of our salesman say that when we start talking about pricing they say well we’ll buy PRB coal if you guys are going to go for a higher price offshore. Now we don’t – we are not doing any thermal coal right now. We are taking the maximum capacity we can for our export and our quality is going metallurgical. But again as we say there has been about 13, 14 million tons go out of the United States, which in effect is not a – a very big percentage versus a billion ton industry. So, to answer it specifically, I am not aware of anything. Kevin are you (inaudible) has actually made a comment like that?

Kevin Crutchfield

No, no. There has been a lot of talk about it, but we haven’t seen it followed up by any discernible actions.

Mike Quillen

Yeah. I don’t know anything is changed in PRB coal come in (inaudible) I think the thing is that really continues to influence that is the quality, the handling characteristics of that coke, particularly with its more stringent finesse. And then you still got the issues of the railroad is you know the freight rate is a significant component that is always going to go into that PRB and then you have the last thing is that if you are shipping a western railroad to a eastern utility, you want your cars back to maximize the use of that infrastructure, that capital asset and you got a lot of activity going on in the east, down your eastern railroad that maybe their first priority is not to turn those cars around. So a lot of factors go into that. But when you just do the straight math, it’s surprises that the – (inaudible) coal you can make an argument that 8400, 8800 Btu PRB coke should more of it be coming this way so obviously these other factors do have a big influence on the purchasing guys even though in a negotiation that’s going to be a factor. They are going to quote from their standpoint.

Justine Fischer

Okay, okay, that was – thank you for that answer. That was very detailed. And then did you guys – I may have missed it earlier – did you give a number of total tons you expect to export in ’09?

Mike Quillen

We haven’t broken it down to the export. I mean this year we are around 70% export. Coke really I mean again with the domestic guys and the international guys this year mostly competing against each other, we will see if that changes and report on it, but right now, our existing number is 70% and I don’t have a reason to think our place in the market is what it is (inaudible) the U.S. consumer and the international consumer.

Justine Fischer

Okay and then sorry last question and again because you guys have deep amount of insight into the export market because of your port interest. Are you seeing the smaller eastern coke companies do a lot of export business? I mean we know that probably the Larger companies like yourselves and then others have I guess – I would think a better ability to do deals with bigger buyers from abroad and a better ability to combine coke cargos into shippable cargos but are seeing a lot of the small companies get export business like the $1 million to $2 million ton companies?

Mike Quillen

What happens on that I mean the way that works is you have X amount of port capacity and up until just recently we even and other owners of DTA, we would lease out certain space and get paid a per ton usage of that space but right now it’s much more viable to us to use that ourselves. So our incentive to least that out to brokers or independents is very low right now even though there is some contracts that have to play out. So over time you have both some sizable brokers that handle tonnage going offshore and then you had a few independents that did tonnage offshore. Their opportunities if this market stays away, theirs are going to be somewhat (inaudible) because the owners are going to want to use that themselves. So, I think we are in a transition phase of that right. We have been at it now for about a year. We’ll have a few more contracts rolling off for our space. Maybe when you go to independents side where Norfolk Southern is going to do it based on just their capacity and – it’s (inaudible) that Norfolk Southern’s advantage if you can load a 100,000 ton (inaudible) sale that’s a much more profitable move for them to handle our coals filling up about just by ourselves and taking six or eight small guys and somebody then get their tons there when everybody else does an the boat sits and waits and you’ve got the capacity if card add up. So being – size counts and being export.

Justine Fischer

Great. Thank you so much.

Operator

At this time there are no further questions in queue. Are there any final remarks from management?

Mike Quillen

We just want to thank everyone for their interest and we are going to strive to stay positive on our safety, work hard on that (inaudible) want to thank all of our employees, and our customers for such a good quarter. We’ll work hard to do this again. Thank you.

Operator

This concludes today’s conference call. You may now disconnect.

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Source: Alpha Natural Resources, Inc. Q2 2008 Earnings Call Transcript
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