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International Coal Group Inc. (NYSE:ICO)

Q2 2008 Earnings Call Transcript

July 24, 2008 11:00 am ET

Executives

Roger Nicholson – SVP, Secretary & General Counsel

Ben Hatfield – President & CEO

Brad Harris – SVP, CFO & Treasurer

Mike Hardesty – SVP, Sales & Marketing

Analysts

Shneur Gershuni – UBS

Ankush Agarwal – JP Morgan

Justine Fisher – Goldman Sachs

Brett Levy – Jefferies & Co.

Laurence Jollon – Lehman Brothers

Jeff Kramer – UBS

Jack Franke – Duquesne Capital Management

Julian Benscher – Sherwood Investments

Operator

Good day, ladies and gentlemen, and welcome to the International Coal Group Incorporated second quarter 2008 earnings conference call. My name is Heather, and I will be your coordinator for today. At this time, all participants are in a listen-only mode. We will be facilitating a question-and-answer session towards the end of today's conference. (Operator instructions) I would now like to turn the presentation over to your host for today's conference, Mr. Roger Nicholson. Please proceed, sir.

Roger Nicholson

Thank you. Welcome to International Coal Group's second quarter 2008 earnings conference call. I'm Roger Nicholson, Senior Vice President, Secretary and General Counsel of International Coal Group. We released our 2008 second quarter earnings report yesterday after the market closed.

With me on the call this morning are Ben Hatfield, President and CEO of International Coal Group; Brad Harris, our Senior VP, CFO and Treasurer; Mike Hardesty, Senior Vice President, Sales and Marketing; and Ira Gamm, Vice President, Investor and Public Relations.

Before we get started, please let me remind you that various remarks that we may make on this call concerning future expectations, plans and prospects for the company constitute forward-looking statements for purposes of the Safe Harbor provisions under the Private Securities Litigation Reform Act of 1995.

These statements are made on the basis of management's views and assumptions regarding future events and business performance as of the time the statements were made. Because these forward-looking statements are subject to various risks and uncertainties, actual results may differ materially from those implied. Factors that could cause actual results to differ materially are contained in our filings from time to time with the Securities and Exchange Commission, and are also contained in our press release dated July 23, 2008.

Non-GAAP financial measures will also be discussed during this call. You will find a reconciliation of the differences between the non-GAAP financial measure and the most directly comparable GAAP financial measure at the end of our press release. A copy of which has been posted on our Web site.

At this time, I'd like to turn the call over to Ben Hatfield for his opening remarks.

Ben Hatfield

Thank you for joining us this morning. Our overall operational and financial performance in the second quarter improved significantly compared to both the first quarter of 2008 and the second quarter of 2007. And our results in June were the best in our brief history. Our improved performance reaffirms our earlier strategic decision to proactively invest in and develop new, higher margin mining projects.

In the second quarter, we began to see the positive impacts of this strategy on our financial results, as the new Beckley and Sentinel projects benefited from the strong global coal market. And as Beckley and Sentinel continue building their production output to the target levels, we expect that they will contribute even more significantly.

In addition to our new Beckley and Sentinel projects, we have been taking advantage of current market conditions by cost effectively expanding our production base. In May, for example, we announced the acquisition of the Powell Mountain operation, which is expected to add approximately 250,000 tons of production in 2008 and ultimately achieve an annual run rate of about 1 million tons at full production.

Additionally, we plan to expand production at our Hazard operation by a 0.5 million tons annually beginning in early 2009 through the purchase and deployment of a new truck and shovel spread of surface mining equipment.

As in previous quarters, we continued our disciplined marketing strategy of judiciously layering in new contracts at current market prices. During the second quarter, we secured contract commitments totaling approximately 5.1 million tons of predominantly steam coal at average prices exceeding $105 per ton to be delivered in the 2009 to 2011 period. We still retain significant open positions for 2009 and 2010 with the bulk of the unsold tons comprising our higher margin metallurgical and steam products.

However, the entire coal industry is being challenged to predict profit margin growth in the face of increased cost for scarce labor, mining equipment, fuel, explosives and trucking. Our company is taking proactive steps to address that challenge. For example, our new Beckley and Sentinel mining operations as well as the planned Tygart complex now under construction, all have direct mine to rail access, thus eliminating the expense of trucking coal.

On the labor front, we have implemented a variety of programs during the second quarter to retain and attract skilled workers and are seeing positive results from those efforts.

In regard to coal markets, indications are that demand for steam and metallurgical coal is expected to remain strong. Through June 30, 2008, Eastern US coal production is up a modest 0.7% compared to the same six-month period in 2007. Meanwhile, electricity generation is up nearly 1% year-to-date over 2007.

U.S. coal exports are up 57% through the first six months of 2008, while coal imports are down 2% compared to the same period in 2007. We expect sustained pricing support through at least 2011 due to strong international demand, solid natural gas prices and robust steel prices.

At this time, I'd like to turn the call over to Brad Harris, our Chief Financial Officer to discuss second quarter results.

Brad Harris

Thanks, Ben. In the second quarter of 2008, ICG reported revenues of $277.9 million including $253.1 million attributable to coal sales of 4.9 million tons. This constitutes a 34% increase over second quarter 2007 revenues of $208.1 million, of which $188 million was attributable to coal sales of 4.4 million tons.

We reported adjusted EBITDA of $53.4 million for the second quarter of 2008 compared to adjusted EBITDA of $11.3 million for the second quarter of 2007.

For the second quarter of 2008, we reported net income of $12.65 million or $0.07 per share on a diluted basis, compared to a net loss of $10.2 million or a loss of $0.07 per share on a diluted basis for the same period of 2007.

These financial results include a $22.9 million pre-tax gain on an exchange of Eastern Kentucky coal reserves in June. Our total reserves increased by approximately 1 million tons as a result of this exchange.

Average revenue per ton for the second quarter was $52.10 compared to $42.30 per ton for the same period of 2007. While cost per tons sold was $44.80 per ton for the second quarter versus $39.43 per ton for the same period in 2007.

Depreciation, depletion and amortization totaled $24.7 million for the second quarter of 2008 compared to $21.8 million for the second quarter of 2007. Corporate SG&A for the second quarter was $10.1 million compared to $8.2 million for the same period in 2007.

At June 30, 2008, total debt was $416 million consisting primarily of $175 million of 10.25% Senior Notes and $225 million of 9% Convertible Senior Notes. Our total debt-to-capitalization ratio was 45% at the end of the second quarter while our debt-to-market capitalization ratio was 17%.

On June 30th, we announced that our 9% Convertible Senior Notes became convertible at the note holders option beginning on July 1st, 2008. We do not believe that a significant number of conversions are likely at this time. To-date, we have not received notices that any of the note holders intend to exercise their conversion rights.

Total assets for the company were $1.3 billion as of June 30th, 2008 which is unchanged from year-end.

Second quarter capital spending totaled $64.2 million, of which 59% related to the development of new mining complexes and 41% related to support of existing mining operations. We have increased our capital expenditure guidance to $179 million in 2008, and $205 million in 2009, to reflect the Hazard shovel project expansion. Previous CapEx guidance was $157 million for 2008 and $192 million for 2009.

As of the end of the second quarter, we have $68.1 million in cash, which was an increase of $13.9 million from March 31st. 3 million of which resulted from the reserve swap transaction. Second quarter cash requirements included $55.5 million in capital expenditures. We retain available borrowing capacity of $28.4 million under our credit agreement. Our current line of credit also supports $71.6 million in outstanding letters of credit.

At this time, I'll turn the call back over to Ben.

Ben Hatfield

Thank you, Brad. I would now like to provide an update on key developments in the second quarter. Although production at the new Beckley underground complex in Raleigh County, West Virginia improved significantly in the second quarter, the ramp up continued to be slowed by a regional shortage of skilled underground mine workers. Beckley region is home to numerous large scale mining operations. All of which compete for a limited labor pool. We have focused our efforts on recruiting and training new miners and developing attractive wage packages and retention programs to remain an employer of choice.

The mine development pace was also constrained by implementation of mine plan revision designed to enhance the long-term integrity of the main entries. This work began in the first quarter and is nearing completion. We are now targeting the Beckley complex to reach its 1.4 million ton annual production run rate of low volatile metallurgical coal in the fourth quarter of 2008.

Production at the Sentinel complex in Barbour County, West Virginia increased 23% from the first quarter to the second quarter. The complex is approaching its targeted annual production rate of 1.5 million tons of high volatile metallurgical and high quality steam coal. Like Beckley, the shortage of experienced mine workers has slowed the development pace at Sentinel.

We are continuing site development work at our new Tygart No. 1 complex in Taylor County, West Virginia. We remain on schedule to begin facility construction work this fall with initial coal development production expected to commence in late 2009. At full output, Tygart is expected to produce 3.5 million tons annually of high volatile metallurgical or premium utility coal.

As previously noted, we expanded our Central Appalachian marketing reach in May by acquiring the former Powell Mountain mining operations located in Lee County, Virginia and Harlan County, Kentucky. We acquired 29 million tons of leased coal reserves, preparation plant and unit train rail load out, and an idle deep mine complex. Both the deep mine and the preparation plant were reactivated in mid-July and we expect to ship the first train post startup by month end. At full production, we expect the Powell Mountain complex to produce and ship approximately 1 million tons of high volatile metallurgical and high quality steam coal annually.

Our ICG Hazard complex in Kentucky entered into purchase arrangements to acquire a 44 cubic yard hydraulic shovel, five 240 ton rock trucks and other support equipment to significantly increase production at its existing East Mac & Nellie Surface Mine. We expect to see net production growth of 500,000 tons of steam coal annually for the next five years or more. Capital expenditures for this project are expected to total $35 million.

In the second quarter, our ICG Hazard and ICG Natural Resources subsidiaries exchanged coal reserves with a privately held coal producer. We divested approximately 4.8 million tons of steam quality coal reserves and 6.8 million tons of resources in exchange for approximately 5.8 million tons of steam coal reserves, 3 million tons of resources, and 3 million in cash.

We recognized a $22.9 million pre-tax gain on this transaction. We expect to mine the properties acquired within the next five years, while the properties conveyed were not projected for near-term mining.

Finally, it is with a great deal of pleasure that we recognize the accomplishments of our ICG Eastern operation, which received a National Award for Excellence by the U.S. Department of Interior's Office of Surface Mining. The award honored ICG Eastern for its innovative and environmentally progressive mine reclamation practices at the Birch River mine. This award was ICG Eastern's third major reclamation award within the last year. ICG Eastern earned these awards while continuing to operate as one of our most consistent performers both operationally and financially.

Turning now to our committed sales for 2008 and 2009. For 2008, committed and priced sales are approximately 19.7 million tons or about 96% of planned shipments. Priced volume for 2008 averages $51.18 per ton excluding freight and handling expenses. Approximately 35% of the unpriced tonnage is metallurgical coal.

For 2009, committed and priced sales are approximately 17.9 million tons or about 80% of projected shipments. Priced volume for 2009 averages $58.85 per ton excluding freight and handling expenses. As with 2008, approximately 35% of the unpriced tonnage is metallurgical coal.

For 2010, committed and priced sales are approximately 9.1 million tons or about 39% of projected shipments. Priced volume for 2010 averages $56.31 per ton excluding freight and handling expenses. Approximately 21% of unpriced tonnage for 2010 is metallurgical coal.

Turning now to our outlook, we have updated our previous guidance for 2008 and 2009 while providing new guidance for 2010. For the full year 2008, we expect to sell just over 20 million tons of coal at an average selling price of $54 to $55 per ton. Our previous guidance was an average selling price in the $51 to $52.50 per ton range.

Coal production in 2008 is expected to total approximately 19 million tons. Of which approximately 1.7 million tons are expected to be sold as metallurgical coal. We expect our average cost per ton sold in 2008 to be in the range of $45 to $47 excluding selling, general and administrative expenses.

Coal exports in 2008 are now projected to total approximately 3.1 million tons consisting of approximately 1.4 million tons of metallurgical coal and approximately 1.7 million tons of thermal coal.

For 2009, we expect to sell 21.5 million to 22.5 million tons at an average selling price of between $72 and $78 per ton based on recent price indications and contracting activity. Our previous guidance anticipated an average selling price of $58 to $63 per ton. Coal production in 2009 is expected to total 20.5 million to 21.5 million tons, of which approximately 2.6 million tons is projected to be sold as metallurgical coal.

For 2010, we expect to sell 23 million to 24 million tons of coal at an average selling price of between $92 and $102 per ton. Coal production for 2010 is expected to total 22 million to 23 million tons, of which 3.2 million tons are projected to be sold as metallurgical coal.

As indicated by our updated guidance, we are forecasting sustained improvement in average coal prices over the next several years. We expect that demand from international markets will continue to drive coal exports that Eastern US production will remain constrained because of regulatory issues and labor scarcity, and the relatively high natural gas prices and robust steel demand will result in sustained pricing support through at least 2011.

At this time, I'll open the call to your questions.

Question-and-Answer Session

Operator

(Operator instructions) Your first question comes from the line of Shneur Gershuni with UBS. Please proceed.

Shneur Gershuni – UBS

Hi, good morning, guys.

Ben Hatfield

Hi, Shneur.

Shneur Gershuni – UBS

Just a couple of questions here. I guess the – I guess my first question is just kind of around contracting and so forth. I was wondering if you can kind of give us some clarity with respect to the physical market obviously the NYMEX strips at all over the lot lately. If you can sort of give us some guidance as to, you said that you had contracts exceeding $105. I don't where was the last one and how is it looking when you're thinking on a two and three year term? Is it kind of a level price above those or is it escalating, falling, if you just give us some clarity with respect to contracting?

Ben Hatfield

Generally speaking, over the past quarter we've obviously entered into several contracts, at least 10 different agreements, and pretty consistently, the pricing that we're seeing on physical grades are at or above the index pricing. So, I think the indexing has anything been somewhat on the low side of the deals actually being closed. We certainly have noted in recent days the flattening, if you will, or decrease in pricing for the indexes. Our assessment based on current deals even that are being negotiated as we speak is that that's somewhat distorted and not really reflective of the physical market.

Shneur Gershuni – UBS

When you say index, are you looking more like NYMEX or are you looking more at rail?

Ben Hatfield

We tend to look more closely at the Central App rail pricing. That's generally a better indication of the market that we participate in. Of course, we're also impacted by the NS side as well. The NS, CSX rail indexes are probably our more common reference points.

Shneur Gershuni – UBS

Okay. You'd mentioned in your comments about cost control is key to making it all happen and so forth. You kind of talked about rail accidents and what you're doing to attract new workers and so forth. Are there any other actions that you're taking to try and keep a lid on costs? Has anything happened with respect to Vindex with respect to that contract that's being, I think, delivered by truck? So, if you can sort of give us some more color on the actions that you're taking to keep costs under control?

Ben Hatfield

Sure. We're somewhat limited with respect to what we can do. For instance, on the impact of diesel fuel, which is obviously very substantial, particularly for surface mine production. But, specifically with reference to Vindex, we are continuing with program that was started two quarters ago to essentially upgrade their equipment and improve productivity and we put in place a large excavator that was activated late in the first quarter, and we're seeing significant improvement from that. So, our focus at Vindex specifically is on improving productivity first and foremost through capital investment, and that's moving forward and we're seeing some success. The other areas, certainly, we're doing much of the same. We're generally trying to make sure that our equipment is in good shape and focusing our capital where it can make the greatest impact, if you will, on cost going forward.

Shneur Gershuni – UBS

Is there any thought to redesigning the way you do some of your surface mining operations to try and get some lower seams out of the ground and so forth, just given the high value of coal these days?

Ben Hatfield

Well, again, you're somewhat limited, again, by the requirements of the permit, and what's already a mine plan that's in place. Generally speaking, when you get a surface mining permit, you lay out a mine plan and you can't really deviate materially from that mine plan, but certainly those permits carry with them some assumptions of economic constraints, particularly, with respect to ratio that we pay close attention to. And, if you see an area, for instance, where the seam is thinning, then that's an area that you pull away from, because obviously the cost is going to up quicker. So, we're attentive to what's happening in those mine plans, but there are certainly limits on what we can do. I think our broader effect is continuing with our capital program, such as we've done, for instance, with this Hazard shovel expansion. We talked a lot about the additional tons that are created from pursing a 44 yard shovel, but the part that's perhaps not as obvious to some people unless you're in the industry is there's also a significant improvement in productivity on the other million tons that were already coming off of that job that were formerly being mined with smaller scale front end loaders and trucks. So, we'll expect to see some improvement in cost on the base load of production as well as the benefits from the incremental gain from that investment. So again, we expect to make some investments that both currently and going forward that are going to continue to focus on improving productivity and help us restrain cost.

Shneur Gershuni – UBS

That sounds great. Really looking forward to that. And just one final question if you don't mind. Just given the amount of met coal that you have now and the amount that you're bringing on over the next couple of years, it's certainly going to be well into the 20% range. What are your thoughts in terms of do you have the staffing involved to take advantage of the international market and getting the met coal out there and getting the best price? And are you planning on exploring blending opportunities to try and upgrade some of the high vols coals that you have and so forth? If you could give some commentary on that.

Ben Hatfield

I'm going to ask Mike Hardesty to answer that question for you.

Mike Hardesty

Well, first of all, with regard to our growing met portfolio, yes, we will eventually have to add a small amount of staff to grow our marketing reach for that. With regard to the blending, that's one of the exciting things about the new Powell Mountain project is its a very low ash, very low sulfur product that will fit quite well with our Sentinel product, which is a higher ash, higher sulfur, but very strong rheologically. We actually have blends in the lab right now, experimenting with that, and we think it's an exciting development for us.

Ben Hatfield

The point you made with respect to metallurgical production and certainly trying to optimize our position at market is also relevant to the cost discussion, because in some cases, we're making specific decisions to move coal into the metallurgical market at a somewhat higher cost. You're sacrificing some yield on coal that might otherwise go into the steam market. So, in some cases, you may see us even divert coals toward a metallurgical opportunity at a higher cost, and it pushes cost up, but we're doing it because there's genuine margin creation. So, sometimes the cost story isn't the full picture that I think really matters to the investment.

Shneur Gershuni – UBS

Great. Thank you very much.

Ben Hatfield

Alright. Thank you.

Operator

Your next question comes from the line of Ankush Agarwal with JP Morgan. Please proceed.

Ankush Agarwal – JP Morgan

Hi, Ben, everybody. With regards to Powell, could you give us some more color on the sort of CapEx levels you're looking at and the breakup between the met and thermal, and also if there are any additional royalties or ongoing leasing costs?

Ben Hatfield

You mean specifically what's our forward view on what's happening with capital expenditures? I'm not sure I fully captured your question.

Ankush Agarwal – JP Morgan

Yes. What sort of CapEx levels are you incurring at Powell right now and going forward?

Ben Hatfield

Okay. Near-term at Powell Mountain, the spending is relatively modest, because we acquired quite a bit of idle equipment. We acquired a preparation plant that was in good condition. So, we had the advantage frankly of being able to essentially restart an operation that had only been idle for a few quarters. So near-term, the load is pretty modest. We are already in production and expect to be shipping coal by the end of this month. Going forward, our nearest capital injection, (inaudible) vision will be development of the Middle Splint mine. It's already permitted and just simply needs to be developed and opened. And there again, we envision using some of the equipment it's on site to greatly mitigate the capital load. So, I don't have a precise number to offer you other than it's a pretty modest investment over the next, call it 18 to 24 months, because most of what we're using is existing equipment. We will be spending some money on buying some support equipment and doing some rebuilding, but most of what we need to reactivate production is right there on the ground. So, the capital load will not be very material.

Ankush Agarwal – JP Morgan

Okay. And the breakup between met and thermal, what sort of levels are you looking at there?

Ben Hatfield

With respect to Powell Mountain? I'm going to let Mike Hardesty respond on that point.

Mike Hardesty

All right. Currently, we would project about 50/50 with the Darby mine we're in now. That will decline a little bit when we go into the Middle Splint as our production grows.

Ankush Agarwal – JP Morgan

Okay. And finally, any additional royalties or ongoing leasing costs there?

Ben Hatfield

No, the royalties that are part of our position there are essentially market level royalties, nothing that's particularly new and different versus what we experience at our other operations.

Ankush Agarwal – JP Morgan

Okay. Great. Thanks a lot.

Ben Hatfield

Alright. Thank you.

Operator

Your next question comes from the line of Justine Fisher with Goldman Sachs. Please proceed.

Justine Fisher – Goldman Sachs

Good morning.

Ben Hatfield

Good morning, Justine.

Justine Fisher – Goldman Sachs

The first question that I have is about the metallurgical coal sales. And I guess in the last – in previous years, before we saw the most recent price run up, that coal in the US used to sell at a bit of a discount versus internationally, and I'm wondering whether you're seeing the spread between what you would sell to a domestic steel mill and what you might sell internationally narrow? Or how are you seeing the dynamics between coal sold domestically and coal exported on the met side?

Ben Hatfield

I'm going to let Mike Hardesty address that question for you.

Mike Hardesty

It's probably premature, but I think this fall when the next round of negotiations come up, it's going to be very interesting, particularly with foreign buyers coming in, snatching up coal properties, I think it's going to put a lot more pressure to have at least parity with the domestic mills paying parity prices with what the producers can get for international prices. I think the domestic guys are going to be very worried about trying to lock up supply when they're seeing supply snatched up from underneath them particularly for the higher quality, low vol, mid vol coals.

Justine Fisher – Goldman Sachs

Okay. And then I guess along those lines, if you guys have coal that you may have thought about selling domestically – and this is – this question is with respect to both met and seam coal, if you may have sold it to a large domestic utility or a large domestic steel mill that you might think about exporting it now, how do you guys think about potentially sacrificing a long-term relationship with either the mill or the utility versus exporting it now? I mean, do you think that we're going to see some domestic producers choose to keep more tonnage at home in order to keep those relationships? Or do you think that we'll see many producers look to export because the pricing maybe a bit better than what you'd get domestically?

Ben Hatfield

Again, I think what you'll see us doing is maintaining a balance. We certainly have some well-established customer relationships that we have enjoyed and want to protect. So, we fully expect to maintain most of our long-term customer relationships with again much of our new production coming on line, participating in export opportunities. We like a balance. We wouldn't want to be wholesale entirely in one market or the other because there are obviously advantages on both ends. So, we are going to be cognizant of relationships and kind of maintaining a balance. There are certain advantages as we've noted on domestic negotiations you can often get more term. You also sometimes have fewer complications associated with scheduling of shipments and freight logistics. So, we see lots of reasons to stay in both markets and we expect to maintain most of our long-term customer relationships going forward.

Justine Fisher – Goldman Sachs

Okay. And then along those lines, and it may be difficult for you guys to comment on this because it's sort of speculating about what other players in the market might do, but it seems that most of the coal exported from the U.S. – and I'll talk about '09 because that's kind of when I think people are expecting a bigger jump in exports will come from Appalachia. And do you guys see other coal companies taking the same approach that you are towards selling domestically versus exporting? In other words, even if they have a significant amount of open tonnage in '09 and even if market observers are saying that, that tonnage may outgrow the export market, do you see them sacrificing that large amount of domestic business to send all of the tonnage abroad?

Ben Hatfield

Well, again, I can't speak for what our competitors will do, but my assessment is they're going to look at it much like we do. And that's again maintain the advantages of a domestic position and an export position. Certainly, over the last year or few quarters, we've seen some dramatically attractive economic opportunities on export shipments. You see a lot of customers – or producers moving to take advantage of those. I expect that's going to continue. But, focusing on 2009, in general, I think as Mike Hardesty suggested earlier, the domestic companies are going to have a lot of pressure on them to essentially meet the price that's available on the export side, and I expect that in most part they will do that. But, there may be some combination of price and term and quality and schedules that kind of brings everything into parity and makes a good deal. So, I don't really expect that any of the major publicly traded coal companies are going to jump wholesale one direction or the other. I expect it to be a balance.

Justine Fisher – Goldman Sachs

Okay. Thanks very much.

Ben Hatfield

You're welcome.

Operator

Your next question comes from the line of Brett Levy with Jefferies.

Brett Levy – Jefferies & Co.

Hey, guys. You gave a completion date for Beckley, can you kind of revise the completion date for Sentinel? And then also give us a little bit of a sense as to what the ramp's going to be on Tygart as you guys now see it given there's been some delays?

Ben Hatfield

Well, again, to recap as you, as you I think accurately stated, we're now expecting Beckley to reach its targeted output some time in the fourth quarter of this year, and we appear to be on pace to – for achieving that, in quarter-over-quarter we've seen significant improvement. Sentinel, we're actually seeing some months now where we're already at that 1.4 to 1.5 million ton pace, but we haven't actually connected a full quarter of output at that level. So, I think it's a matter of some time in the next few months seeing some predictability and stability at that operation, particularly as we get the last crews fully staffed. So, I believe Sentinel is within just a few months of being at that level. With respect to Tygart, we actually have equipment on the ground right now working on building a new mining complex, pretty small scale activity at this point, but it is moving forward. We, at this point, are predicting the initial – we call it development production in late 2009 and by development production we're actually focused on production where we're indeed mining coal, but you're generally connecting two portals. For instance, a shaft portal and a slope portal. So, it's fairly small output more almost to the nature of construction output, but you're generating coal production everyday. We believe that will get underway late 2009 and commercial production coming on line in the first half of 2010.

Brett Levy – Jefferies & Co.

And then the 3.5 million tons per year level, what point in 2010 are you aiming for?

Ben Hatfield

That last step up, I think comes with the long haul coming on line and that occurs in 2011. So the ramp up, I don't remember the precise number, but in 2010, I think production will be something under 1 million tons. And then 2011 by midyear you're at that pace, that 3.5 million annual tons pace.

Brett Levy – Jefferies & Co.

All right. And then in terms of the split there, I mean you guys have, I'm sure, done some of the geology already. How much of it do you think is split between what is truly met and what is truly kind of quality that you're going to need to blend to get to, I don't know, 200 plus type price?

Ben Hatfield

We feel pretty confident that the Tygart product is going to be very attractive, high vol metallurgical coal have some very attractive rheologic and petrographic qualities. We're at this point predicting I think pretty conservatively that about 40% of that coal is going to move into the high vol metallurgical market. And we'll move the balance to selected steam coal customers.

Brett Levy – Jefferies & Co.

Alright. And then, I've asked this on a couple of calls. What's the impact on you guys if Chambers is not overturned and what's your contingency plan?

Ben Hatfield

Well, if Chambers isn't overturned again, it all comes back down to implementation and what's the effect of. The Chambers ruling doesn't actually do away with valley fields. It simply puts a lot more technical constraints on them, if you will. It essentially makes the mine permitting process, particularly for valley fields more extended, more technically burdensome and it essentially stretches the amount of time that you need to bring a new surface permit into fruition and bring surface mine production on line. So, I think the bottom line, if Chambers isn't reversed, is that, that becomes an ongoing constraint on Central App production growth, particularly surface mine growth and limits it. It's certainly going to impact existing operations as they run out of valley field space. But, in each case, again, I would envision it to be a constraint and not by any means a prohibition or suspension. So, you're going to see a dampening effect on production. We believe we're pretty well-positioned in our – at our West Virginia operations that may be impacted by Chambers through the latter part of 2009 without any significant concerns, perhaps some of them longer than that. So, you'll generally see that impact hitting the entire industry in my view over the course of the next year if you don't see a reversal. But, it just becomes another one of those regulatory hurdles that we have to deal with.

Brett Levy – Jefferies & Co.

Alright. Thanks very much, guys.

Operator

Your next question comes from the line of Laurence Jollon with Lehman Brothers. Please proceed.

Laurence Jollon – Lehman Brothers

Good morning. I had a kind of an industry related question for you all. I know the common belief is that production is coming down in the east over the next few years, and I just wanted to kind of – I'm hearing from potentially private equity buyers thinking about investing money and developing new mines, and you all and your competitors are expending CapEx to bring on new mines. Do you believe that this is simply going to kind of offset other mines that are going offline or just the general degradation of reserves? I guess my concern is, given the high prices that when you start seeing private equity money in the industry, and people opening up mines that have been closed for 20 years, that there may in fact be more production coming on line than people expect?

Ben Hatfield

Well, I think you've accurately assessed the situation. There are certainly a lot of companies that are trying to create new production and reactivate older operations and get new ones permitted and in play, but if you just look at the statistics on what's happened over the last few quarters, when people have had as much incentive as ever to try to grow new production, production growth has been remarkably modest. We saw the same thing really in 2006 with a much smaller price pike. So, in my view, there are a lot of people trying to grow production much like we are, but you're in – we all run into the same kinds of constraints, scarcity of labor, slow approval of permits. You have the steepened enforcement factor where mine safety and health administration and other regulatory agencies are certainly stepping up their program on enforcement and that has a dampening effect on productivity. So I think when you throw it all in the bag and mix it up, I don't think production growth is going to be material, I think it's going to be flat more than likely, particularly in Central Appalachia, because again, you're constrained by the reserve depletion issues, lot of mines are being announced as open. What you don't see are announcements of closures and you also have mines every month, every quarter that are running out of coal and being closed. So, that's not something that normally goes into a press release. So, all that is to say the impact of the Central App depletion and geologic restrictions and labor restrictions is, I think going to keep Appalachian region production pretty flat going forward, perhaps modest growth, nothing material.

Laurence Jollon – Lehman Brothers

That's great color, Ben. Thank you. And then my second question was just around in the past you've mentioned potentially accessing the capital markets to fund the CapEx. In my opinion it's given improving outlook and you're posting stronger numbers, the way I model your business, you probably don't need to do that. I just wanted to get an update on your thoughts there.

Ben Hatfield

You're speaking to the discussion we had earlier about possibly going to the capital markets in conjunction with the Tygart investment in '09?

Laurence Jollon – Lehman Brothers

Yes, sir.

Ben Hatfield

At this point, clearly with the market improvement and the stronger performance, that date has moved out pretty significantly. We – prior to the market improvement, we were expecting that, that point was likely to be late first quarter '09 or early second quarter. At this point, I think it's our internal assessment that we won't be going – have the need to go to the capital markets before at least late 2009 and potentially even further out.

Laurence Jollon – Lehman Brothers

Great. And my final question is just around acquisitions. I just wanted to get your thoughts on the gap between buyers and sellers expectations and where international coal – or how international coal might participate in consolidation of the sector?

Ben Hatfield

I'm not sure I got your question correct. Could you repeat that?

Laurence Jollon – Lehman Brothers

I wasregarding acquisitions, one, I was – I just wanted to get your thoughts on the gap between sellers' expectations, given high prices and potentially where buyers are looking to purchase assets or companies? And then two, how international coal might participate in any consolidation in the sector?

Ben Hatfield

Well again, we've seen some intriguing headlines over the last quarter with clearly some gathering momentum on the consolidation with some big deals that have been announced. So, I think it's clear that the industry's general enthusiasm for these opportunities is pretty strong. You do still have the old price gap that we've talked about before the buyer and seller gap that you reference with prices today, if they're at $120 do you assume it's going to stay at $120 or $130 for the next 10 years or do you assume some backwardation? You know, all the indications are certainly in the near-term that they're going to be pretty strong, but that becomes the biggest point of debate I guess on valuation. But, what I find particularly intriguing in the last few months is the level of interest from international buyers, particularly, focused on the metallurgical reserves in southern West Virginia. So, I think that's going to become a factor that perhaps others had not envisioned that it could become kind of an accelerant to the overall consolidation story. So, I think it's going to if anything add to the interest in consolidation and make some deals more likely to occur than they might otherwise.

Laurence Jollon – Lehman Brothers

Thanks, Ben.

Operator

Your next question comes from the line of Jeff Kramer with UBS. Please proceed.

Jeff Kramer – UBS

Hi, good morning, guys.

Ben Hatfield

Good morning, Jeff.

Jeff Kramer – UBS

I just wanted to touch base on – get some specifics if you could on met coal production or tons sold from Beckley and Sentinel in the second quarter?

Ben Hatfield

You mean specifically what tons were sold from Beckley in the second quarter?

Jeff Kramer – UBS

Sure. And Sentinel?

Ben Hatfield

We don't normally break it out by business unit, again, for various competitive reasons; we don't get into that level of detail in our public announcements. But, I think it's sufficient to say that certainly production stepped up pretty significantly in Beckley in second quarter versus first and we expect continued growth going forward.

Jeff Kramer – UBS

Okay. I guess maybe more general, the met coal tonnage guidance increased from 2.2 million to 2.6 million tons for '09. Is that generally from greater production or I guess greater crossover from what might have been considered steam coal tonnage next year?

Ben Hatfield

It's a combination of factors, one, certainly being the Powell Mountain acquisition that gives us a few more tons, because they're likely to be a participant in some of the high vol metallurgical transactions. And we've also looked at some coals that again as I noted to one of the earlier questions with some processing and segregation become pretty significant metallurgical opportunities. We're seeing that at our Vindex operation. We're seeing it to some extent at a few of our Northern App operations. So, we're identifying some increments of existing production that with segregation and processing can create more metallurgical opportunities. So, it's a combination of Powell Mountain and kind of quality optimization and some improvement in the production outlook.

Jeff Kramer – UBS

Okay. And in 2009 overall, your guidance was raised by about 1.5 million tons sold, I guess 0.5 million tons will come from Powell. The other million tons, I guess there certain complexes you expect like compared to a few months ago that will be producing more?

Ben Hatfield

I think in 2009 we're anticipating that the Hazard shovel will add about 0.5 million tons and Powell will be near million tons in addition to that. So, that's the biggest piece of the growth that you referenced.

Jeff Kramer – UBS

Okay. And on the new contracts that you're signing, the U.S. utilities, I guess it seems like they're starting to come around the fact that they need to begin signing and renewing some of the contracts at these elevated levels. Do you expect to see a lot more of that going forward? And I guess some of your thoughts around the inventories at some of your customers and what you see in the utility space, it seems there's a little bit of a disconnect there versus what they're saying.

Mike Hardesty

This is Mike. With regard to the utility inventories, we are getting calls daily. There's a lot of pressure on utility inventories right now. Fundamentally, it makes no sense given the OTC index change. We think the signs are more bullish than they've been at any point this year. With regard to the contracting levels, first of all, yes, they have recognized, this is a long-term fundamental as represented by some of the contracts we've executed, and we're continuing to see that today, and we are in substantial discussions on several more term deals as we speak.

Jeff Kramer – UBS

Okay. Just on the index levels, I mean I guess specifically NYMEX has come down from about 140 into the mid-90s. I guess my understanding is (inaudible) even much coal at these docks. Any color around that?

Mike Hardesty

Absolutely. We've got calls from competitors. There's a shortage of coal in the docks particularly of decent quality coal. NYMEX is trading off the swings in the API 2 market in Europe. It's very thin trading right now, because of the European holiday. I think you'll see this index trading very choppy between now and the end of August, and then once the Europeans come back from holiday and the activity picks back up you'll see the appropriate response.

Jeff Kramer – UBS

Okay. Thanks, guys.

Mike Hardesty

Welcome.

Operator

Your next question comes from the line of Justine Fisher with Goldman Sachs. Please proceed.

Justine Fisher – Goldman Sachs

Sorry, my question's been answered. Thank you.

Mike Hardesty

No problem.

Operator

(Operator instructions) And your next question is from the line of Jack Franke with Duquesne Capital.

Jack Franke – Duquesne Capital Management

Hey, guys, thanks for taking my call. I just had a quick question. I thought I heard you guys mentioned that you thought that the cap pricing is more similar to the rail versus the river or the NYMEX price. I just wanted to see if you could add some color to what the difference is?

Ben Hatfield

Yes, this is Ben Hatfield. That was specifically my comment. Our experience is that the Central App, particularly CSX Rail index price and the Norfolk Southern Rail index price are far more representative of the market for the physical trades, and the NYMEX certainly seems to be more volatile and perhaps more greatly influenced by speculators and paper trades. We certainly found the rail indexes to be far more reliable and more reflective of the real market. Mike, you want to add any color to that?

Mike Hardesty

No. I think that's exactly spot on.

Jack Franke – Duquesne Capital Management

Does the NYMEX – I don't think it settles physically, right? But the rail does.

Mike Hardesty

Actually, there is – NYMEX settles physically on certain – on the over the counter transactions. The bulk of the trading in the last year has been financially settled products. There are CSX financially settled products now. And one of the broker – she tell you to track the index values, they've even included now a financial price and a physical price which is starting to recognize there's a difference.

Jack Franke – Duquesne Capital Management

Got it. Thank you.

Mike Hardesty

Welcome.

Operator

Your next question is from the line of Julian Benscher with Sherwood Investments. Please proceed.

Julian Benscher – Sherwood Investments

Hi, guys.

Ben Hatfield

Hi, Julian

Julian Benscher – Sherwood Investments

Couple of quick questions. You didn't mention that your operation has the mining manufacturing equipment, the coal car design….

Ben Hatfield

Coal car. Yes.

Julian Benscher – Sherwood Investments

How is that going?

Ben Hatfield

Actually, it's doing well. We've got several contract mining operations. As you know that business unit makes money about two different modes. One, being the contract mining on various other properties, and we have several systems that are working both in the western United States and the Midwest. And secondly, we're continuing to move forward with opportunities for new machine sales and still seeing a lot of interest, particularly in the current market where people are anxious to generate low cost production as quickly as they can. So, I think the short answer is we still feel very good about the outlook for the ADDCAR business unit. We have lot of inquiries on new machine sales. We haven't actually concluded any recently. By that, I mean signed contracts and ready for delivery, but we have several active negotiations that we believe are going to give us a good load going forward.

Julian Benscher – Sherwood Investments

So the interest mentioned by the earlier caller from Lehman with all these private equity guys looking at getting into the space should help that division of yours, but basically because of the spread of your operations and the strength of your client relationships won't have a negative impact on your sales capabilities?

Ben Hatfield

No, actually, I mean, as you surmised that, that business unit certainly will be well-positioned to provide equipment and quick mining response for new entries in the market where it's practical. They'll be permit constrained like most of the production situations in Central App, but certainly the ADDCAR system, I think is going to get a lot of attention, particularly as large scale surface mining becomes more and more under scrutiny and challenged on the valley field size. The ADDCAR system can be part of the remedial effort to reduce the size of valley field. So we think the outlook's good.

Julian Benscher – Sherwood Investments

Fantastic. Good luck, guys.

Ben Hatfield

Okay.

Operator

As there are no further questions in queue at this time, I'd like to turn the call back over to management for closing remarks.

Ben Hatfield

Thank you. International Coal Group is looking forward to building on our progress of the past quarter during the second half of the year. These are exciting times in the coal industry and we look forward to the opportunities that this strong coal market should bring. Thank you for your interest in International Coal Group. We look forward to joining you again next quarter. Have a good day.

Operator

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Have a great day.

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Source: International Coal Group Inc. Q2 2008 Earnings Call Transcript
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