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Walter Energy (NYSE:WLT)

Q3 2012 Earnings Call

November 06, 2012 9:00 am ET

Executives

Paul Blalock - Vice President of Investor Relations

Walter J. Scheller - Chief Executive Officer, Member of The Board of Directors, Member of Executive Committee, President of Jim Walter Resources and Chief Operating Officer of Jim Walter Resources

William G. Harvey - Chief Financial Officer and Senior Vice President

Michael T. Madden - Chief Commercial Officer and Senior Vice President

Daniel Paul Cartwright - President of Canadian Operations

Richard Allen Donnelly - President of Jim Walter Resources

Analysts

Curtis Woodworth - Nomura Securities Co. Ltd., Research Division

James M. Rollyson - Raymond James & Associates, Inc., Research Division

Shneur Z. Gershuni - UBS Investment Bank, Research Division

Caleb M.J. Dorfman - Simmons & Company International, Research Division

Brandon Blossman - Tudor, Pickering, Holt & Co. Securities, Inc., Research Division

Andre Benjamin - Goldman Sachs Group Inc., Research Division

Michael S. Dudas - Sterne Agee & Leach Inc., Research Division

J. Christopher Haberlin - Davenport & Company, LLC, Research Division

Lucas Pipes - Brean Murray, Carret & Co., LLC, Research Division

Ralph Wayne Atwell - Global Hunter Securities, LLC, Research Division

Mitesh Thakkar - FBR Capital Markets & Co., Research Division

David S. Martin - Deutsche Bank AG, Research Division

Operator

Welcome to Walter Energy's Third Quarter 2012 Earnings Call. [Operator Instructions] I would now like to turn the meeting over to Mr. Paul Blalock, Vice President of Investor Relations. Sir, please begin.

Paul Blalock

Thank you, Kathy. Good morning all, and thanks for joining us today. This call is being webcast live over the Internet and a recording will be available and archived on our website for at least 30 days.

On this call, we may refer to forward-looking statements made in yesterday's press release, and we may make those and other forward-looking statements during this call.

For more information regarding the risks associated with forward-looking statements, please refer to the company's SEC filings.

Joining me on today's call are Walter Energy's CEO, Walt Scheller; and CFO, Bill Harvey, as well as other members of the management team, who will be available for Q&A.

Walter J. Scheller

Thanks, Paul. Good morning, everyone, and thank you for joining us. I would like to begin today with a brief report on safety, which always comes first at Walter Energy. Our emphasis on safety continues to show results, and I'm pleased to report that the majority of locations are achieving improvement in reportable injury rates. On a year-to-date basis, across all Walter Energy operations, reportable injury rates are lower by 22% than this time last year.

Turning now to our results. Third quarter met production of 3.3 million metric tons was a record for Walter and represents a 47% increase from the 2.3 million tons produced in the third quarter of 2011.

While U.S. Operations turned in a solid performance of 1.7 million tons, Canadian operations almost matched the U.S. performance by producing 1.6 million tons and establishing their best quarter on record.

Walter's clearly delivering on our promises. Production is solid across our operations and within our projected guidance. Costs are low in the U.S. and consistent with our expectations, and Canada is showing real strength in maturing the operations and achieving lower cost targets.

Further, we continue to make progress on keeping safety first in all that we do as our accident rates continue to decline. And everyone should be aware all is not well in the global economy, and Walter's third quarter sales were 2.6 million tons as excess global supply exceeded market demand. And while there are some encouraging short-term signs, we will continue to monitor world markets, tighten our belts on spending and reduce production at certain facilities until demand and pricing improves.

I'd like to begin by discussing the strong third quarter production in our Canadian operations, which is a direct result of the mining plants we've talked about last quarter. This production increase, coupled with weak market demand, resulted in higher inventory levels in our Canadian operations at the end of the third quarter. As a result, we're reducing production at 2 of our 3 Canadian mines in the fourth quarter and plan to reduce Canadian inventory.

In the U.S., we are also reducing production at the Maple mine, and in the U.K., we are planning to idle the Aberpergwm project in Wales. We significantly reduced U.S. mid-vol inventory by 220,000 tons during the quarter, which is now within normal parameters. Low-vol inventory for Mine No. 7 in the U.S. remained at reduced levels.

We are also tightening our belts on spending in all areas of the business, and at this point in the current economic environment, we're making plans to reduce 2013 capital spending to approximately $220 million based on current global pricing.

On the operational front, I'm pleased that Canadian total hard coking coal production increased from 466,000 tons in the second quarter of 2012 to 641,000 tons in the third quarter.

At the Wolverine mine, production increased from 452,000 tons to 551,000 tons, and the cash cost of sales decreased to a record low of $107 per ton and significantly better than our end-of-the-year cost-reduction target.

Similarly, at the Brule mine, production of PCI increased from 566,000 tons last quarter to 765,000 tons in the third quarter. And cash cost of sales at Brule decreased 37% from $203 per ton in the second quarter to $129 per ton in the third quarter. So both Brule and Wolverine have exceeded their targeted cost reductions for the year.

However, before I move on, I should caution that in the near term, our production decrease will cause a modest increase in cost per ton. I should also mention that at the end of October, we moved the Brule mine to an owner-operated status, which we expect to provide additional cost reduction opportunities going forward. Once demand improves, we will return to full production and expect further cost improvements.

At the Willow project, PCI production improved from 154,000 tons last quarter to 198,000 tons in the third quarter, and hard coking coal production increased to 90,000 tons in the third quarter. The Willow mine will continue to increase its hard coking coal production, which is a low-vol product, in 2013. Cash cost of sales at Willow were abnormally high in the third quarter due to final contractor payments and a lower of cost or market adjustment. However, cost of production at Willow continues to improve, and we're well positioned for further cost reduction. In addition, we virtually completed the investment for the Willow project during the third quarter.

Overall, the message should be clear. Our Canadian operations are performing well, increasing production and achieving a solid track record in reducing costs and improving their operating performance. Wolverine and Brule are ahead of our expectations, and Willow continues to ramp production up and reduce operating costs. Going forward, we believe that Willow will soon become breakeven from a cash flow perspective.

Turning now to the U.S. Operations. Production was once again solid at 1.7 million metric tons, and most importantly, Mine No. 7 continues to perform well. U.S. cash cost of sales grew slightly from $107 in the second quarter to $119 in the third quarter as a result of selling a higher proportion of mid-vol inventory. However, production costs in the underground operations remain low. In the second quarter, we sold approximately 26% mid-vol tons, and in the third quarter, we sold approximately 42% mid-vol tons. In addition, Mine 4 not only represented a greater proportion of third quarter sales, it also represented a slighter greater proportion of third quarter production as Mine No. 7 had 1 week of miners vacation during the period.

Adjusting for greater production and inventory reduction in mid-vol, U.S. underground cost of sales were within a few dollars per ton from second quarter levels. In the fourth quarter, U.S. operations are scheduled to complete several longwall moves near the end of the year, and I'll let Rich Donnelly speak to the progress in those important operations if you have further questions.

Overall, consistent performance in U.S. underground operations for the first 9 months of 2012 is a significant improvement over the challenges faced just 1 year ago.

In summary, Walter Energy has safely mined 9.2 million tons of met coal so far in 2012, and even with our new action plans to reduce production in the fourth quarter, we expect to meet or exceed the low end of our previous 2012 guidance of 11.5 million tons. I'm pleased that our Canadian operations are continuing to improve in terms of both production and cost. And once again, U.S. underground operations continue to have a solid production profile, reasonable costs and strong cash generation.

Finally, our thermal operations have significantly reduced costs this quarter, and our coking gas businesses continue to perform well even in a lower price environment.

I will now turn it over to our CFO, Bill Harvey, who will discuss our financial results, after which I will provide some additional comments before we begin the Q&A portion of our call.

William G. Harvey

Thanks, Walt. In the third quarter, our net loss was $1.06 billion, including goodwill and asset impairment charges that total approximately $1.1 billion. Net income, excluding these charges, was $29.8 million or $0.40 per share.

During the third quarter, given our share price, the near-term market outlook and the actions we are taking to scale back production at our Canadian and U.K. operations, we determined that these could represent potential indicators that the fair value of the company's goodwill could be less than its carrying value. We performed a goodwill test as of July 31, 2012 and recorded a goodwill impairment charge for the 3 months ended September 30, 2012 for the full carrying value of the goodwill.

Additionally, we reevaluated our capital and operating plans and determined that a shale natural gas exploration project had not proven capable of providing commercially sufficient reserves. We have recorded a pretax charge of $40 million and an after-tax charge of $25 million to write off this investment.

Revenues were $612 million in the quarter as compared to $670 million in the second quarter, primarily since we sold approximately 220,000 less tons due to softer demand. Cost of goods sold was $37.3 million lower as a result of the reduced sales volume and improved cost per ton. Depreciation in the quarter increased by $8 million as compared to the second quarter partially due to the entering into service of several capital projects at the end of June. Prospectively, we expect depreciation and depletion to be in the $80 million range.

SG&A was $3 million lower in the third quarter as compared with the second quarter. Although there was some volatility in the number, we expect to trend this number down as we implement cost savings. We expect interest expense to be higher in the fourth quarter as a result of an amendment to our bank facility and less capitalized interest, increasing interest expense by approximately $5 million. We recorded a tax benefit in the quarter of $41 million based on our reduced profitability. Our adjusted EBITDA in the quarter was $117 million and included a onetime $6.9 million charge to cost of goods sold relating to sales tax.

In the quarter, we spent $85 million on capital expenditures as compared to $125 million in the second quarter, and year-to-date, our capital expenditures are $331 million. We expect it to total roughly $400 million for the full year. As Walt discussed, we are focused on stringently managing capital spending and, at this point, are planning on spending $220 million in 2013.

During the quarter, the Willow Creek development mine had exceptionally high cash sales cost of $329 per ton for hard coking coal and $290 per ton for PCI. This is a result of both the elevated production cost per ton at the mine during development and because we took a lower of cost or market charge on the inventory of the mine of roughly $28 million or $142 per ton. The production cash cost at the mine actually declined materially in the third quarter as compared to the second.

We ended the quarter with liquidity of $297 million. Our inventories increased approximately $58 million in the quarter, and we expect, with our current operating plan, that inventory will decline over the next several quarters. We will be managing our working capital levels very carefully.

I'll now turn it back to Walt.

Walter J. Scheller

Thanks, Bill. Turning to the macro environment, I just returned from a round of visits in Europe, and I can tell you that steelmakers have recently purchased met coal cautiously, even as excess volume has been available at reduced prices due to weak demand. Europe continues to take delivery of high-quality coals even in a relatively depressed economy, where everyone knows they're struggling to resolve economic issues.

In South America, the market is transitioning toward an improved export market for steel as tariffs on steel imports are being implemented in Brazil. In Asia, demand has been choppy, and we've seen recent pushback on short-term pricing offered by certain global suppliers as these markets clearly prefer a quarterly benchmark process. Globally, many met suppliers are increasingly reluctant to offer tons at recent market prices, and many in the industry believe that additional supply cuts are forthcoming. Although there are some signs that the excess supply of met coal available over the summer is beginning to diminish.

Lastly, many analysts are watching the signs of a gradual return of China to the demand side of met markets. The upcoming transition of leadership in China may provide greater clarity on the timing of stimulus programs over the next few months, which will likely be the key to the pace of global recovery in the met market.

Before we wrap up and get to your questions, I'm going to switch topics for a moment and share with you that in September, the coal processing facility at Mine No. 4 in Alabama received a certificate of achievement, with which many of you may be familiar, called the Sentinels of Safety Award sponsored by the National Mining Association. As one of the top finishers in the industry, the prep plant at Mine No. 4 achieved more than 156,000 employee hours worked without a lost workday injury. Congratulations to the Mine 4 employees for an outstanding job in safety.

In summary, third quarter results clearly demonstrate that over the last year, Walter has stabilized our operations, enhanced our production profile and diversified our customer base. I'm particularly pleased that both the Canadian and the U.S. operations are now maintaining solid production levels and tracking to both reasonable and improved cost structures.

Overall, the cyclical effects of the bottoming of the met coal pricing have been felt for lower-quality coals for some time now. However, the high-quality coal that Walter produces is usually the last to feel those effects. So while we remain bullish on our accomplishments and at maturing our operations, increasing production and reducing costs, just as we promised to, we believe that it's prudent to take steps announced today to continue to monitor world markets, tighten our belts on spending and reduce production at certain facilities until demand improves. Lastly, and as I have often said, no other coal company has a met focus like Walter Energy, and in my view, the margins we expect on hard coking coal will continue to make us a one-of-a-kind coal company.

Thank you for listening. The team and I will now be happy to take your questions. Operator, please begin the Q&A session.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from Curt Woodworth of Nomura.

Curtis Woodworth - Nomura Securities Co. Ltd., Research Division

I was wondering if you could provide some more specific guidance on ASP for the U.S. business. Looking into the fourth quarter, I mean, the benchmark is down roughly $50, $55 a ton, but you guys then benefit from the uplift that happened in Asia this quarter. So I was just wondering if you're going to see more of $30, maybe $35 per ton change. I know, obviously, there's some mix issues, too, if you continue to think No. 4 sales will be a little bit higher on an percentage basis as well into the fourth quarter.

Michael T. Madden

Curt, this is Mike Madden. What we're seeing out there right now is a fallout still from Q3. The benchmark dropped, as you know, by $55. The reason for the drop was the tremendous amount of spot coal that came into the market, particularly after the labor issues in Australia were resolved. With the benchmark set at $170, we continue to see spot, although we do start to see spot pricing increasing slightly, which tells us that there is some volume coming off the market. But it's extremely difficult in the environment we see today for buyers to commit all their tons to the benchmark. So what we're seeing is a basket of pricing right now.

Curtis Woodworth - Nomura Securities Co. Ltd., Research Division

Okay, understood. And then on Wolverine and Brule, obviously, very good cost performance this quarter. I mean, you mentioned that Brule, you're going to have some production cuts this quarter, so costs will probably trend a little higher. Can you just give us some more -- any more specific guidance you can in kind of where you see cash cost coming out for, basically, your Canadian operations kind of more kind of year-end run rate basis to help us with our 2013 models?

Walter J. Scheller

Sure. I'll let Dan Cartwright answer that question.

Daniel Paul Cartwright

Yes, Curt, this is Dan. Your questions are on Wolverine and Brule, just to be clear?

Curtis Woodworth - Nomura Securities Co. Ltd., Research Division

Yes. And I mean, if you can touch on kind of Willow. I know there's the, I guess, the $29 million inventory charge. Kind of what you would see for Willow going forward, too?

Daniel Paul Cartwright

Okay. Well, if I could, let me just set some things to set the stage for that, if I could, please. As Walt mentioned, in our Canadian operations, we achieved significant progress from both production and cost improvement in Q3. Walt mentioned the 1.6 million tons that we produced was a new record for Canada for a quarter, and I'm particularly pleased to note that all 3 mines continued -- or contributed to this quarterly record. And one thing I'd like to point out is that this run rate does annualize to just over 6 million tons, and that's significant as we previously represented that as the capacity for Canada's asset base, so we are touching that. But as you point out, as we come into Q4, we'll be balancing our run rates for Q4 and as long as necessary with our inventory levels as market conditions dictate. So what we'll be doing is reducing our PCI production, and we've already started doing that at -- for Q4 at Willow and Brule to reduce our higher PCI levels. At Brule, we'll be taking the bulk of the reduction -- the transition from the contractor-operated to the company-operated mine took place last Thursday, on November 1, as we have said it would, and it's going well. We're in a 2-week period, where we're getting government approvals for the shift and on-boarding the employees that have come over. So we will be out of production there and shipping out the inventory until November 14, so that's going well with that. When we come back into service, and actually, we have been for some time in October, we have reduced production levels there to the amount of coal that will be hauled over the Falling Creek Connector Road, which, as you know, has the lowest cost rate. So that will cause the run rate at Brule to be at about 60% of what it has been in the course of the year. At Willow, we'll be running Willow fully out, and the intention is that in the fourth quarter, we'll be working toward the full development of our hard coking coal. And as a result, we'll be having about a 50-50 mix of PCI and hard coking coal during that period. But we will take, as Walt said, a 2-week outage around the holidays to be able to ship out the inventory and reduce that as well. The other thing that we talked about in our cost to sales is that we've actually hit the targets, at least for Wolverine and Brule, that we've mentioned earlier in the year, and that is that we would have cost in the 130s. In fairness, I need to say that last quarter, I gave a lengthy explanation as to why Brule's costs were high as being in the unfavorable part of the mining cycle. Well, in Q3, Brule then benefited from being in the favorable portion of that cycle. So we did receive some benefit there, but we did achieve those cost numbers. And then Willow's costs, as we said before, we expect, and this gets to the part of your question as well, we expect Willow to be, in the fourth quarter, around $180 cash cost of production plus transportation. And so that's about what we've said in the -- that's what we've said in that same guidance in which we gave the 130s. As far as cash cost of production, our Canadian operations, we continued since the first of the year -- and of course, that's the component of the cost at the mine through the load-out. We've seen a 25% reduction from Q1 costs, and again, each of the mines have contributed to that. Our primary focus has been -- the way we've accomplished that is we worked on reducing contractor costs, and that's essentially been at Willow and Brule. We've transitioned to owner-operators at both those places. [indiscernible] taken over the contractor work that we can do at lower cost, and the development work at Willow is essentially complete. That's what brings us down to the level that we spoke about. And then at Wolverine, we've put in the basic mine management processes that I've spoken about quite a bit before, and that's starting to bear fruit, and it shows in Wolverine's third quarter performance, although there was some benefit from mining cycle there, too. So we've accomplished the things that we said. The owner-operator conversion at Brule took place, as we said, and we're well into that, and the bulk of the contractor work is done at Willow. Fourth quarter, we see Wolverine's costs probably up slightly from where they are, somewhere -- probably 120s, depending in the shipment, probably mid-120s, 130. Willow, as I said, will be somewhere in the $180 number, and the Brule number will be elevated, and that one's hard to tell. We are actually -- as we said, we're cutting back the most production there, so we'll probably be in the 130s, I would guess, at that area. So in those cases -- and those are production costs that I'm giving, so that's essentially where we see ourselves for Q4.

Operator

Our next question comes from Jim Rollyson from Raymond James.

James M. Rollyson - Raymond James & Associates, Inc., Research Division

Walt, I may have missed it. I know you kind of hint around it, but just -- is there any chance to get your view on kind of, all-in, what you're expecting for hard coking coal and PCI volumes for fourth quarter? And given what you've got contracted and what you know today, maybe kind of roughly what you think average prices will work out to be just in relation to the $198 and $164 this quarter.

Walter J. Scheller

I'll hit the production side of that, and I'll let Mike talk a little bit about what he thinks the pricing will be around that. Right now, we're anticipating getting up to about that 11.5 million, maybe a little above that area for the year. Right now, we're at 9.2 million, so that puts us at about 2.3 million for the fourth quarter, plus or minus, in terms of total production. And again, since that's sales, there will be -- consider about probably 25% PCI, 75% hard coking coal in that mix. And I'll let Mike talk about the pricing that we're seeing.

Michael T. Madden

Jim, I guess also, we're tracking pretty well on committed shipments to what our production would look in Q4, particularly based on the outage that we're going to take in December. We are seeing some uptick on PCI lifting, so we expect to bring down inventories gradually in Q4. As regards to pricing, we are seeing -- we have not concluded everything. As of today, we're very close. We have a couple of open accounts. But what we are seeing is the delta on the pricing for the mid-vol 4 and Wolverine is widening, and that's being driven by spot pricing. It's very difficult for the buyers to resist some of these spot prices that are out there today, so it's putting a lot of pressure on the pricing.

James M. Rollyson - Raymond James & Associates, Inc., Research Division

Do you think that you'll end up with your hard coking coal price then a little bit lower than kind of what the -- the quoted benchmark number, the $170, on average?

Michael T. Madden

Yes, on average, yes.

James M. Rollyson - Raymond James & Associates, Inc., Research Division

And then PCI, what do you think for fourth quarter?

Michael T. Madden

I think the PCI, we're holding pretty good on the $125 level.

James M. Rollyson - Raymond James & Associates, Inc., Research Division

Okay, that's very helpful. And Walt, just a follow-up on CapEx commentary. You mentioned, obviously, cutting things back for next year. Should we think of -- when you think beyond all the projects you've been working on and doing a great job on this year, when it comes to the next level of development for Walter in the U.S. to the west of your current Alabama operations, have you kind of slowed that down dramatically until you see some improving market conditions? Or maybe just talk about the status of that.

Walter J. Scheller

Well, we'll continue to work on that project as much as we can next year. And given where we are in that project, we can make some cutbacks in that project next year, we believe, without adversely impacting the start date of that project. If the market picks back up, we can't cut back to this type of a capital level for multiple years and expect to bring that project online in that time frame. But if we do it for a year, I think we should still be fine in terms of the timing, and our goal was to bring that project around -- online somewhere around 2018. We'll slow down the Aberpergwm project considerably next year from where it has been this year. And the Bel-Sax project, really, there was not an awful lot of capital being put into that project right now, so that really doesn't represent much of a slowdown.

Operator

Our next question comes from Shneur Gershuni from UBS.

Shneur Z. Gershuni - UBS Investment Bank, Research Division

My first question is just about production, I guess. You've shown an ability this quarter to flex it up a little bit. I was wondering if you can sort of remind us what your longer-term objective, I guess, kind of like a '13 target, I guess, as an exit rate for production and also whether you think that the $100 cost target is still achievable in Alabama.

Walter J. Scheller

Well, I'll let Rich talk about the $100 cost target in just a moment. But as we look out, we've stated that our goal is to get to 20 million tons by 2020. We still have that as a goal. We don't think anything we're doing today will adversely impact our ability to get there. Shorter term, we are going to adjust our production expectations in 2013 to the market, and we probably will not run everything at full capacity. But we're developing -- as Dan said, we've got ourselves to a point now where we have production capacity in Canada of about 6 million tons, and in Alabama, we're getting ourselves quickly to the point where we'll be at 7.5 million or so tons of capacity at the 2 big underground mines and then the miscellaneous production out of West Virginia and the Alabama surface operation. So we feel pretty confident that we're growing the production capacity, and we're just going to mark -- match the production levels to the demand. And Rich, I'll let you talk a little bit about the Alabama operations.

Richard Allen Donnelly

Shneur, this is Rich Donnelly. Just talking about the U.S. Operations, as we've stated, our goal was to be in that $100 a ton range. And currently, if you look at our numbers, the No. 7 Mine combined is at that level now. They've been at that level for several quarters. As we've talked about No. 4 Mine, No. 4 Mine is continuing down the path where we've got several short longwall panels. So during the course of the year, really, the last couple of years, we've had quite a few longwall moves, quite a few incidents were they are waiting on the longwall panel. So if you look at the cost structures of both mines, they're very, very similar. Both mines are working hard to control spending and to reduce their overall cost. But as you know, tons is a major factor in cost per ton. And with the short panels at No. 4, our tonnage is down from what it normally is, and that's the reason their costs are high. They ran about $135 a ton. That's really where they've been all year, right in that range. As we move into next year, midway through the first quarter, we'll get back into a reasonably long panel, a little over 1 mile long. And we'll start seeing production ramp up, and we'll start getting No. 4 back down closer to that $100 range.

Shneur Z. Gershuni - UBS Investment Bank, Research Division

Great. As a follow-up question, and maybe this is for Mike and kind of a build-up on Jim's question, we've seen met pricing start to pick up in the spot market, and I understand that there's been a dislocation between the spot and settlements and so forth. But I was wondering if you could, I guess, at a bare minimum, hazard a guess as to where you think the next benchmark settlement will head out. And are you seeing that pickup that's causing price to -- spot pricing to move up the way it has lately?

Michael T. Madden

Well, to answer your first question there, we also have seen a little bit of pickup on the spot pricing. Some of that, I think, is pushback. I think some of the supply is going off the market that everybody anticipated, maybe not as fast as we would like. We also saw just recently the Chinese market coming back. They've been very selective on what coals they will buy on the spot, but they are buying spot again. And I guess the next benchmark is a real moving target right now. There's a lot of speculation out there, so I really couldn't answer right now. I got to really wait a little bit on that one.

Operator

Next question comes from Caleb Dorfman from Simmons & Company.

Caleb M.J. Dorfman - Simmons & Company International, Research Division

I guess first off, I know that we've talked about the geological issues in Canada a bit, and last quarter obviously had a negative impact. This quarter helped a little bit. As we look into next year, are there going to be continuing geological issues, a topography role that we should be thinking about? Or will it be more of a leveled-out steady state, where the cost of the Canadian operation, exclusive of other issues, should be fairly steady?

Walter J. Scheller

Dan, I'll let you answer that.

Daniel Paul Cartwright

I think, really, probably the best way to answer that, I wouldn't characterize what we see in Canada as a geologic issue. I mean, it's -- that term to me gives the connotation of surprises and things that we don't know there. What I addressed last time had to do more with the mining cycle of periods of time when we would be in more coal and less rock and then other times where it would be the other way around. So all those mines will have periods of time when they'll be in those cycles, Brule most of all, because the seams are relatively flat there. So there's periods of time when you're between the upper seams and upper seams and lower seams, as we saw in the past quarter. But I think -- and that's one of the reasons that it's difficult to get too excited or unexcited on costs for a particular quarter because of those cycles, and we'll try to do a better job of pointing those out in advance than we did in the second quarter. But I think overall, no, I don't expect to see anything unforeseen and major there, and I think we'll be able to both smooth out and better advise whenever we're running at these particular types of cycles.

Caleb M.J. Dorfman - Simmons & Company International, Research Division

Is it usually an issue where one quarter will be good and then one quarter will be a little tougher, or sometimes will you get 2 quarters of good conditions?

Daniel Paul Cartwright

I think, well, again, the issue, really, I believe, is more of an issue at Brule than anywhere else. The rest of the places I don't think have significant cycle issues. And in the case of Brule, depending on the tonnage rate, we'll be in that cycle that we were in in the last quarter probably once every 9 to 10 months on the average.

Caleb M.J. Dorfman - Simmons & Company International, Research Division

Okay, that's pretty helpful. And then I guess, Dan, you had mentioned that there are some customers who are like being a little hesitant about pricing, but the Chinese are back in the market buying. Have you seen any deferrals of tonnages or anyone wanting to push back on kind of either tonnages from a demand perspective and not a pricing perspective?

Daniel Paul Cartwright

Well, we haven't seen this year, really, the full commitments being lifted because most of the mills are running at a reduced level. It's not a question of pushback. It's just -- they're operating levels are dictating what they can take.

Operator

Our next question comes from Brandon Blossman from Pickering, Holt & Co.

Brandon Blossman - Tudor, Pickering, Holt & Co. Securities, Inc., Research Division

This is a follow-up and a pretty high-level general question. But just in terms of production flexibility, labor flexibility in the Western Canadian assets, how much flexibility is there? And I guess just generally speaking, how much influence will prices through the trajectory -- met price trajectory through '13 have on production levels quarter-by-quarter in Canada?

Walter J. Scheller

I guess what I'll say there is as we transitioned the Brule mine from contractor-operated to owner-operated, it gave us a chance to rightsize it to where we see the market right now and where we see the kind of what the low-cost scenario is for that operation. It's very difficult to flex those mines on a quarter-by-quarter basis unlike a lot of U.S. operations, where you have a workforce that is far easier to flex up and down. Up in that area, you're kind of -- it takes you a little while to ramp up, and if you cut back on your labor, it's more of a long-term decision. So I guess what I'll say is once you develop that capacity and you staff yourself for that capacity, it's a little more difficult to keep a reasonable cost structure and flex the production.

Brandon Blossman - Tudor, Pickering, Holt & Co. Securities, Inc., Research Division

Okay, that's very helpful and understood. And then probably a simpler question, just on the $220 million CapEx for '13, how much of that is just pure maintenance CapEx and on the maintenance CapEx side or the portion of that that is maintenance CapEx? Is that a sustainable number? It's obviously a very attractive total number there.

Walter J. Scheller

The maintenance capital there is probably in the $180 million range, so we've got about $40 million in growth capital remaining in that type of a budget scenario. We haven't finalized that budget yet, so that's why we're saying it'll be around the $220 million number. But we anticipate out of that number a $180 million maintenance capital, $40 million growth capital.

Operator

[indiscernible] from Citi, you may ask your question.

Unknown Analyst

Walt, so my question is with just your cost structure in Canada. I know you've gotten that down. And when we look at PCI contract prices, it's still below your cost structure. So how long would you maintain this production run rate and kind of meet market demand, even though pricing is arguably well below what's sustainable?

Walter J. Scheller

Well, where we see -- when we look at the -- I should let Mike answer this question. But when we look at what Mackenzie is projecting next year for the annual price in the mid-180s and we back that into a PCI price, it comes out to about $130. And we project our Brule operation to be able to be profitable at sales prices in that $130 range. Our Willow operation, as we continue to grow it and it becomes basically a 50-50 hard coking coal and PCI mine, we expect also to be able -- with the type of pricing right now suggested by Wood Mackenzie, that that mine will be breakeven or positive slightly over the next couple of quarters as we finish out its full development.

Unknown Analyst

Okay. And then -- but if you add back CapEx to those costs, they're not going to be free cash flow positive anymore.

Walter J. Scheller

There'll be very little CapEx added or needed up there over the next couple of years, we believe.

Unknown Analyst

Yes, okay. And the second one is just on -- any carryover tonnage from 3Q contracts because the shipments were a little bit light.

Walter J. Scheller

I'll ask Mike to answer that.

Michael T. Madden

It's about 300,000.

Unknown Analyst

Do have quality and price?

Michael T. Madden

That's about 100,000 from Alabama and the rest is from Canada. And right now, we're looking at an average carryover price about a little over $200.

Operator

The next question comes from Andre Benjamin from Goldman Sachs.

Andre Benjamin - Goldman Sachs Group Inc., Research Division

First question, I just want to make sure I was clear on how to think about the sales versus the production levels, which -- the improved production levels that you've shown. The low end of the 11.5 million to 13 million guidance for the year seems implied pretty healthy step-up in sales volumes quarter-over-quarter, which is a little more optimistic than a lot of your U.S. and Australian peers have been guiding to. What are you seeing in your conversations with your customers that give you the confidence in such a healthy increase quarter-over-quarter? And then I guess how much of that midpoint of, I think, on my math, about 4.5 million tons, if it's correct, is still unpriced?

William G. Harvey

I'm not sure where you're coming with 4.5 million.

Andre Benjamin - Goldman Sachs Group Inc., Research Division

Your total met sales number, if I'm correct, is about 7.8 million, 7.9 million for the year, and the production levels were much higher 9 million, 9-point-something million. So 11.5 million sales over 4 million tons in the fourth quarter?

Walter J. Scheller

The 11.5 million is production.

Andre Benjamin - Goldman Sachs Group Inc., Research Division

Yes. I was trying to understand what we should be thinking about in terms of sales for the fourth quarter.

William G. Harvey

Well, I think you can surmise that with the 2-week outage we're going to take up in Canada, we're going to drop out some production up there. But in Alabama, we should still be on a relatively flat basis quarter-to-quarter.

Andre Benjamin - Goldman Sachs Group Inc., Research Division

Okay, that's helpful. And in terms of Willow -- I'm sorry.

Michael T. Madden

I was going to say, Andre, if you bake in the 2-week that we're going to take up in Canada with what scheduling we're looking at right now, we're tracking very well with production forecast.

Andre Benjamin - Goldman Sachs Group Inc., Research Division

Okay, that's helpful. And then in Willow Creek, you have started to show progress yet you're guiding towards $180 in cost for the fourth quarter. As we think about the future, as you move kind of out of the development mode and into more of a steady state, do you have any early views on how low you can get that cost? Is it in that same $130 to $140 as the other mines, or is that always going to be a higher-cost operation?

Daniel Paul Cartwright

This is Dan. Over the long term, yes, we do see being able to get that into the $130, $140 range. But as Walt said, going into next year, depending on how that develops, we're thinking breakeven or a little better given the 50-50 mix of the hard coking coal and PCI.

Operator

Question comes from Mike Dudas from Sterne Agee.

Michael S. Dudas - Sterne Agee & Leach Inc., Research Division

Walt, I guess this one is for Walt or Mike. So you've done obviously, well, a very admiral job in getting the operations where they are and where the costs are in the U.S., and we're showing improvement in Canada. How do you see the overall global met market? How oversupplied are we? And you've had some pretty good growth into an oversupplied market. And as you look towards 2013, how much adjustment to the marketplace are you willing to make to help correct the oversupply situation, or we can still manage for positive cash flow to generate returns for shareholders at, say, this lower-than-benchmark prices?

Walter J. Scheller

Well, I guess I'll start off by saying the oversupply, I think, is primarily on the high-vol side, but all of that -- all of those tons have been sitting out there and coupled with the -- as the labor situation in Australia corrected itself, the quick influx of tons is a result of that. We've seen all the pressure that we're seeing, and we've seen kind of the inventory levels go up. We've seen the availability of a lot of the high-vol tons in the spot market be available. But I think what we're starting to see now as a lot of those tons are starting to come off the market, a lot of that inventory is being used up, and our expectation is over the next -- I don't know if it's over the next quarter or next 2 quarters, that inventory will be burned off and we'll get back to a more stable situation. We don't intend -- well, I said we can't -- we really can't flex the labor easily in Canada on a quarter-to-quarter basis. We don't intend to run operations that we can't run profitability throughout the year. So we're prepared to do whatever we have to do to assure that we're profitable operation by operation.

Operator

[indiscernible] Haberlin from Davenport & Company.

J. Christopher Haberlin - Davenport & Company, LLC, Research Division

You mentioned that mid-vol spreads were widening some just due to the weak market conditions, and I think during the last conference call, you had suggested that that spread had widened from kind of its typical $5 to $10 a ton to $15 to $20 a ton. Are you seeing further widening from that range above $20 a ton?

William G. Harvey

Yes, we have seen it. It has gotten wider.

J. Christopher Haberlin - Davenport & Company, LLC, Research Division

And then some of your competitors have forecasted seaborne met market growth in 2013 as being up anywhere from 5% to 15% next year. I'm just trying to get an idea of what you all are looking for in terms of seaborne met demand.

Walter J. Scheller

Well, most of the forecast we see are steel growth looking around anywhere from 3% to 5%, and so I would say it may be a bit bullish to go up to 15% on the demand side.

Operator

The next question comes from Lucas Pipes from Brean Capital.

Lucas Pipes - Brean Murray, Carret & Co., LLC, Research Division

A quick clarification on the Canadian cost. Obviously, a very good performance this past quarter. Should we still think about kind of the target in the $130 to the $140 range on a normalized basis for Wolverine and Brule?

Daniel Paul Cartwright

I think on -- this is Dan. I think on a go-forward basis, that's still a good number, although as we continue to put the processes that are beginning to give us traction in Wolverine and the others in place, our intent is to drive that down. But I think for the foreseeable future, yes.

Lucas Pipes - Brean Murray, Carret & Co., LLC, Research Division

That's helpful. And then I guess we're kind of 1/3 through the fourth quarter here, and I wondered if you have a sense of how sales are tracking so far and if that's a good run rate to use for the entire quarter.

Michael T. Madden

Well, this is Mike. We've said earlier that with the reduction we're going to take on work time out in Canada, if you build that in against our schedules today, we're tracking well on that right now.

Lucas Pipes - Brean Murray, Carret & Co., LLC, Research Division

Okay, that's helpful. And then lastly, transportation costs in Canada are included in your cost figures that you provide and a significant portion. How are the rails responding to this weaker market environment? Are you getting some benefit there?

Michael T. Madden

We're having dialogues. We are having dialogues.

Operator

The next question comes from Wayne Atwell from Global Hunter.

Ralph Wayne Atwell - Global Hunter Securities, LLC, Research Division

I just wanted to sort of clarify some of the guidance you've given us. What was the payment you made to the contractors when you went from contractor mining to owner-operated?

William G. Harvey

It involved the purchase of the equipment that we had gotten and...

Walter J. Scheller

Typically, also, the final billings lag anywhere from 30 days to 60 days. So you have final billings from the contractors, and that is coupled with us bearing the costs in that month as well, so we kind of double up on cost for a short period of time.

William G. Harvey

And the demote charge. And I'm sorry, but I don't have that figure with me.

Ralph Wayne Atwell - Global Hunter Securities, LLC, Research Division

Right. Well, what I was trying to do was, for modeling purposes, figure out what the extraordinary cost was in the third quarter that won't be duplicated.

William G. Harvey

Well, we have -- for one thing, we -- well, I see what you're saying. Of course, in the third quarter, we have the full contractor charges in there, as we always have had. And in the fourth quarter, of course, they operated up through October, so we have those charges as well in addition to the demote charges that I don't have off the top of my head.

Ralph Wayne Atwell - Global Hunter Securities, LLC, Research Division

Okay. And just using the numbers you've given us, you've produced 9.2 million for the year so far, and you said you like to have committed the 11.5 million, or that's just -- you're just sort of giving us that as the range? Because that would imply 2.2 million. Should you go from 3.3 million down to 2.2 million between the third and fourth quarters?

Walter J. Scheller

Yes, right now, what we're saying is we'll exceed 2.3 million tons of production. That's likely where we'll end up, somewhere in that range for the fourth quarter.

Ralph Wayne Atwell - Global Hunter Securities, LLC, Research Division

Okay. And then I guess you haven't really given us sales guidance. I guess you were 2.6 million for the third quarter. If you work off some inventory, conceivably might that be 3 million? Can you give us any thoughts?

Walter J. Scheller

We expect it to hopefully exceed our production level, but by how much, we're just not sure at this point. With the market where it is, we're not going to -- we're not just going to move tons to move tons.

Operator

The next question comes from Mitesh Thakkar from FBR.

Mitesh Thakkar - FBR Capital Markets & Co., Research Division

My first question is just broadly for Brule. How comfortable are you on the liquidity on the balance sheet side? Do you think this is enough, or any plans to enhance liquidity levels?

William G. Harvey

I believe we have adequate liquidity. And as you're probably aware, we just finished a bank amendment that provides a good runway for us and at the same point, allows us -- provides an ability for us to raise money in the market. And we are looking at the capital markets right now, and they are attractive.

Mitesh Thakkar - FBR Capital Markets & Co., Research Division

Good. And can you just give me a sense of your inventory levels in various regions?

Michael T. Madden

This is Mike. The inventory we're carrying is a normal inventory here in Alabama. It's just slightly above 400,000. Where we're carrying the major inventory is up in Canada, and quite a bit of that is in the PCI.

Mitesh Thakkar - FBR Capital Markets & Co., Research Division

And is it fair to say that the Canadian inventories will trend down in fourth quarter, whereas Alabama will more or less be flat?

Michael T. Madden

That's the objective, yes.

Operator

The next question comes from Dave Martin from Deutsche Bank.

David S. Martin - Deutsche Bank AG, Research Division

I had a few follow-ups. First, just on the fourth quarter production guidance, and sorry if I missed the details, you're pointing to a production decline of about 1 million tons. You noted that PCI production will be down, but that's likely to represent just a portion of that 1 million ton decrease. So I'm just curious what else you're doing from the production side.

William G. Harvey

We have 3 longwall moves in the fourth quarter. We've cut back our Maple mine. So those also will have an impact on fourth quarter production levels.

David S. Martin - Deutsche Bank AG, Research Division

Okay. And then my other 2 questions are -- first, on the tax rate, Bill, I know you mentioned taxes in your prepared remarks. What's the tax rate we should be using for the fourth quarter, if any? And then my last question, Walt, you mentioned that you've been successful in diversifying your customer base. I'm just curious what you mean by that.

William G. Harvey

Yes. On the tax rate, you could use roughly a 40% tax rate for the fourth quarter.

Michael T. Madden

This is Mike. On the customer base diversity, we started moving some of our Alabama products into Asia, and we started moving some of our Canadian products into South America and Europe.

Walter J. Scheller

Operator, I don't see any more questions. If not, that will conclude our call.

William G. Harvey

Thank you, operator.

Operator

Thank you. This concludes today's conference call. You may disconnect at this time.

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