Alliance Resource Partners LP (ARLP) 2007 Q2 法說會逐字稿

Good day, ladies and gentlemen and welcome to the second quarter 2007 Alliance Resource Partners LP/Alliance Holdings GP, L.P. earnings conference call. At this time, all participants are in a listen-only mode. We will conduct a question-and-answer session towards the end of this conference. (OPERATOR INSTRUCTIONS). As a reminder this conference is being recorded for replay purposes.

I would now like to the presentation over to your host for today's call, Mr. Brian Cantrell, Senior Vice President and Chief Financial Officer. Please proceed, Sir.

Welcome everyone. We appreciate your interest in Alliance Resource Partners which we refer to as ARLP and Alliance Holdings GP which we refer to as AHGP.

As you know, we released our 2007 second quarter earnings this morning prior to the market opening. With me today is Joe Craft, our President and Chief Executive Officer and together we will discuss our results for the second quarter and our outlook for the remainder of the year, as well as answer any questions you may have.

Since AHGP's only assets are its ownership interests in ARLP our comments will be directed to ARLP's results and outlook unless otherwise noted.

As a reminder some of our remarks today may include statements which are not historical in nature and may concern future expectations, plans, and objectives of the partnerships regarding their future operations. Such comments constitute forward-looking statements made pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995 and are based on the beliefs of the partnerships and those of their respective general partners and management, as well as assumptions made by and information currently available to them.

Although the partnerships, their general partners and management believes the forward-looking statements are reasonable at the time such statements are made, no assurances can be given that such statements will prove to be correct. These forward-looking statements are subject to a variety of risks, uncertainties, and assumptions which are contained in our filings from time to time with the Securities and Exchange Commission, and are also reflected in the partnership's press releases dated July 30, 2007.

If one or more of these risks or uncertainties materialize or if underlying assumptions prove incorrect, actual results may vary materially from those the partnerships anticipated, estimated, projected or expected. In providing these remarks the partnerships have no obligation to publicly update or revise any forward-looking statement, whether as a result of new information, future events, or otherwise.

We will also be discussing non-GAAP financial measures. Definitions and reconciliations of the differences between these non-GAAP financial measures and the most directly comparable GAAP financial measure are contained at the end of the ARLP press release, a copy of which has been posted on the partnership's website and which was furnished to the SEC on Form 8-K.

We will begin this morning with some brief formal remarks and will then be happy to take your questions.

At this time I would like to turn the call over to Joe for his opening comments. Joe.

Thank you, Brian, and good morning and thank you for joining our earnings review.

We have once again delivered outstanding operating and financial performance through the first six months of 2007. With ARLP reporting records across the board for coal sales and production volumes, revenues, net income, and EBITDA, I am particularly pleased that we delivered this record performance while our mines continue to be among safest in the industry.

At ARLP, safety is our first core value and our results reflect a focus on safety by all of our employees. I wish to express my appreciation to them for a job well done.

ARLP's incident rate -- which is the industry standard that measures lost time accidents -- was 45% better in the first half of 2007 compared to our own 2006 performance; and was 54% better than the industry average according to the most recent mine Safety and Health Administration safety data for 2007.

Even though our production was lower in the quarter due in part to reduce demand in the near-term, we are starting to see improvement in demand and pricing compared to earlier this year. Market indications continue to support our view that long-term supply demand fundamentals are favorable for high sulfur coal in the Illinois Basin and Northern Appalachian regions. The insulation of scrubbers at targeted utilities in the markets ARLP serves appear to be on schedule.

We continue to receive positive indications of increased demand from potential customers for production from our organic growth projects in the Illinois Basin and Northern Appalachian regions.

We made significant progress on our growth initiatives during the second quarter. Last month ARLP acquired from Consol more than 78 million tons of scrubber quality coal reserves in Webster and Hopkins County, Kentucky. We view this transaction as strategic, strengthening our already strong position in the growing Illinois Basin market. This acquisition provides us with operating flexibility and efficiencies by providing access to these reserves through our low-cost Dotiki and Warrior operations. By gaining control of these products reserves from Consol, we improved our position to secure even more reserves in the area, giving us the opportunity to extend the operating lives of these existing operations by another 10 to 15 years.

To further take advantage of the developing Illinois Basin market opportunity on a timely basis, ARLP recently executed a contract to construct a slope and shaft at our new River View complex in Western Kentucky. We currently anticipate the construction work will begin within the next 30 days.

We also expect our new rail facility at our Gibson County complex to be ready for operations in August of this year. Through this facility will have access to do the CSX and Norfolk Southern rail lines. This will allow us to expand our market reach beyond the local truck market for our existing Gibson mine and our Gibson South development project.

In Northern Appalachia, permitting and marketing efforts are moving forward. And at this time I am going to ask Brian to review our financial results after which I will return to discuss our outlook for the rest of the year. Brian?

Thank you, Joe. We are pleased to report another quarter of strong financial and operating results. Looking first at our income statement, ARLP's net income for the 2007 second quarter increased 14% to $46.2 million or $1.03 of adjusted net income per diluted limited partner unit, compared to $40.6 million or $0.94 of adjusted net income per LP unit in the second quarter of 2006.

EBITDA in the second quarter increased to $70.5 million, a jump of 17.8% compared to 2006 second quarter EBITDA of $59.9 million.

Now before drilling down into the details I would like to briefly elaborate on several factors that affected our overall results this quarter.

In June we reached the final settlement with our underwriters for insurance claims relating to the December 2004 Excel No. 3 mine fire. The settlement reflects gross amount of $31.6 million which after various deductibles and coinsurance resulted in a net settlement amount to ARLP of approximately $23.4 million. We had previously received partial payments in 2005 and 2006 totaling $16.2 million and the remaining balance of 17.-- I'm sorry, $7.2 million was received last month following the final settlement.

As a result of this settlement ARLP recorded a net gain of $11.5 million and an $800,000 reduction in operating expenses in the 2007 second quarter.

We also experienced increased compliance costs reduced productivity and lost production shifts related to the recently enacted Federal and State Mine Safety Regulations. While the direct and indirect impact is difficult to quantify, we estimate our consolidated second quarter operating expenses increased approximately $0.50 to $0.60 per tons sold as a result of these compliance efforts.

Most of the increased costs were in response to the unprecedented emergency temporary standard adopted by MSHA on May 21, 2007, relating to the [CIO] regulations. Although we expect our compliance initiatives will continue to affect results over the remainder of the year, we currently believe the impact will be to a somewhat lesser degree.

Production in the 2007 quarter was approximately 450,000 tons below our expectations. In addition to the lost production I just mentioned, ARLP also responded to an oversupplied market by selectively reducing production during the quarter. However, market conditions have recently [approved] allowing ARLP to secure sales commitments for an additional 500,000 tons in 2007. In addition, we do not currently anticipate our safety compliance efforts will result in continuing production interruptions, and as a result we expect to return to full production capacity for the remainder of the year.

Revenue in the 2007 quarter increased 19% to a record $263.3 million compared to $221.3 million for the same period last year. Increased revenues were driven by both higher average coal sale prices per ton which were up 4.6% to $38.60 per tons sold and increased coal sales volumes up 12.7% to 6.3 million tons.

ARLP's operating expenses increased to $178 million in the quarter compared to $140.9 million in the second quarter of 2006. Expenses at our Mettiki complex increased approximately $17.1 million quarter-over-quarter, primarily due to the anticipated higher operating cost structure of mining in West Virginia compared to Maryland.

As you may recall ARLP anticipated this higher cost structure at Mettiki, once we completed the transition of (inaudible) operations to our new Mountainview mine from the depleted Mettiki D mine in the fourth quarter of last year.

Although our Mountainview costs are higher they are generally offset by higher revenues from new coal sales contracts.

Our Elk Creek mine also experienced higher operating expenses of approximately $10.1 million as the mine operated at increased production capacity in the second quarter of 2007, compared to development activity in the 2006 second quarter. Higher sales-related expenses and higher labor-related expenses, and material and supply costs also contribute to increased operating expenses in the 2007 quarter.

ARLP's second quarter results also reflected higher DD&A of $5.1 million due to recent capital spending related to our growth initiatives.

Turning now to our segment schedules, increased production capacity at our Elk Creek mine and increased productivity at the Warrior mine drove sales volumes higher in the second quarter. ARLP also saw increased sales from coal inventory during the 2007 second quarter, compared to the 2006 second quarter. As you may recall, ARLP built inventory in the Illinois Basin during the second quarter of 2006 due to a slight delay in completion of a new preparation plant at our Elk Creek mine.

In addition, coal inventory in the northern Appalachia region increased in the 2006 second quarter, due to timing differences between production and sales commitments after Mettiki mine. ARLP also realized higher average coal sales prices in the second quarter of $38.60 per ton compared to $36.90 per ton in the second quarter of 2006.

As I mentioned earlier, new coal sales contracts for sales from our Mountainview mine reflect the higher cost structure of mining in West Virginia compared to Maryland. ARLP also experienced improved central Appalachian contract pricing in the second quarter as sales prices per ton increased nearly 9%, compared to the 2006 second quarter, reflecting the exploration of a low-priced contract at the end of the first quarter of 2007.

On the cost side, we have already you talked about the impact of reduced production and higher operating expenses associated with the new mine safety standards which resulted in increased operating expenses in all of our regions.

In addition to the higher cost structure of the Mountainview mine, expenses in the northern Appalachian region were also impacted by the [longwall] move in the 2007 second quarter.

Looking ahead we expect expenses per ton to improve over the remainder of 2007 as the anticipated regulatory cost impact diminishes, and our production capacity utilization improves with a strengthening market.

Looking briefly at our balance sheet you can see the impact at the Providence Reserve acquisition in our reduced cash balance and increased borrowings on our revolver. You'll also note that ARLP continues to maintain a conservative capital structure, which provides us with flexibility as we consider the future capital required to pursue our growth initiatives.

With that I will turn the call back to Joe for his guidance review and some closing comments. Joe?

Thank you, Brian.

I would like to turn now to our 2007 guidance, starting with capital. As a result of the Provident Reserve acquisition last month, the capital we expect to spend for River View and our current understanding of the capital required to comply with the new safety standards, ARLP is increasing its estimate for 2007 capital expenditures to be in a range of $175 million to $185 million.

We are adjusting our estimate for 2007 coal production to the range of 24.3 million to 24.8 million tons to reflect the production shortfall of 450,000 tons in the 2007 second quarter that Brian previously discussed. For delivery this year, we have secured sales and price commitments for approximately 24 million tons.

Looking ahead ARLP has secured sales commitments for approximately 19.1 million tons and 15.4 million tons for 2008 and 2009, respectively, of which approximately 4.3 million tons and 9.7 million tons are currently open to market pricing in 2008 and 2009, respectively.

ARLP is reiterating its previous guidance ranges for revenues, excluding transportation revenues of 985 million to 1.015 billion for 2007. EBITDA is in a range of $255 million to $285 million; and net income is in the range of $155 million to $185 million.

I would like to point out that while our previous guidance excluded any potential benefit associated with the settlement of the MC Mining Insurance claim, we anticipate this benefit will be offset by increased costs and expenses of complying with the new Federal and State Mine Safety Regulations, the reduced production caused by our market discipline and some isolated adverse geologic conditions.

During the second quarter we estimate these cost increases were approximately $7.2 million (technical difficulties) expect about $5 million plus or minus an additional costs in the second half of this year.

As reflected in the press releases, for both ARLP and AHGP the Board of Directors of each partnership also announced increases to their respective unitholder distributions for the second quarter just ended. The ALRP Board declared a quarterly cash distribution of $0.56 per unit for the 2007 second quarter, which represents a 3.7% increase over the distribution for the first quarter of this year and a 12% increase over the 2006 second quarter.

The AHGP Board also declared a quarterly cash distribution for the 2007 second quarter of $0.265 per unit which represents a 6% increase over the cash distribution paid for the first quarter of 2007 and a 43% increase over the expected initial quarterly distribution at the time of AHGP's initial public offering on May 15, 2006.

Several factors influenced our distribution decision this quarter. Of primary consideration was the potential impact on capital expenses and productivity, resulting from the extensive changes in Federal and State Regulatory Safety Regulations. Particularly the emergency requirements recently implemented by MSHA for inspecting and remediating underground mine seals.

As we discussed earlier today in responding to these new standards, we experienced production interruptions and incurred incremental capital and operating expenditures, which we are currently estimating at approximately $17 million in 2007. Although we anticipate many of these expenditures to be nonrecurring, our ongoing compliance costs will be higher in certain areas and uncertainty exists as to the interpretation and enforcement of these standards, as these standards continue to evolve.

Our Boards also reviewed our practice of considering changes to distributions on a biannual basis and concluded that this approach remains consistent with our business and planning cycles and allows distribution decisions to be made with the most relevant information available. Consequently, increases to ARLP's and AHGP's quarterly cash distributions to unitholders will continue to be considered by our Boards at their January and July meetings.

Hopefully by January 2008 we will have more certainty surrounding future compliance rules and the costs associated with them. We should also be in a better position to predict how much of these costs will be picked up by our customers.

In closing we continue to believe our strategy of positioning ARLP to take advantage of significant growth opportunities for high-sulfur coal in the Illinois Basin and northern Appalachian regions will benefit our unitholders over the long term. We continue to make progress in the development of our organic growth projects and we remain focused on securing the coal sales commitments necessary to allow these projects to proceed ahead of the anticipated demand increase for scrubber quality coal in these regions.

We remain optimistic about our future prospects.

That concludes our prepared comments so we will now open the call to your questions.

(OPERATOR INSTRUCTIONS). Mark Reichman with A. G. Edwards.

Just a few questions. On the maintenance capital expenditures, any of these cost creeps affect your guidance with regard before you've talked about your maintenance capital expense budget being driven on a dollars per ton production basis? Could you just maybe remind me that this quarter's maintenance CapEx and then how you look at that moving forward?

We tend to, as you know, take a look at that on a longer term basis as opposed to quarter to quarter. And what we have indicated in the past is that we think a reasonable number to use is $2.75 per ton and we think that number is still valid.

That's produced and no, we don't believe the safety regulations will change that. Most of the capital we are spending for safety is a one-time -- we believe to be a one-time occurrence.

On AHGP what was the G&A expense when computing a distributable cash flow per unit calculation? What G&A was isolated at the general partner level?

Both direct and allocated G&A at AHGP was about $720,000 for the quarter.

And over the year we are targeting around $2.2 million.

That's correct. Year-to-date we are at about $1.4 million and as Joe said we are estimating $2.2 million for the full year.

On these syn fuel tax credits that expire at the end of the year, how do you think about that and any offsets to that? Should there be some losses there? Maybe you could talk a little bit about some of the growth projects that you have on plan and if there's any updates there.

I think relative to synfuel, as far as considering it for distributions, we have historically ignored it even though it does factor into our numbers. We don't really factor that in as long-term sustainable cash flow because the credit does, in fact, expire at the end of the year. So relative to our distributions from really day one, we've ignored that in our judgment as to what the distributions should be.

Relative to our growth projects as I mentioned they are continuing to move pretty much as we've disclosed before. We would not expect there to be any earnings benefit in 2008 as a result of those projects, primarily because most of them are targeted to come on later in '09 and 2010 time frame.

So it is possible that unless the market does respond or unless we reduce some acquisitions that we would have a reduction by the amount of the synfuel credit we are receiving this year in our earnings per 2008.

Great. Thank you very much. I will ask maybe some questions on follow-up.

Paul [Forward] with Stifel Nicholas.

Few questions here. You had an expiration of a low-priced contract at the end of the first quarter that helped out your realizations in Central Ap in the second quarter. Do you have any more of those coming up? That you can foresee through the start of next year, maybe?

There was another small contract that actually expired in the second quarter of this year that will benefit us a little bit in the second half, but it is pretty small. Maybe 100 -- 200,000 tons. I can't remember precisely.

But it was another legacy contract if you want to call it that. Other than that, I think that the revenues on a consolidated basis for 2008 are going to be comparable to 2007.

(multiple speakers) On a part-time basis.

Following up on that synfuel question, with crude prices up what do you think the risk is that the '07 assumption for net income is too high for this year and you may have to go back and actually -- that you may not actually realize the 25 to 27 million because of the sliding scale on the tax credit relating to crude oil prices?

We have been in communication with the operators of the Synfuel Facility and as you know oil prices have been high throughout the year and we have received no indication from them that they plan to curtail their activities as a result of that at this point.

We've told you what our first half was and we obviously have operated during the month of July, so we've got another month under our belt as well.

And so the way that works is basically if you are operating then you get the benefit of the credit and it's the Synfuel plant operator itself that has more of the crude oil price risk? Is that right?

Yes it is.

Owner as opposed to the operator. The owner of the Synfuel credits would take that risk, but we as an operator of the machines and or selling our coal to other operators have no exposure on a retroactive basis for what we've already been able to sell sale and receive benefit for.

And just to be clear, Paul, we do not receive a benefit directly from the credit. We receive incremental revenues associated with the operation of those facilities.

Also a [looksee] on acquisitions right now. We had a nice selloff for the public companies. Do you think the valuations out there look more attractive to you now after this selloff over the last couple of months or are there any markets you would be interested in increasing your exposure to, right now?

I think it is safe to say that, yes, our appetite for M&A has grown -- is higher today than it was a year ago. But -- and we are more than happy to look for opportunities to add value in the long term for our Company. Our primary focus continues to be on the organic projects however. But we would definitely consider opportunities to make good attractive investments, if they become available.

What about those -- what's the star-tup timing looking like? Any change to the new growth projects that you talked about for 2009, 2010? Any change over the last two months to the planned start-up times for your new projects?

No. There's not really any change from what we discussed previously. That's -- they're still subject to finalizing coal sales agreements. So we do need to try to reach agreement by the first quarter of next year to stay on track with the previous estimates we have given to you all.

What do you think the level of your -- what's the level of appreciation among your customers for those new projects on the cost inflation? Whether it is worker safety or materials cost? Do they understand it is going to be -- that the cost inputs from your end have gone up and there's likely to be a step up in the contract levels? Or is that too far down the road for them to really put a whole lot of thought into?

No. I think they understand it. I mean they are seeing it and experiencing the cost increases themselves as they are constructing these scrubbers. So when they made their projections as to what the scrubbers were going to cost, they are seeing higher costs related to the commodity price input.

So, yes, they understand that and they understand what is going on in the safety arena and how that has impacted cost. At the same time, the market has been soft, relative to the expectations for this new capital. So there is a delta that makes it difficult for them to reach a commitment. Notwithstanding that, they know they need the coal and there's definite focus on their ability to make sure they get security a supply for the capital invested by their companies and what is in the best interest for their shareholders.

So I do believe you will see contracts being committed to, in order to provide production for these units. We are seeing several RFPs as we speak and we are anticipating in those. So, yes, I think the utilities are definitely focused on it.

Michael Blum with Wachovia Securities.

Just one quick question, really. Wonder if you could just expand on your comments in terms of what you are seeing in the market in terms of just fundamental demand because I guess, especially, just in context with some of the comments coming out of your competitors, which seem to be pretty negative. Your comments sound a little different. So just curious if you could expand on that.

I mean I think the positive factors influencing the market -- really, you look at the net markets they are continuing to be strong. International markets are strong with the Australian shortfall. US dollar is favorable for exports. All of these benefits to crude having coal -- moving from the utility sector into the -- either international and or the mid sector.

There have been supply disruptions. There have been both an Illinois Basin and Central Ap. We have seen several mine closings that just occurred in the first quarter or second quarter of this year. You are aware of the [Buchanan] fire situation in Virginia. Synfuel expirations, I think there is an expectation that you will say more production pull off in '08 as a result of the Synfuel expiration.

So there are some positive factors. I think the other factor is, 2006, we did have supply increase in excess of demand and that is slowly being reduced even though the stockpile levels continue to be at high levels if you look over the last two, three years.

But I think that those are positive factors that we see and for our particular markets, again we see some scrubbers coming on in 2008. They are going to solidify some of our opportunities in Illinois Basin.

Then, just in terms of pricing where do you see that going in '08?

I think pricing again as I mention a little earlier if you look at our consolidated average sales price per ton we don't see it being much different than what we are going to experience in 2007.

(OPERATOR INSTRUCTIONS). [Wyatt McCormack] with Raymond James.

I was wondering to get to your full productive capacity in '07, it sounds like there is going to be a bounce back in the third quarter or more gradual improvement?

I think what we're looking at is at midpoint -- it will probably be -- in the fourth quarter we have got some vacation days. So if you look at the quarter to quarter there will probably be more production in the third quarter versus the fourth quarter. I think to answer your question it's probably going to be more gradual but that we are targeting sort of at the midpoint about 24.55 million tons of production for the year.

Can you give any guidance for production in '08?

I would say it is going to be comparable. We haven't done our 2008 plan but my guess is it is going to be similar to the range that we gave at the first of this year for 2007.

[John King] with RBC Capital Markets.

Just a couple of quick questions for Joe, follow-up. If you could just expand a little bit on basically with synfuel credits running out and the impact of safety compliance of increasing basic costs to mines, do you see further mine closures of marginal coal mines in the Illinois Basin?

I would say in the Illinois Basin there is a possibility. I think more than likely it is going to be more Central Appalachia and Illinois Basin as far as mine closings as a result of these costs. I think that the margin opportunity for Illinois Basin is still -- would allow most of these operations to stay in business with possibly one exception.

Is that a big exception or --?

Yes. It's probably in the 30,000 ton a month. Plus or minus.

Then just wondering any indication on the stockpile levels of perhaps the utilities that the Illinois Basin typically services? Or is that too detailed of a question?

Cantrell: No. I would say that based on our information is probably in the 50, 55 days.

Still relatively -- like on par with the rest of the (inaudible).

Yes. Pretty much consistent with all the other regions.

Less question, I guess, from me is in terms of new scrubber sales. Have you had any -- because I'm sure you are relatively close to some of the plants that had been able to put on some scrubbers. Have you sold anything recently or is it more of a 2008 time frame when you expect to capture some of that market?

Well we did pick up some additional sales in the first quarter, roughly one million tons, a little bit more than that, that do stretch out to the '09 time frame. So there was some production or some sales pick up in the first quarter. And as I mentioned earlier we've got several other RFPs that we've responded to.

So we've got several opportunities that are out there that are specifically focused on new scrubber demand.

Right and that is why you have a bunch uncommitted '08 and '09 kind of capture some higher pricing?

It's just to be responsive to the market. So it is when they're going out to the market and they are out. And we anticipate there will be more utilities that will be out in the third quarter, fourth quarter. And I think decisions will be made in the fourth quarter and/or the first quarter of 2008 for the scrubbers that are coming online in 2008 and/or 2009, 2010.

There are no further questions at this time. I would now like to turn the call back over to management for closing remarks.

I would like to thank everybody for your continuing interest in the Alliance Resource Partners and Alliance Holdings and, in particular, thank you for taking the time to visit with us today. We look forward to speaking again in the future. Thank you.

Thank you all.

This concludes the presentation. You may now disconnect and have a great day.