Alliance Resource Partners LP (ARLP) 2008 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the third quarter 2008 Alliance Resource Partners LP and Alliance Holdings GP LP earnings conference call. My name is Dan and I will be your coordinator for today.

At this time all participants are in listen-only mode. We will conduct a question-and-answer session towards the end of this conference. If at any time during the call, you require assistance please press star 0 and a coordinator will be happy to assist you. As a reminder, this conference is being recorded for replay purposes.

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

Thank you, Dan, and 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.

We release our 2008 third quarter earnings earlier this morning and will now discuss these results and our outlook for the remainder of 2008. Following our prepared remarks, we will open the call to your questions.

As is our practice since AHGP's only assets are its ownership interest in ARLP, our comments today will be directed to ARLP's results and outlook, unless otherwise noted.

I will also remind you that some of our remarks this morning may include statements which are not historical in nature and may concern future expectations, plants and objectives of the partnerships regarding their future operations. Any 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, the respective general partners and management as well as assumptions made by and information currently available to them.

Although the Alliance partnerships, their general partners and management believe these forward-looking statements to be reasonable at the time made, no assurances can be given that such statements will prove to be correct. 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 today's press releases from the partnerships.

If one or more of these risks or uncertainties materialize, or if our underlying assumptions prove incorrect, actual results of the partnerships may vary materially from those we anticipated, estimated, projected or expected. In providing these remarks, neither ARLP nor AHGP has any obligation to publicly update or revise any forward-looking statement, whether as a result of new information, future events or otherwise.

Finally today, we will also been discussing certain 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, which has been posted on its Web site and furnished to the SEC on Form 8-K.

Now that we are through with the preliminaries, I will turn the call over to Joe Craft, our President and Chief Executive Officer. Joe?

Thanks, Brian. Good morning, everyone. Thanks for joining our third quarter 2008 earnings review.

The coal markets remain strong through the third quarter of 2008 as supply and demand fundamentals continue to support attractive prices in all of the ARLP markets. As has been the case all year, these favorable market dynamics allowed us to commit our coal production at prices substantially higher than historical levels.

During the quarter, we executed agreements to sell 22.9 million tons of coal at an average base price that was more than 65% higher than historical levels for delivery terms ranging from three years to 10 years. With our 2008 production substantially committed and priced, ARLP now expects average price realizations per ton this year will be 2 to 3% higher than last year. Considering results to date, and current projections, we are also confirming our previous 2008 guidance for revenues, EBITDA and net income.

As we have previously communicated, ARLP will start to realize significant benefit from its recent contracting efforts beginning next year. Based on existing commitments and ongoing discussions with customers for our open positions, ARLP continues to anticipate prices on a per sales ton basis, which will increase over 2008 levels by 25% to 35% in 2009 and 40% to 50% in 2010.

During the quarter, we also made good progress on our growth initiatives. Last month, we announced our commitment to build the new Tunnel Ridge mine in West Virginia. Once Tunnel Ridge is operating at full capacity, now scheduled for the fourth quarter of 2010, we expect this mine to employ up to 300 people and produced approximately six million tons of coal per year.

Construction of our new River View mine in western Kentucky is well under way. And we have successfully hired approximately 20% of the 600 new jobs we expect to add to fully staff this operation.

Today, the Board of Directors of both ARLP and AHGP announced increases to their respective unitholder distributions for the third quarter just ended. The ARLP Board declared a quarterly cash distribution of $0.70 per unit for the 2008 quarter; a 6.1% increase over the distribution for the second quarter of this year; and a 25% increase over the distribution for the 2007 third quarter.

Reflecting the distribution declared by ARLP and the resulting increase in cash-flow available to AHGP from its ownership interest in ARLP, the AHGP Board declared a quarterly cash distribution for the 2008 third quarter of $0.39 per unit. This represents a 47.2% increase over the cash distribution paid by AHGP for the 2007 third quarter, and a 10.6% increase over the 2008 second quarter distribution.

These distribution increases are consistent with our previously stated goal of increasing ARLP's unitholder distributions by a 6% to 8% per quarter through 2010. The decision to temper the distribution increased to the lower end of this range and reflects both confidence and caution -- confidence in ARLP's business strategy and opportunities for continued growth and caution given the uncertainties created by the current economic climate.

We recognize that the current economic interment creates risks and uncertainties, and make it more difficult to predict the future supply and demand for coal.

On the one hand, a slowing US and global economy will likely result in reduced demand growth and potentially actual demand reduction for coal year-over-year. On the other hand, US coal supplies are likely to remain constrained as the industry continues to struggle with increased regulatory pressures, permitting challenges, tight labor markets and, in some cases, limited access to capital and equipment.

Notwithstanding the extreme uncertainties facing the world economy at this time, we are hopeful that coal will suffer far less than other commodities on a relative basis in this weakening economy. Due to the baseload nature of coal demand and the recent shortage of coal supply, we think it is more likely that coal supply will not outpace coal demand any time soon, even though we do expect coal demand to fall in response to a slowing economy.

In the current climate, we are fortunate that ARLP has a strong balance sheet, significant liquidity, and diversity of operations. We are also fortunate that we have nearly 90% of our anticipated 2009 production and 80% of our anticipated 2010 production committed in both price and tonnage to credit worthy customers.

As we manage through the challenges facing the economy, ARLP will remain disciplined and flexible in the execution of its business strategy by committing capital and expanding production only after securing the necessary coal sales commitment.

At this time I'm going to turn the call back to Brian for a more detailed look at our financial results. And after that Brian and I will be happy to address any questions you might have. Brian?

Thanks, Joe. We again delivered solid financials for the 2008 quarter of which are generally in line with our expectations.

For the third quarter 2008, ARLP reported EBITDA of $60.8 million and net income of $29.1 million or $0.48 of adjusted net income per diluted limited partner unit. As has been the case all year, these results were below those reported for the same period last year, primarily due to the loss of non-recurring synfuel benefits realized during 2007.

After normalizing for these non-recurring synfuel benefits, EBITDA in the 2008 quarter actually increased slightly over the 2007 quarter, while net income declined by approximately 5.1% over the same period. This drop in comparable period net income was primarily due to ARLP's [ongrowing] growth initiatives which resulted in increased DD&A during the 2008 quarter of $3.6 million, compared with the 2007 quarter, as well as the impact of our recent $350 million debt financing, which resulted in increased interest expense net of interest income by $3.3 million over the same period last year.

Increased price realizations during the 2008 quarter in each of our operating regions drove ARLP's average coal sales price up 4.8%, compared to the 2007 quarter, to a record $40.79 per ton sold. On the strength of this record pricing and higher coal sales volumes, ARLP also reported record revenues of $258.8 million, an increase of 9.7% compared to the 2007 quarter.

Higher coal production volumes, which increased 7.9% compared to the 2007 quarter, helped drive ARLP's operating expenses up $22.5 million in the 2008 quarter to a total of $199.3 million. Ongoing pressures on labor expenses, materials and supply costs and then, particularly, our consumables such as steel, power and fuel, as well as higher maintenance costs, also contributed to increased operating expenses and total segment adjusted EBITDA expense per ton. All of ARLP's operating regions also continued to experience reduced productivity and higher compliance costs during the 2008 quarter, as a result of more stringent regulatory environment.

In addition, increased coal purchases, transportation costs, water treatment costs, and contract mining expenses drove per ton expenses higher in the northern Appalachian region. On a segment basis, coal sales volumes in the Illinois Basin jumped 9.2% during the 2008 quarter compared to the 2007 quarter, as ARLP benefited from expanded production capacity at our Elk Creek mine and increased production at the Gibson and Warrior mines.

These increases were partially offset by reduced productivity in the Central Appalachian region, which resulted from adverse mining conditions and increased regulatory scrutiny, as well as reduced production in the Northern Appalachian region, due to a longwall moved during the quarter and sandstone intrusions encountered over last three months.

ARLP also continued to deliver record results on a year-to-date basis. Through the first nine months of 2008, ARLP has reported records for coal production which is up 8.8% over the first three quarters of 2007. Coal sales volumes up 8.2%, coal sales prices of 2.2%, and revenues up 8.3%. In addition after normalizings for non-recurring synfuel benefits mentioned earlier, ARLP also reported records for EBITDA and net income which were increased 11.5% and 3.3%, respectively, through the first nine months of this year.

Turning for a moment to ARLP's balance sheet and liquidity, we are fortunate to have completed our $350 million debt financing prior to the difficulties currently buffeting the economy and the credit markets. Total liquidity in excess of $380 million and relatively low current debt obligations of $18 million as of the quarter just ended, ARLP's balance sheet is strong.

In addition to coal sales commitments and expected increases in price realizations for 2009 and 2010 that Joe discussed earlier, support a visible growth in cash flow from operations for this foreseeable future. As a result we remain well-capitalized and well-positioned to execute ARLP's growth strategy.

That concludes our prepared comments. Again, thanks to all for joining us today and for your interest in both ARLP and AHGP, and with Dan's assistance, we will now open the call to your questions.

(Operator Instructions) Jim Rollyson from Raymond James.

Good morning. Joe, you spent some time I guess really reiterating your outlook for pricing versus what you're thinking a quarter ago and obviously you kept your distribution growth expectations, at least at the lower end of the range. Could you maybe talk a little bit about what is going on on the cost front, how you see things going forward over the next couple quarters or so, just given some of the issues that have come up in the quarter and for the industry?

I think from a cost perspective, as we were putting our budget together we were projecting continued pressure on the commodity prices. Since October 1, that outlook has changed pretty drastically. We are right in the process of trying to analyze what does that mean. I think we are hopeful that with the slowing economy and what we have seen in other commodities, that that will bode well for our cost.

We do think that pressure for labor is still there. We just gave some sizable increases to maintain and retain and attract work force. So from the labor front I think that we will seek increases, but in all of the areas, as far as pricing, we think we are now going to see some relief.

Productivity continues to be pressured as well. Regulatory issues that our competitors have talked about are real. We are feeling those also. So as we look to next year we will have a different administration, so it will be another opportunity for us to help to adjust to different leadership. And it's really impossible to predict what that is going to mean at this moment in time.

So, overall, I think from a cost standpoint, if you take out some purchased coal this quarter and our costs did come back in the low single digits on a year-over-year basis. And I think that those cost increases really were driven more by productivity than they were inflationary pressures.

So I think from an inflationary standpoint we've got some good news on the horizon. Hopefully that -- any more elaboration, I will be glad to elaborate.

Yes. That's good color. You brought up coal purchases which are obviously a little bit -- seem a little higher this quarter. Kind of what you are looking at and how that plays out going forward as well?

That is driven really opportunistically so we don't really have any long-term relationships to where we don't, we are exposed, so as the market creates opportunities for us to add margins we will take advantage of that. We don't have large volumes.

At the same time, with the prices being where they have been, they can't have an impact quarter-over-quarter even if you have 100,000 tons. So we'll just have to wait and see on that. I think, based on what we're seeing in the marketplace, we believe that there will probably be opportunities for us in 2009. We are essentially -- we've got 90% of our production committed.

That's -- again, it is very difficult to determine what if any demand destruction we might see. I think that from our perspective it looks like 2009 is going to have relatively stable pricing, but we'll just have to wait and see, monitor that.

And the last question maybe for Brian, you have obviously been fortunate to be put into a pretty good position balance sheet-wise with your debt financing. You reiterated, I think, CapEx for this year, I know you haven't given guidance for next year. But any preliminary thoughts on where CapEx might be for '09?

Obviously we are in the middle of our planning process right now and will be able to give you more color once that is over. That being said, with River View under construction, Tunnel Ridge under construction, obviously we will see CapEx increase in 2009 compared with this year.

Our expectations aren't anything out of the ordinary from what we've previously talked about as far as capital costs for Tunnel Ridge and River View. And we have locked up a lot of River View, but not so much on Tunnel Ridge with the lower commodity prices. Maybe we can see some benefit out of that over the next two years.

Paul Forward from Stifel Nicholas.

Good morning. Just a couple of questions here on the geology issues in the Appalachians that you saw. What's the possibility that those are -- that those stick around and that maybe 2009 volumes will come in below what you have been used to in recent years?

I think for Central App, for us anyway, we are going to revise our mine plan to mitigate that issue. So we believe that it's a lower -- we don't expect as much volatility next year on that front. I'm putting the coal miners into different coal (inaudible).

Relative to the other operations, right now I think we've anticipated, based off drilling, etc., that geology should not be any more difficult next year than it has historically been for us. Can't answer to other people.

Maybe just thinking along those same lines, scarcity of labor you have mentioned. You had to bump up some of your compensation levels. Do other issues in Central App, like labor scarcity, possibly the increased inspection activity, could those have an impact in the way that could cut volumes beyond just a geological constraints?

Not for us. We're really -- our hiring is more focused in Illinois Basin where we are adding the 600 jobs, and at River View, as well as focused on Tunnel Ridge. So I think from a Central App, East Kentucky we don't see those pressures being material for us.

All right and switching over to the new projects, River View and Tunnel Ridge. What do you think that -- having new mines is always a good thing for cost. What do you think those -- the addition of those two mines will do for your overall cost within the region, Illinois Basin and Northern Appalachia, compared to what you've got right now?

I think that for Illinois Basin, they should come in in line with what our costs are for the other operations. I think, relative to Northern App we would expect to see costs lower than what our current experience is. At Northern, if you look at our [Mountain View] mine in Northern App, we've got essentially our coal mine where we are having to transport the raw coal to a preparation plant that's several miles away. That increases the cost at our Mountain View mine that with the Tunnel Ridge mine we are going to be essentially just building the coal right into the plant.

So we should have lower costs there. We are hoping to have better recovery as well at Tunnel Ridge relative to Mountain View.

Great. You had mentioned also that the production from River View is somewhat more committed and priced already than the production from Tunnel Ridge. I don't know how much detail you want to get into on this, but can you give us a sense of just how much of Tunnel Ridge's output is still yet to get to sign up, let's say, for the first couple of years that you plan to produce beginning in late 2010 from Tunnel Ridge?

And also what's been the response? If you've been talking with utility customers, how gas their attitude about their willingness to sign up new volume commitments changed over the past month or two based on, first of all weaker economic conditions, but also competitors in the area missing on their production targets?

Relative to the production percentages, I think through 2010 (technical difficulties). 2011, we have exposure probably for 40% of production assuming we don't move contracts around.

At Tunnel Ridge we have, continued to have ongoing conversations to sell that balance to the utility markets. We've got -- we continue to have discussions. I think it is fair to say that the utilities are trying to evaluate where these markets are going equally as much as we are. We have been willing to talk in terms of market-based contracts for that balance.

So I think there is an interest to see that supply locked up. I think most utilities are looking for security of supply with credit worthy customers, as well as some diversification.

So I believe that there is a willingness to commit. Price will continue to be a heavily negotiated item, I guess, is the best way to say that.

I guess as it always is, but maybe lastly how --? Has the pullback that we have seen just across the board and almost certainly in the private side but most noticeably on the public side with the equities, has this changed any of your views on potential acquisitions in the industry?

Or are you just simply focused on -- your developing your new projects and not really thinking about taking this opportunity to expand through acquisition?

We are definitely considering that. I think the key question obviously is going to be back to whether you would have sellers that would sell at these price levels. I don't think anybody believes in coal space anyway if the equities are reflecting real estate value propositions. So that does suggest that there are some attractive investment opportunities.

Whether we will be able to take advantage of that, time is going to have to tell, but we are evaluating it. We are looking at it, we are considering several opportunities there.

But at the same time our primary focus will be to implement our organic projects because those have a very high probability of occurrence. I think the M&A sides is probably more in the possibility than the probability category.

(Operator Instructions). Ron Londe from Wachovia.

Thank you. Just a couple of items. The longwall move in the third quarter, can you give us a feel for the impact of that on the bottom line?

Yes. I think we probably -- I think it's probably eight days of production loss, I think, which is obviously a significant issue, but that's part of the cost increase. I think another part of our cost increase when you look at Northern App, you can see we didn't lose that many tons on the tons sold line. So we did have some purchased coal in Northern App and that probably.

Probably $1 a ton or thereabouts.

Yes. So that has an impact on our costs when you think of the [luck]. So it was a combination of production from the longwall move. We did (inaudible) sandstone intrusion as well during the quarter at that operation which affected productivity.

But we were able to pretty much come within the same tons sold by buying some outside coal, albeit at a higher cost. So that's behind us now. Hopefully, next quarter, we will be back closer to historical levels.

Can you give us a feel for what your current exposure is to the export markets, and where you might be going over the next year?

Our export sales are not significant. We have been able to take advantage of some opportunities in the export market. But tonnage-wise -- I don't know, maybe a couple hundred thousand tons. Something of that magnitude. So it is not a significant number for us.

Yes, I know it was small, but just thought it might been --

Maybe 400,000 max, something of that magnitude.

One other thing, you were talking earlier about potential for lower costs for various expense items. I was wondering, on the fuel side -- which is probably one of the more visible of the expenses that you have and easier to track -- do you do any hedging there? Are there any hedges you have to work through going forward? Or are you just, buy your fuel as needed?

We bought it as needed. We are looking at that right now though. Because I'm not convinced that all of the commodities are trading off of economic realities.

So I think when things we are seeing in the commodities markets, similar to what we have been seen in equity market where there's a major deleveraging occurring, I think that's having some impact on commodity prices. So Brian and [Cary] have been working pretty hard to look at potentially putting in some hedges at these falling commodity price levels that I'm not sure are going to be sustainable.

Luther Lu from FBR Capital Markets.

Good morning. You guys mentioned a committed [and] price tonnage for 2009 at 25.7. I was wondering if you can provide a production range for 2009?

We indicated that is about 90% of our anticipated production. So [when we] come in around 27 million or so this year, you can just do the math.

Right. Okay. Also you mentioned production discipline; and I was just wondering given that you are bringing on some new cost, low-cost mines, what is your highest marginal mine? And what's the typical cost for those mines?

We don't break out each individual mine as we mentioned for Riverview. That's an Illinois Basin mine. And we think the cost will be comparable to our other Illinois Basin operations.

So we were able to contract at higher prices than we have here. We've given some guidance as to the revenue increase that we expect year-over-year for '08, that's roughly in the 35% to 45%, or 25% to 35% -- sorry -- range. So that is going to give you an average around $50 to $54 or something in that neighborhood.

I don't know. So that's the best I can give you.

Right. Okay. So what about the Central App marginal cost? If you can talk about your Company's specific number, I was wondering if you can provide a general assessment for the industry?

As far as our Central App, we are right at $48 currently. And you've seen -- that's a difficult question because the [met coal] mix against the steam coal mix. So there has been some supply brought on this year to meet the met markets. And I think there is coal out there that's costing $90 to $100 a ton to meet those markets.

If you look at the coals that are meeting the steam coal markets, I think they are definitely trending up as well. And my guess is, we are going to continue to see pressure ourselves in Central App because of the nature of the geology.

Every year, it gets tougher. Seams get thinner. The reserve, the reserves are being depleted; so that new generation reserves are still tougher than the older ones.

Fortunately, we are still in mines that were open a few years ago. So we've got a few more years to run at levels that I think will definitely allow us to the competitive in Central App. At the same time I would expect Central App prices to trend up to the $70 plus level if you look at it industry wide, over the next year or two.

The cost? Trend upwards?

Yes, it's the costs. So that's obviously going to support the market prices.

So even if the steel price and diesel price all coming in, the costs will still stay in the $70 range?

I think so. Because I don't think you are going to see significant decreases in those costs. I just think you are going to see a slowing of the growth of those costs. And I think productivity continues to be a challenge.

As I mentioned earlier, we are going to have a new (inaudible) in '09. And we will have to wait and see what the new (inaudible) is like.

Okay.

(multiple speakers).

Okay and final question on the Tunnel Ridge. You said that full production starts fourth quarter of 2010?

Yes, of the longwall. (multiple speakers) development is starting in '09, but it will be development tons developing for the longwall which will be fourth quarter of 2010 before the longwall would be operational.

Do you have a rough estimate for what the development tons will be for '09, 2010?

Timing is -- I can't -- I mean, I think it's going to be -- I don't really know. Let me just -- let us go through our planning process. And I think we are going to have a better idea of the exact timing and we can give you some guidance, definitely in January if not sooner.

Great. Thank you for your time.

(multiple speakers) might want to mention, back to your Central App question. Another big issue for the industry or back of these surface mines and the 404 permits and there's becoming increasing belief that some of that surface mining coal is going to be coming off the market. And that is lower-cost coal in the mix of things.

So that's another cost pressure item, not only for reducing tons, but also increasing the average cost per ton.

At this time you have no further questions in queue. I would now like like to turn the call back over to Mr. Brian Cantrell, Senior Vice President and CFO, for closing remarks.

We very much appreciate everybody joining us today and your continued interest in both of our companies, Alliance Resource Partners and Alliance Holdings GP.

We look forward to talking with you during the next quarter call. Thank you.

Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Good day.