Peabody Energy Corp (BTU) 2003 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to Peabody Energy quarterly earnings conference call. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session with instructions given at that time. If you should require assistance during the call, please press star then zero. As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Mr. Vic Svec.

Good morning, everyone. Thanks for taking part in the second-quarter conference call for BTU. Today, Executive VP and CFO, Rick Navarre, will review our second-quarter performance. Chairman and CEO, Irl Engelhardt, will discuss the energy markets and BTU's outlook. We will be making some forward-looking statements today and they are consistent with our press release.

We would encourage you to consider these, along with the risk factors that we note at the end of our earnings releases, as well as those documents that we filed with the SEC. For more detailed reconciliation schedules and other financial information, we also refer you to PeabodyEnergy.com. There you'll also find a replay of our call.

Thanks, Vic. Good morning and thank you for joining our review of Peabody. The second-quarter was very active and we again posted stronger than expected EBITDA in earnings. We held the line on costs in the face cost pressures that have affected most American businesses. We completed our favorable $1.7 billion refinancing. We purchased the remaining stake in Black Beauty and completed its integration. And we completed a number of transactions to improve our reserve base and improve costs.

I will begin my review with the income statement on page 6. Our sales volume for the quarter and the year are roughly equal to last year even as estimated industry-wide shipments declined 4 percent. Revenue increases of six percent for the quarter and three percent year-to-date were lead by higher Powder River prices and volume and improved brokerage sales. These more than offset lower prices in volumes in Appalachia on business that we signed in 2002 when the markets were much softer.

Operating profit was $30 million for the quarter and $65 million for the first half. Cost control and reengineering efforts allowed us to hold the line on controllable costs while our revenues increased. Like most American industries that have a pension and retiree health care plans, we were affected by the very low-interest discount rates, the effects of sluggish returns on the equity markets over the past three years and higher health-care costs.

These expenses for Peabody increased $11 million for the first six months, even as cash spending was in line with prior year levels. The higher selling and administrative costs of $28 million relate in part to the favorable impact of our rise in share price on incentive plans, combined with costs to control health care and costs associated with the new Sarbanes-Oxley regulations. Overall our lower headcount cost helped us to offset some of these issues.

Our $53 million in early debt extinguishment costs for the six months came from redeeming our high rate bonds in mid-May and concluding our favorable financing. This lowers our average interest rate 200 basis points and should lead to more than $15 million per year in interest savings. Peabody's net income includes a $41 million tax benefit for the first. We expected tax benefit of about $50 million for the year, mostly related to the tax effects of depletion.

By comparison, our 2002 tax benefit totaled $40 million. Income for the six-month period was a net loss of $12 million after consideration of the $10 million of cumulative effect of accounting changes and the early debt extinguishment charges of $53 million which I mentioned earlier. Turning your attention to the summary at the bottom of page 6, you'll see that EBITDA for the quarter was $96 million versus a target of $80 to $90 million. Our income before accounting changes and debt repayment totaled $31 million in the second-quarter versus $25 million last year.

Earnings-per-share excluding these special items was 59 cents for the quarter and 98 cents for the first half compared with 45 cents and 87 cents per share in the prior year. Please turn to the supplemental data on page seven. Tons sold for the quarter held steady in the East as several Black Beauty mines increased production and offset declines from Appalachia and the Highland Mine startup in the Midwest. Our Western volumes improved, driven by higher Powder River Basin sales including a record 20.2 million tons from our North Antelope/Rochelle Mine in the second-quarter.

Even with those record shipments, they were lower than we expected because in the month of June we had heavy rains in the Powder River Basin and Appalachia which disrupted power service, flooded both mine and rail systems, and hindered employee access. Our shipments were also restricted during the quarter due to a number of customer repairs and planned installations of emissions control equipment that we discussed with you in the first quarter.

Looking at our revenues per ton, you'll see lower prices in the East reflecting commitments made in 2002 when the market was soft. However our Western price per ton improved again on strong Powder River Basin demand and our volume and revenues both increased in our trading and brokerage operations. I'm pleased to report our operating cost per ton for the quarter was held in check primarily due to a focus on controllable costs.

Healthcare, workers compensation, absenteeism, and system bottlenecks were just a few of the areas where we refocused our attention during the second-quarter. Our results were also impacted by higher energy costs. Heavy rains and running the mines at below optimal levels. Energy costs in the quarter added 20 cents per ton to our Eastern cost structure and six cents per ton in the West.

So you can see absent the higher energy prices we would've had lower quarter over quarter costs in both of those regions. Production and costs in the East were also affected by the ramp up at the new Highland Mine in Western Kentucky and the installation of new long wall equipment in a new reserve area at the Federal Mine in Northern Appalachia. As you can see, total gross margin from U.S. mining operations approximated prior levels for the quarter.

Our Australian margins were affected by negative currency fluctuations and lower pricing. Our trading and brokerage operations and our resource management segments both turned in very solid performances. The increase in other operating costs was driven primarily by the higher mostly non-cash pension and retiree health care increases I mentioned earlier. Our operating cash flow was in line with the prior quarter and is running ahead of the prior year for the full year.

Peabody invested $33 million in capital during the quarter, and we expect full year spending of approximately $200 million. Turning to page 8, our June balance sheet movements reflect our refinancing. Our cash grew to $112 million based on our first half performance. We will put that cash to work in the second half as we consider a number of alternatives. Our higher interest bonds have now all been redeemed and our net debt is again below $1.1 billion. The new 6 7/8 percent bonds are trading very well. Currently they are trading above par and yield just over six percent.

During the quarter we also took the opportunity to swap $100 million of fixed-rate debt to floating-rate debt, which gives us a comfortable 55 percent to 45 percent fixed to floating ratio. You'll also notice significant decline in our minority interest balance, and that is due to our purchase of the remaining interest in Black Beauty during the quarter.

In summary, I believe that Peabody has navigated through the toughest part of the year. Our cost structure is steady despite external cost pressures, required accounting changes and running the mines at below optimal levels. Based on our order backlog, we look forward to a strong second half with higher volumes allowing us to improve our productivity; and we expect to realize significant interest savings due to the completion of the attractive new capital structure that creates additional financial flexibility for the company. With that, I will now turn the call over to Irl Engelhardt, our Chairman and CEO.

Thank you, Rick, and good morning, everyone. To sum up our results, Peabody is performing well on a number of fronts; and we expect the improving markets to benefit us as we move forward. We are using cost controls, acquisitions, refinancing new mines, reserve management activities and prudent sales to add value to Peabody for the long-term. I want to take this opportunity to thank our very talented employees for their good work. We plan to take a moment to review the market and our outlook before we take your questions.

To start off with the market, the U.S. energy markets are creating a very bright future for coal. Coal is benefiting from the high prices and production limits of competing fuels. Supply and demand is in reasonable balance in most regions and coal inventories are at normal levels at most customers and suppliers. We believe that total U.S. electricity generation grew about 3 percent in the first half. Demand for electricity was uneven, with the retail sectors showing growth in most regions and the industrial demand flat or down due to the soft economy.

The normal winter weather and the cool wet spring in most condition -- in most regions increased electricity demand in the first quarter and they dampened the growth in demand in the second-quarter. We believe coal use for electricity generation grew by about 4 percent during the first half. Coal and hydrogeneration gained market share, while nuclear and natural gas units ran at lower capacity levels.

We believe the coal plants ran very well given the number of plants that were down for major maintenance and installation of emission control equipment, the weak industrial load, and the fact that summer didn't start in many parts of the country until Independence Day. U.S. coal shipments ran 20 to 25 million tons below the prior year levels for much of the second-quarter and generator stockpiles are 10 to 15 million tons below those of a year ago.

We expect the pace of demand to pick up for coal in the second half as coal plants use more tons for the total year and Peabody's order book confirms this belief. Natural gas remains an important part of our equation in a different way than one might think. High gas prices have been with us for three years, and America has attended a three year class in energy economics during that period. We have learned that high natural gas prices reduce the discretionary spending of American households.

We have learned that high natural gas prices depress the U.S. economy and they chase industrial plants offshore. The high cost of natural gas is a feedstock, and the high cost of electricity for natural gas make it very difficult for American industry to compete and survive. So our energy economics lesson is that America needs a diversity of energy supplies to support a sound economy and a sound economy in America means coal.

Against that backdrop, we're seeing a very steady stream of new coal generating plant announcements, and interest in Peabody's Thoroughbred and Prairie State projects has picked up sharply for both potential partners and from customers. This strong interest in new coal generation is good long-term news for both Peabody and the U.S. coal industry.

In the midst of the improved and improving markets, Peabody has carefully managed its portfolio of sales commitments to improve its outlook in 2004 and beyond and to deliver our results for 2003. Peabody sold out for 2003 at planned production levels. We expect to produce about 10 percent more coal in the second half to serve our sales commitments. Our targeted production volume for 2003 is in the range of 175 to 180 million tons, and we have 2 to 3 million tons of additional production each quarter that we can add this year should the market conditions warrant.

Our production target for 2004 is currently 190 to 200 million tons. During the improved market conditions earlier this year, we sold and we priced more than 100 million tons for 2004 and beyond. We have commitments and firm prices for 159 million tons of planned 2004 production and 109 million tons of the planned 2005 production. We are very comfortable with our book of business. We have locked in better utilization of our production base and improved pricing for 2004, while we're allowing for market improvements and optimization of a portion of our production.

Peabody continues to target full year 2003 EBITDA in the range of $405 to $415 million with second half EBITDA improving 10 to 15 percent over the first half performance. Excluding the special items that Rick discussed, full year 2003 earnings targets have risen to $1.60 to $1.75 per share. Third quarter EBITDA is targeted in the range of $95 to $105 million based upon improved shipments and the ramp up of new mines.

Third-quarter earnings are targeted in the range of 25 to 40 cents per share. I'm very grateful to Peabody's team for a strong first half amid a number of industry challenges, and we look forward to the future. At this time, we would be happy to answer any questions.

Thank you. (CALLER INSTRUCTIONS). Michael Dudas.

Bear Stearns. Irl, in the commitments that you made, the 100 million tons for '04 and beyond, could you show us a little bit of the (indiscernible) type of contract, what are the utility's mindset in negotiating with you? Are they thinking about going a bit longer, are they still trying to play the spot game, their sense of urgency with regard to those contracts, and maybe a tenor of pricing relative to spot?

I think there has been a more prudent approach this year than in some of the prior years. They are more concerned about reliability and credit worthiness. They are looking longer-term as a viewpoint. They are wanting to have the product that they contract for delivery. I can't talk about prices, but the traded market gives an indication of the price trend, and the pricing has been quite favorable. So we see them being willing to sign two to five-year contracts depending upon the electricity customer and their specific needs in view of the market. So generally a much more prudent approach.

Thank you.

Brett Levy (ph). Your line is open. Next we will go to the line of Bill Burns (ph).

Bill Burns of Johnson Rice. In the quarter, your EBITDA was outside and higher than your guidance and I was just wondering why you didn't take the opportunity to raise guidance for the full year?

Well, I will give you a couple of reasons. Number one, you can tell we are fairly conservative. We like to over-deliver on our promises. Second, some of the benefit this year was a result -- or this quarter was a result of moving some repairs into this quarter for the next quarter, so that and the number of customer repairs that have occurred that are beyond our control make us take a fairly conservative view.

Thank you.

Andy Pettigene (ph).

Andy Pettigene from Goldman Sachs. I was wondering if you could give us a little detail about some of your off-balance sheet items? For example what did you have out for your AR securitization? What did you have out for letters of credit and what was drawn and what was available on your revolver?

Sure, I will with the revolver. A revolver is -- a $600 million revolver that was drawn -- we didn't have any of it drawn at all. The AR securitization was about $130 million which is pretty consistent with the levels that we normally maintain, usually 130 to 140 million. We had letters of credit about 230.

One follow-up. The asset retirement obligation expense on your income statement, is that a non-cash item?

That particular account is a non-cash. It is essentially an amortization or accretion balance to accrete to a full liability. We do spend cash of course on post mining reclamation, but it's not necessarily correlated with the balance that we are recording on the balance sheet.

So what do you expect this year for reclamation cash costs?

Probably $25 million to $30 million for final closure. So the balance that we are accruing toward is for final closure of future mines, whereas the amounts we're spending relate to mines that are already closed.

Thank you.

Dan Roling.

In line with the maintenance comment that was in the release, you said that second quarter was above because you accelerated. Should we imply from that that third and fourth quarter maintenance cost will then be lower and by how much? I noticed that second quarter versus a year ago was up 8.8 percent and year-to-date were up 6.5 percent. Both of those would suggest significantly lower second half. Am I right?

Well, I think the best way -- rather than focus on one single item would be just to take the overall guidance that we have provided, which considers thousands of variables that affect a big company like us, and just look at it from that perspective. But generally the third-quarter of our company is a period where a couple of things happen.

One, you have miners' vacation. During miners' vacation, some extra maintenance if performed at Peabody and almost every other major mining company in the United States, and that increases the rate of spend versus the prior quarter. But going the other direction, we did have some that we moved into the second-quarter because we had customer plants that were down. So on balance, I would look at the overall guidance for the quarter as opposed to that specific item.

So basically we should not look for the operating costs in line to be down significantly in the second half versus the first half?

I think the operating cost overall in the second half will benefit from the improvements in our capacity utilization and in the ramp up of several mines. We have new mines that are coming on. I will give you just a few, Willow Lake, Vermillion Grove, Highland, the Federal move to the new areas essentially a major new mine, all of which are ramping up in the second half and we will have improvement versus the first half. The problem in answering your question is we have a mix problem because we are so diverse and costs are kind of lumped into two pockets, East and West. So on balance, we should do better, but the mix may affect what appears in those pockets. As you are looking at it just to really add one point to that, we will drive down our costs in the East and we will have more volume in the East. As you know, the East is a higher cost operation in total, and our cost will be better in the West as well, but as the East has more -- the volume picks up in the East, it will start to weight the overall cost per ton.

These new mines, are they incrementally -- how many incremental tons are they going to be or are some of them replacement tonnage?

Some of them are replacements. For example, the Highland Mine replaces the Camp 11 long wall mine that we closed in November, or November/December of last year, and it is continuing to come up. It served a customer that had major repairs and it had installation of new emission equipment, so it really didn't ramp up as fast as we had hoped this first half. Vermillion Grove serves a customer under a long-term contract and it will actually increase volume versus last year's slightly. Federal is a replacement and a slight increase due to productivity improvements. Willow Lake is an improvement slightly because of productivity improvements versus the previous mine.

David Gagliano.

Just following up on Dan's question there, I was wondering if you could give us a little guidance in terms of your sales volume expectations for the Eastern operations, and broken down by East and West for the remainder of 2003 and if possible for 2004?

Probably not going to give for '04 at this time in time but can probably give it to you for '03 but I'm going to have to get back to get the exact numbers. I don't have those on my fingertips. I think overall we expect volume to go up about 10 percent as we said earlier, so that is going to raise total sales volumes some 8 million tons in the second half of the year.

Presumably that is weighted a little more towards the East given the ramp up at the Eastern operations?

East will get a little bit more of that plus the East is running a little bit behind as you can see from the schedule for the six-month period. (indiscernible) running behind last year's pace.

Okay, and then another follow-up question. On the 2004 commitments, where would you like to be by the end of the year? Would you like to be fully committed for 2004 or what are you targeting for in terms of tons committed for 2004 by the end of this year?

It is information that we should not disclose for competitive reasons, but we are very comfortable with where we are right now. Absent some very mild weather in May and June, we would have expected considerable increase in demand to have already occurred for U.S. coal. If the energy crisis occurs that everybody is worried about, having the tonnage available that we have available for upside is a very good situation. So we are very comfortable with where we are. We're going to just work away, along this year and see what develops in the marketplace and make the decision as it comes along, but of course for competitive reasons we can't say exactly what we're going to do.

Fair enough. Thanks.

John Woodbury (ph).

Maybe you could put a little more color on (a) use of free cash and (b) on the CAPEX side how do you split that up maintenance versus expansion?

Sure, on the free cash flow side, John, as we look forward we've got a number of options, obviously, and those can be accretive acquisitions that we can look at and create value or they can be prepayment of debt or share buybacks or dividends. We will do whatever makes the most sense and it's really not appropriate to probably tip our hand at this point in time what we're going to do, but essentially we will do whatever creates the most value for the company.

Is there much debt you can really payoff or buy back?

Pardon the debt, is that the question?

Yes.

On the new debt structure we built in $450 million of prepayable debt without any penalties involved. That was part of our strategy on the refinancing, so we've got term loan B debt that is all repayable.

Smart.

So we can easily take that route. As far as maintenance and expansion capital, typically when you look at the total spending of about $200 million, I would say the maintenance numbers may be 100 to 125; and then the remainder of that number is either related to capacity expansions or cost improvement initiatives.

David Conning (ph).

On your comment on some downtime for emission equipment installation. Do you have a sense of how many millions of tons were affected?

It was about 2.8 million tons in the first half that we curtailed, if you will; and we hope to make a lot of that up in the second half if we could. There were a number of plants that were down, as I said, some of them for plant repairs that we knew about and had forecast, others for maintenance problems that we couldn't forecast.

Do you have a projection maybe for 2004?

Well, we don't have the projection yet, but there is a good and bad aspect of installation of the emission control equipment. The good is that there is a cleanup of the emissions from the plants. Second, the customers are installing significant amounts of money, billions of dollars in the coal plants to run them for the long haul, and those are the good things.

In our case, we fuel over nine percent of the U.S. electricity, so we automatically share a little bit of that pain, but it's short-term and we manage our way around it. But there will be significant numbers of installations, primarily SCR units, scrubbers, Low Nox burners and equipment of that sort.

On the amount of coal that you contracted for I guess the second quarter, could you give a sense East versus West of how much, if you could break out the difference?

I don't think we have disclosed that information yet, but it was primarily -- it was a combination of several new long-term contracts in the Midwest and a portion of tonnage in Appalachia and those two on balance would be 40 to 50 percent of the new tonnage. That is purely judgment.

John Bridges (ph).

Just reading between the lines on your tonnage numbers it sounds as if you are taking a bit of marketshare here. I just wonder if you could comment on that. And also, looking at the labor costs and the interest rates, as I recall from the 10-K, the interest rates that you are using are still pretty high compared to those in the market today. Do you see any further reduction in those things and, if so, on what sort of time scale?

Let me address the market share issue, not setting out to take marketshare, that is not a strategy. It is simply contracting some very profitable business. And our goal is to make money in all market conditions by keeping very low-cost operations efficient and we are looking at the price run ups that occur at the beginning of the year and the types of customers that were there, very high-quality customers with good credit ratings and said to ourselves that it would be prudent and very profitable to take that business. So that's all we were doing is just making that prudent decision. I will hand off to Rick to answer the question about interest rates.

John was your question specifically around the interest discount rates?

Yes the interest rates -- on the liabilities, labor liabilities.

Our rates that we used last year were roughly seven percent is what we did use and obviously the interest rates have continued to decline in 2003, so that is an issue that we will have to look at as we go forward and see what happens with rates, longer-term rates, because that is what we are really more interested in, longer-term rates, in the second half of 2003. If they don't move up at all, then more than likely we will probably have to lower our discount rate as much as one-quarter of a point.

When would you do that? Would it be for this (multiple speakers)

We don't have to make that decision until the end of the year, so it won't impact 2003 at all. It is only related to the projection for future liabilities, and we don't make that projection until before the 2004 period forward.

It is a non-cash --

-- once again that is one of those issues that as I spoke about earlier, it creates a non-cash charge is essentially what this artificially -- and I will say artificially low interest rate environment that won't last the life of some of these liabilities. We have use that rate anyway to make that projection, and many companies are facing the same issue with respect to pension liabilities, but we may have to adjust it down. It won't impact '03 at all.

Thanks a lot.

Barry Haynes (ph).

I had a question on the tonnage for '04 yet to be contracted, could you give us a feeling for what the rolloff prices were on those tons? Thanks.

I cannot for competitive reasons other than to say that generally in Appalachia it was business that was contracted in 2002 and the pricing is higher at this point than it was at the time it was contracted. Likewise, for Powder River, that was a mix of pre -- of business signed in the '90s during very low pricing environment, a little bit signed -- or some signed in 2001 when pricing was very strong, and some that was just a small amount signed last year when the pricing was low. So it's a blend, but my best guess is that pricing would be up. I would remind you that in the Powder River one has to consider that taxes and royalties take a significant percentage of the price improvement and you can't take all of it into your modeling.

Thanks a lot.

Robert Sullivan.

Along the same line, could you give some indication on the volumes that you do have contracted for '04? Are those prices -- where they compared to the prices we are seeing now in terms of realized prices? In other words, at the end of last year you indicated that '03 was similar to what you experienced in '02, same type of guidance?

Repeat your question again, make sure I answer it.

Sure, in 2004 your contracted volumes, what prices are those at relative to the second quarter prices that we are seeing realized?

Well, most of our contracted business, about 75 percent of it, was done in the January through April time frame, so that gives you an indication of when we tried to do our business. We wouldn't have taken the price if we didn't view it as profitable and good for the company. I can't really probe. I can't talk about the pricing very much because of who all listens to this call, including some of the trade publications.

Okay, your composite prices you can't talk about whether those are above or below?

We are up, that is --

Yes Bob, I think the point that Irl made on the last question to the last caller, was essentially if you look at what is rolling off from the East for 2000 -- what we're selling in 2003 which is what you are comparing it to, 2003 this quarter, and what we're contracted for in '04, we're contracting for that in the East in a higher (indiscernible) than what we had in -- than what we contracted for '02 for today's deliveries. So clearly the Eastern tons in pricing should be up.

In the West, a lot of that business is a conglomeration of business that was signed really anywhere between the late '90s to sometime in 2002, and the blended number should be higher as we replace more of that older 1990-ish type contracts with prices that are some 40 percent higher than they were in the late '90s, so on a blend it would be higher.

And Bob, I'm sorry, but we have not provided '04 guidance at this time. We actually do not have our latest budget of '04 done, so it wouldn't be very good guidance if we did give it to you. So on balance we're very pleased with the business we have taken and I think that as much as I can say.

We have a lot of tons still to price for '04 so that will also have an impact on where we end up.

For the remainder of the year should we look at the second-quarter here as being a good run rate for the resource management as well as the trading businesses?

Well those are lumpy pieces of business, but I think as I said to Dan, if you look at the overall guidance that we provide, and make your judgment about the company's ability and track record for hitting its guidance, that is probably the best way to deal with us, because there are so many moving pieces and we are factoring in customer outages. We are factoring in trading. We're factoring in deals that may or may not happen. We are factoring in major repairs. All those things are included in a very complex model, so I just can't say that that one component is the right way to look at it.

Just one final question, which I'm not sure whether you can answer. In terms of production volumes, should we see volumes ramping up in the third-quarter through to the fourth-quarter? In other words, should fourth quarter be significantly higher than third-quarter because of miner vacations or how should that run?

I think there will be a ramp up in the third-quarter above this quarter and it should continue into the fourth-quarter.

Dick Price.

Westminster Securities. I had just a question on one of your recent acquisitions. Looking at your back of the K, the tons you reflected on the Mirant properties out of Australia were significantly different than those in the early announcements. I presume that is due to your own evaluation after the acquisition, and also the tons shipped in Q1, while it is not significant to your overall, I'm wondering if it is reflective of general market conditions or what in Australia?

First of all, I think the key is that there is a lot of those tons down in Australia and it is -- the adjustment was based upon our more detailed drilling and analysis of the reserve. Generally the market conditions in Australia have deteriorated. I am sure that some of the other producers that are in the international arena have explained that the currency fluctuations have gone the wrong direction related to the U.S. and that the prices dropped starting in that Japanese fiscal year of January 1 -- I mean of April 1. So we are no different than anybody else. We will manage our way through it and fortunately that is not a huge contributor to our company at this time. It could be in the future, but not at this time.

Indicator outlook for Seaborne particularly in the Pacific Basin was (indiscernible) some of your competitors up for next year. Do you have an outlook on that?

I think part of the Seaborne equation is a complex equation. The demand overall will be higher. One of the key questions is the ocean freight rate, because with the military chartering so many vessels and with the large quantities of raw materials flowing into China, there it is a spike in the cost of the Seaborne freight at the current time. Those are two big factors and then the real question is what is China going to do in that marketplace? It is too early to tell whether they are going to be able to sustain their growth trend or not and whether they will be smart on pricing. So time will tell.

Thanks. Good number for a really tough market this quarter.

Mark Reichman (ph).

I know you had a question on -- in terms of the gross margin per ton declines in the East, I see revenues declining a little bit and operating expenses declining -- I should say increasing. How much of that gap could be narrowed by increasing production in the East in the balance of the year?

I think you are on page 7 on the gross margin line. It is a function of several things. Number one, it is a function of the average price dropping slightly and that is due to the soft markets in 2002 and some of the business we took. It is a function of mix because in the East and the West -- in the East is the Midwest and West Virginia, and generally our margin per ton is slightly lower in absolute dollar values than in the Midwest than it is in the East. So we have increased a mix of Midwestern business, but probably other than some of the standard energy costs increases, the insurance cost increases, the bonding cost increases and all of those things that are impacting the entire industry, probably the biggest factor is the fact that we are ramping up so many minds at the same time.

The federal move to its East side was a 70 plus million dollar project that had a two-week period where we didn't produce coal from a big long wall project. The Highland project is a very large project that is ramping up as we speak. The Vermillion Grove project is not operating yet at full capacity, and Willow Lake is in the same boat. So all of them were ramping up during very soft market conditions with a bunch of customers that were going through repairs. So that last group of items is probably the single biggest problem.

I just wanted to touch on the tax benefits for just a moment. With EBITDA guidance remaining unchanged and the earnings-per-share guidance being increased, it looks like the increase in the tax benefits is a large contributor to that. How much is remaining for 2004 and beyond in terms of the tax loss carryforwards and what can we expect for 2004?

For 2004 I couldn't give you an exact tax benefit for the year. We have over $550 million of net operating loss carryforwards still available to us as we look forward, so that is a good asset for us. What we try to do to give you a little bit, since it is difficult to model, on our website we've provided a reconciliation as required by the SEC regulation G that just came out.

We basically estimate in our guidance what we think the tax benefit will be and if you look at last quarter's estimate for this quarter, we had about $23 million of tax benefit in that particular guidance. So we came in just a little bit better than that this quarter. You'll see that we've got $10 million of benefit projected for the third-quarter and roughly $51 million for the whole year of a benefit for '03. When we put our '04 guidance out we will give you the exact same information as well for '04, so you will be able to factor that in.

Great, thanks very much.

Bruce Klein (ph).

I was just wondering in the West in terms of absent normal weather patterns and some new mines opening up do you see -- what is your sense (indiscernible) end market demand out there? And secondly synthetic fuel tax issue and what might be any implications for you?

Let me tackle the second one first, and I will probably ask you to restate your first one after the second one. But related to the synthetic tax issue, we're not an owner of any of the plants that are in question. We are a host for some and receive some monthly rentals and some other fees for those. It is not a significant item for us; and it is really a situation that each of the plants has to be examined by the IRS on a case-by-case basis to determine and by the way, quite properly, that the alteration process is occurring as intended by law, so for us it is not a huge deal. Now, would you repeat your first question.

Just trying to get a sense of end market demand, what you are seeing in the West absent any -- once weather patterns return to normal, absent that are you seeing a pickup in market demand?

We just see the steady inroad of the Western coal into the Eastern United States continually moving further than it ever has before. And especially with the problems that have existed for some of the Appalachian producers with their cost structure problems, their bankruptcies and issues like that, it just increases the tension that the users of coal place upon the Western coal.

So we see it as continuing to grow at least for the near-term. With all of the money that is being spent on scrubbers and other equipment for emission controls and improvements, we think that the market will also rebound overtime for the Midwestern high sulphur coal, and as you know we are number one in terms of volume in the Powder River Basin, so we're happy about that and the near-term growth. Also the number one producer in the Midwest, so we're happy about the longer-term growth that is coming there.

Thank you.

Wayne Atwell.

I apologize if I ask a question that has already been asked. I was in a meeting and got in a little late. Are you seeing much competition from imports? Is that a factor or is that not something that concerns you?

The imports continue to make good progress along the Gulf Coast and parts of the upper East Coast in New England. They are down from probably three years ago, up slightly -- or actually -- yes, up significantly from last year. Actually they are not, I'm just looking at the numbers. They are roughly flat. It is not a big issue for our industry right now. The cost of the Seaborne freight is so great that Australia, South Africa can't really get into our country very well, and South America has its political issues in both Columbia and Venezuela at the present time. So it is there but it is not a huge issue for us.

Is there anything new in the regulatory arena at all?

A lot of things going on in the regulatory arena that are good for Peabody and good for coal in general. Certainly the prescription drugs coverage that is in both the Senate and House is good for almost all heavy industry in the United States. You look at the major auto companies, the steel companies, anybody that has retiree health care, we think it will be good for them. Second, the energy bill is continuing to be debated and it contains some good language about the clean coal technology and incentives to develop and deploy clean coal technology and that is excellent and that includes by the way the President's hydrogen based initiative, which would get us close to zero emissions from coal plants if it is commercialized.

And then we have clear skies, which we hope will move faster than it currently is. That will continue to clean up the emissions from all plants continue a long trend and it will also provide the certainty to allow some major investments in existing coal generating plants. So lots of good things happening. I just hope we can get our Congress to get past the politics in looking forward for an election next year and reach some kind of consensus that is good for the country.

And lastly the tone of the market, are the utilities inclined to get their pen out and start signing contracts or could you just give us a little bit of review of the tone of the market?

The tone of the market ebbs and flows. Like I said, the utilities I believe are being much more prudent. They are also much more disciplined than they were several years ago for instance, so very savvy people that are doing the negotiations. They value reliability. They value creditworthiness. They value a company that will really deliver on what they say they are going to do much more than they did several years ago.

They are signing multiyear agreements, many of them are signing multiyear agreements. And most have experienced a bankruptcy or two in the supplier base or a bankruptcy or two among their peers and they are very focused on creditworthiness and reliability. So that is good for us because we fit those criteria.

Thank you.

James Chrome (ph).

Just a couple of details and then a little broader. I think -- should we expect -- I know you said there is a broad mix, but in general should we expect the trading tonnage to move up in line with the production tonnage in terms of overall sales?

I think the trading tonnage really fluctuates based upon market volatility, and we do not count on it being a high-growth item. As you know, trading is difficult to predict; so we are very conservative about it in our forecast, so at best flat.

And I could be wrong here but I think in the past you have said that you have actually an additional 4 million tons a quarter and then I think you just said in today's comments two to three. Have you brought additional tons on line, or has something changed or maybe I just misquoted you?

No I think we said earlier in the year that we had four to five million tons a quarter that was available without much capital investment. We nibbled into that a little bit for 2003 and frankly we looked at some higher cost production that we had in some regions and we reduced our production and took the opportunity in the marketplace to fill up with some third party output (indiscernible) more money.

Okay and the last two quick questions, you gave the tons for '04 that you have committed. Is that all priced or is some of it just committed and unpriced for '04?

It is all priced.

And the last thing is you said with the cash flow you are going to potentially make strategic acquisitions. I wonder if you could talk a little bit more about that given your size, is it a regional play either within North America or outside, and also you didn't talk about any asset dispositions that might come through, since you have done that in the past as well.

Well, as you know, related to acquisitions or divestitures, bet you can count on one hand the number of times you have had a CEO answer that question in a way that you could write it down. So I'm not going to be any different. We just really can't talk about it other than to say that we are very inquisitive. We look at everything. Everything that is available we see and if it makes sense for the long-term it is a good asset, one we can add value to and make it a good buy, we are not afraid to buy it.

We completed the acquisition of Black Beauty earlier this year. That was about $90 to $100 million and that is going very well for us and we will continue to look on divestitures. We did all kinds of deals involving the resource management area this last quarter. We both bought and sold in that quarter, and sold assets that were not strategic to us and sold them at what we considered to be a great price and bought a number of other assets that extended the lives of our mines and helped us create long-term values. We are in there on almost every deal that is in the marketplace.

(CALLER INSTRUCTIONS). Jay Turner.

Just a quick question. We have talked about Australia but have you seen with the strengthening of the euro there has been a pretty good pickup in U.S. price thermal coal out of South Africa, and I was just wondering if you could comment, have you seen any pick up on your exports based on the stronger euro for both thermal and are you also seeing any increase in met coal demand?

Jay, we are certainly not the size of a player, some of the big Australian producers that have already made their earnings announcements. They are probably far more reliable than us, and our small operation there is largely committed for the rest of the year, so we are not really --

Sorry, I meant out of the eastern U.S.

Again, with the eastern U.S. to Europe, we generally sell metallurgical coals to the marketplace and have not been a major player in the steam coal. The met coal prices are extremely strong right now and what we have done over the years, I think you have followed us a long time, you've watched us take our preparation plants in West Virginia and set them up so that we can run either steam or met coal and really chase the margin and right now the margin is in metallurgical coal. So that is what we are focused on.

Met coal exports, if I understand it, were up almost 30 percent in the first-quarter. Are you seeing similar type demand for the second quarter?

We are seeing strong international demand primarily because, especially in Europe, the cost of the freight, the ocean freight, is so expensive. It is difficult for Australian producers to take metallurgical coal to Europe. It is very expensive. So that is good for the United States, but a lot of our business in the U.S. from our eastern operations is into Canada or into domestic locations. That is a good market for us right now.

Michael Malarkey (ph).

Michael Malarkey (ph) from Markeston (ph). One or two quick questions. Looking out five years, what percent of production would you anticipate would come from affiliated MLPs (ph)? It seems to me that things like the Penn Virginia partnership give you an advantage from a financing point of view and that there may be a trend in that direction.

We certainly entered into the relationship with Penn Virginia to try to find a synergy and a growth vehicle for them and a good vehicle for us. So far, that has worked. I think both of us have benefited from it. We continue to look at other projects, and of course it is premature to announce anything. We also talked to other MLPs (ph) about the same kind of approach. I cannot give you an exact number. It is a function of the way we grow our company and a function of their performance with us. And all I can say to you is it is a strategy that we are looking at very closely and are quite active in our involvement in it, but I cannot give you a number at this point.

Okay and then the second question, in your beginning remarks you indicated that there was an increased interest from partners and customers in your two energy campuses. Can you give us any additional details and when do you think you will be fully committed? It seems to me that it is the equivalent of an open season in natural gas -- on a natural gas pipeline.

Well, first of all let's talk about the reason that there is so much interest. We are now into an extended period, several years of very high natural gas prices; and the old model of building a combined cycle gas plant and using it as a baseload facility is not panning out for companies that made huge investments in it. They found that they are -- very expensive electricity comes out of it.

They don't really track load as well as they thought they could and they are a little higher cost to operate than they thought they were. So all of that is looking good for coal, so now as we go along with several years of high gas prices we have electricity customers, electricity producers all over the nation who see rising demand for their product especially from the retail sector right now. and they are saying I have got to adjust my strategic plan, so coal is the solution.

They can't build more nuclear plants. They can't build more hydroplants. They can't make money with gas plants. The coal plants are the solution. That is why we have the interest and it is not just one or two parties. It is dozens of parties who are looking for their long-term power supply either as a customer or a partner.

Now that I have been involved in the developing of these generating projects for a couple years, I can't give you the exact date. That is exactly the wrong thing for me to do. All I can say is we will be disciplined and sign up creditworthy, liable partners and creditworthy, reliable customers and when we get those elements in place, that is when we will pursue the projects. But we won't pursue the projects on a speculative basis.

Let me see if I can just bottom-line this. As a shareholder, I am trying to figure out. Are you saying that in your view there is a 95 percent probability that the two projects will go forward?

I have never put a probability on it. There is a high probability that they will go forward. We are in the permitting process. They are good projects. They are economical. Everything is stacking up well for them. They have got demand. I have never quantified a probability, but let's just say I wouldn't be investing in them if I didn't think they would be successful.

And last question, if I might, the other week the president of Eastman Chemical made a presentation to Congress about synthetic coal-base gas. Could you just comment at all on where you think we stand as a nation on that?

Well, I think I support his testimony generally, I think it is an important step toward zero emission technology for this country. It is slightly different to operate gasification plants for a chemical process than it is for electricity generation, and that is the part that we need to perfect as a nation.

That is why the President's clean coal technology money is so important and the money that is in the energy bill is so important, to do just that, take some very promising technology, make sure that it is developed because it is an important step toward the future. The primary issues on the gasification plants, it is clear they can gasify. They can be reliable. But we need to spend more money on their efficiency and on the emissions clean up from the gasification plants and that is why that energy bill is so important.

Thank you.

Brett Levy.

I am guessing that you probably do have this metric, but if you were to take the current situation for coal and look at the most modern facilities that are being brought on that are coal fired, where would natural gas have to go to before it starts to make sense to look back at natural gas?

Let's just take the model that makes the most sense, and that is a model of Thoroughbred and Prairie State, which delivers the fuel in at less than 70 cents one million BTU and when built they will be among the cleanest coal plants East of the Mississippi River, they will set the new standard. Gas, to compete, would have to be about $2.00 or less per million delivered on a thirty-year basis.

No kidding! Thanks very much.

Michael Dudas.

Just about every other issue very well, but just one quick question. How long is Prairie State behind Thoroughbred in the permitting and discussion process, just a general sense?

It is anywhere from four to six months behind the process. The permitting process that we have found is a function of how many protests the environmental community want to file. And as just a reminder, Thoroughbred has its preliminary air permit issued to it. It is in the appeal process right now and we are working our way through it. We expect many steps during that process.

Thank you.

Dick Price.

A couple questions additionally on the power plants. Do you anticipate any impact on your developments from the recently announced tax incentives in Illinois?

We expect very positive benefits, which we have not included in our economics for the plant. The plants are great plants and Illinois is taking a, what I called a leading-edge approach, to stimulate their economy. They are using their natural resource they have available, which is the most coal in the nation, coal reserves in the nation, and they're stimulating it to provide jobs and low-cost electricity. We have not tried to tap that at this time. We may try at a later date, but we think it is a good step for us.

A follow-up question of Appalachia. The Federal (indiscernible) projects, (indiscernible) property from moving in that direction?

No, Federal was a very large reserve area. It mined for close to 20 years on the West side and now it is moving to the East side, and that is a move of some ten miles or so. It is in northern Appalachia. As you know it is Pittsburgh 8C and 6 1/2 to 7 foot coal (ph) and really high quality products so it is all right there at the Federal prep land.

Thanks again.

John Bridges.

Just a quickie. You mentioned the cogen, I just wondered if you had a sense as to how much cogen capacity, cogeneration natural gas, has been built and is probably now stranded?

Well, I usually don't describe it as cogen. The combined cycle plants, is that what you are talking about?

The ones that were built as an attempt to baseload.

I really don't have the number. I am happy I don't own any is all I can say.

Okay, just another one. If you were a betting man, when do you think we might see a prototype of a coal gasification plant?

There are some gasification plants that exist in North Dakota and the Wabash River Station in Appalachia and when we mentioned Eastman Chemical, they run some of the most successful gasification plants in the nation, and I think that was a very wise testimony their CEO made.

Just thinking more in terms of new generations.

My best guess is that we have to get the clean coal technology money approved. We have to go through some clean up in metallurgy and other steps involving the gas-fired (indiscernible) and that is probably a four to five-year project to prove it out. There is another major project that is underway. Again, the State of Illinois is a major advocate of this, and that is the President's hydrogen based initiative, and that involves gasifying coal, cleaning up the gas stream, separating the hydrogen, capturing the Co2, sequestering it, and then using the hydrogen in fuel cells to generate electricity and as a feedstock for chemical processes. So it is out there also.

And just as a reminder, Thoroughbred and Prairie State really represent a tremendous improvement in the emissions technology, just using really the suite of new technologies that are available out there, putting them all one-to-one place. We can get to a place that far over complies with today's clean air act standards with these new plants.

Appreciate it. Thanks a lot.

Dan Roling.

Staying on a power plants for a moment, Irl, what is your new estimate of ownership by Peabody of these plants? I think originally you wanted to be less than 50 percent. Are you now willing to own over 50 percent if you have commitments from customers?

Dan, first of all an observation. This may be the longest earnings conference call you've stayed on in history, but second --

It's interesting.

Second, no we're staying with our model of approximately 50 percent or less. What we continue to do is look for a partner that has built these plants, that knows how to operate these plants, that has complementary skills to us, and we do not pretend that we know how to build and operate one of these plants. There are far better people out there. So there are some of those folks that have expressed a very strong interest to us, and we are continuing to talk to them.

Thank you.

I would now like to turn the conference back to management.

Thank you very much and thanks to everyone for your interest in Peabody. It has been one of our longer conference calls, and we appreciate your interest very much. Again, you have our earnings guidance. It's something that we don't take lightly, and we will do our best to meet or exceed that as we move forward. So thank you again for your interest.

Thank you. Ladies and gentlemen, this conference will be available for replay after 1:30 PM today running through August 16th till midnight. You may access to AT&T teleconference replay system at any time by dialing 1-800-475-6701. International participants may dial 320-365-3844 and entering an access code of 686997. (CALLER INSTRUCTIONS). That does conclude our conference for today. Thank you for your participation and for using AT&T executive teleconference. You may now disconnect.