Peabody Energy Corp (BTU) 2003 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the 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, and the instructions will be given at that the time. (OPERATOR INSTRUCTIONS) As a reminder, today's call is being recorded. I would now like to turn the conference over to our host, Mr. Vic Svec. Please go ahead sir.

Well, good morning, and thank you, Janine. Thanks for taking part in the conference call for BTU. Today our Executive VP and Chief Financial Officer, Rick Navarre, will review our third-quarter performance and Chairman and CEO, Irl Engelhardt, will discuss the energy markets, as well as BTU's outlook. We will be making some forward-looking statements today, and they are in line with our press release. We would encourage you to consider these, along with the risk factors that we note at the end of our release, as well as those documents that we filed with the SEC. For a more detailed reconciliation schedule and other financial information, we would also refer you to www.peabodyenergy.com. There you'll find a replay of our call, as well. Rick?

Thanks, Vic, and good morning, everyone. And thank you want for your interest today. To summarize another solid quarter, Peabody's EBITDA of $104 million and earnings per share of 49 cents were both at the high end of our targeted range. Our continuous focus on costs led to improvements versus the prior year and prior quarter. And we set a new quarterly sales record of 52.6 million tons -- fueled by record production and demand from the Powder River Basin.

I'll begin today with a review of the income statement on page 6 of the earnings release. Our revenues for the third quarter were $702 million, approximating prior year levels. Strong demand and favorable pricing in the West offset slightly lowered Eastern prices. Operating profit was $36 million for the quarter -- compared to $51 million last year. I would point out that the prior year quarter and the year-to-date amounts, were helped by a $37 million gain on two Southwest contract resolutions. Operating profit was also impacted $6 million for the quarter and $18 million for the year, due to higher health care and pension costs from interest discount rates and inflation. The benefits of our refinancing are reflected in lower debt-related interest expense of almost $5 million for both the quarter and the year. Moving to the summary at the bottom of page 6, third quarter's EBITDA of $104 million is at the high-end of our target range. Net income is $22 million for the quarter and $73 million year-to-date, excluding the refinancing costs and the effect of accounting changes reported in the first two quarters. Earnings per share is also at the high end of our targets.

I'll now turn to the information on page 7. In the last two conference calls, I explain that our sales backlog would lead to higher volumes in the second half of the year. I am pleased to report that are quarterly sales volume did increase 6 percent. Driven by production and record production in the Powder River Basin and demand that led to higher Western sales overall. We were shipped a record 28.3 million tons out of Powder River Basin, and overall our Eastern volumes were in line with the prior period. As explained in footnote one on page 7, our revenues per ton in the West were higher after excluding the revenue impact of last year's contract resolutions that I have mentioned. In the East, revenue per ton for the year was marginally lower due to contracts we signed during the softer market conditions in 2002.

Our drive to be the low-cost producer paid dividends as our costs for the quarter were better in both regions -- 57 cents in the West and 32 cents better in the East. For the first half, our Rawhide Mine was the most productive mine in America. And Peabody has three of the top seven most productive operations in the country. Notwithstanding these accomplishments, there were some challenges. For example, year-to-date our operations incurred $17 million of higher diesel fuel and other energy-related costs which were partially offset by about -- by approximately $7 million from our hedging program. We had poor performance on new equipment at our Highland Mine. We had start-up issues in our Vermillion Grove operation. And we had extensive repairs to a damaged conveyor system at Appalachia. We also experienced higher health care and insurance costs during core. So despite these challenges and external cost pressures, our operating managers posted solid results, and were able to improve their overall costs per ton.

Moving down the page, our gross margins from U.S. mining operations are a $138 million for the quarter. This compares favorably with the prior year, when considering the $37 million in contract resolutions already mentioned. The trading and brokerage resource management segments continue to perform well, creating value beyond the mining operations. Moving to other operating costs, the increase there is driven primarily by higher -- and mostly non-cash -- pension and retiree health costs. The change in operating cash flow included swings in both periods. Most significantly, the prior year includes $50 million related to the contract resolutions and an excise tax refund. Our stronger sales in the third quarter also increased our accounts receivable. And we spent $25 million more this year on closed mine reclamation and pension-funding than we did in the prior year. Capital expenditures were lower, as the majority of capital associated with the large federal and highland projects has now been completed. We expect 2003 total capital of $175 to $190 million -- which is slightly lower that our previous target.

Turning to page 8 -- our balance sheet remains solid. We have a good cash position. And both debt and long-term liabilities were improved. We completed the final phase of our refinancing with the registration of our bonds. In addition, we acted on the continuing low interest rate environment and executed two interest rate swaps which will further reduce our floating-rate borrowing costs. This strategy will result in savings of more than $2 million annually. To sum-up our financial review, our team posted solid performance. We're shipping at record levels. And we are encouraged by the very favorable market conditions. At this time, I will now turn the call over to Irl Engelhardt, our Chairman and Chief Executive Officer, who will discuss the markets and our outlook. Earl?

Thank you, Rick, and good morning everyone. During the third quarter, we welcomed the Greg Boyce to Peabody's already strong management team. Greg joined us as the President and Chief Operating Officer after serving as the CEO of Energy for Rio Tinto. Greg brings us experience and a very fresh perspective, and I'm confident that Peabody's operations will perform at a much higher level under his leadership.

Turning to the market conditions, I'm happy to report that Peabody is participating in both near and long-term market improvements. In the near term, the market conditions have improved in both the East and the West -- with nuclear and gas generation hitting their practical limits. We see coal plants that are operating at very high-capacity levels. We anticipate strong demand for coal in most U.S. markets throughout 2004 and that strong demand is driven by increased use of coal for electricity generation. Peabody's capitalized on those very strong markets by signing multi-year sales agreements where prices re attractive. The agreements allow us to raise our production targets for 2004 to 190 to 200 million tons and that's up 9 to 10 percent versus 2003.

Longer-term the development activity for new coal plants is a reminder of the 1970's. In just the past three months, developers broke ground on the new coal plant in Iowa. Two Wisconsin generators await regulatory approval for new capacity. An Arizona generator is completing financing and coal supplies for its new plant. And construction is progressing on plants in Kentucky, Pennsylvania, South Carolina and Illinois. Those are just a few examples of the new plants that create long-term market opportunities for Peabody and the remainder of the U.S. coal industry. Peabody's Thoroughbred and Prairie State Projects are also moving forward. During the quarter, our Thoroughbred Project made very good progress on a number of its permits. Prairie State took similar strides forward. And we're seeing power sales agreements for the output of both plants. And both those power sales agreements are receiving considerable attention. And we're attracting strong interest from prospective partners for the plants. So we're quite happy with how they're proceeding.

Regulatory and legislative developments in Washington are also a positive for coal. The PA's clarification of the new source-review regulations should result in improved reliability, efficiency and air emissions -- and that comes by giving the generators the freedom to maintain their plants. The Senate and the House versions of the energy bills contained important clean coal technology provisions. And support is growing for clear skies and other proposals that would further reduce emissions and improve the certainty of investments in new coal plants. So within those improving markets, Peabody is booked attractive business for 2004 and beyond. We expect production in 2004 of at 190 to 200 million tons and that is up 15 to 20 million tons versus this year. Most of the increase is in the Powder River Basin. And our production for that region is largely committed for next year. We have 110 to 120 million tons of targeted production to be priced over the next two years. And that book of business gives us significant upside should prices continue to improve.

Turning to our outlook for 2003, Peabody continues to target full-year EBITDA in the range of $405 to $415 million. And we're targeting earnings of $1.00 of $1.75 per share, and those figures exclude the special items reported in the first half. In summary, Peabody's participating in the near-term market improvements using a portfolio of very strong operations. We are also participating in the long-term market improvements, using our excellent reserve base and our generation development skills. So with that wrap-up, I would like to thank you for your interest in Peabody, and we would be happy to take questions at this time.

(OPERATOR INSTRUCTIONS) Our first question comes from the line of Dan Rolling with Merrill Lynch. Please go ahead.

Thank you and good quarter, gentlemen. Irl, you went through the power plants rather quickly. Are you suggesting or did I -- are you suggesting that we are actually seeing construction on what -- about six or seven new coal fire plants now? And if that is the case, could you give us the approximate size of these? Are these 300 megawatt units or 1000 megawatt units?

Well, they vary from plant to plant. But there are a number -- I rattled through just a group of plants that are quite active and some of the announcements have occurred in the last quarter. What I would like to do, Dan, is -- we will assemble a slide in the sum of the presentations as we are presenting around the industry. We will cover it in more detail. Generally, what I was talking about then in the list of plants that mentioned is somewhere in the 2,000 to 4,000 megawatt range. So that's quite sizable and that's quite good for all.

Very. A follow-up question, if I may. Have you seen any -- I am asking that incorrectly. Have you guys signed any meaningful, new contracts with utilities for '04 or longer business? And what percent of your '04 sales are now under -- anticipated sales are now under contract?

Well, we have reported as we gone through the year, generally, our uncommitted position. And I think you noticed that in the first five months of the year when pricing was quite strong, we signed a considerable amount of tonnage during that period. As the markets softened, we backed away from the market, and we have recently signed some additional tonnage. We have about 168,000 -- 168 million tons for 2004 that are committed and priced at this point. And we're quite happy with that position. We plan to produce about 190 to 200 million tons next year. And we think we are in good position.

Thank you.

Our next question comes from the line of Dave Gagliano with Credit Suisse First Boston Corporation. Please go ahead.

Thanks. Just a quick clarification question. On the year-over-year comparisons in the supplemental financial data, the revenue per ton and the costs -- or actually the revenue-per-ton figure in the West -- the $10.61 figure for September of '02 does that include the impact of the $37 million contract re-valuation?

Yes. It does. If you look at footnote one, it was $1.30 of that $10.61, so if you take that out -- apples-to-apples basis-- your costs would have been -- your revenue per ton would have been $9.31 compared to $9.45. So we actually had a slight increase in the West.

Okay. Thanks very much for that, and then just to follow on Dan's question. On the -- just on the power plants -- I'm curious if you have a sense as to the potential incremental increase in coal demand associated with those new plants and sort of a sense of terms of the timing of the new plants coming on -- things like that?

Well, the incremental coal demand -- there is a rule of thumb that you take four to five times their megawatt and you get the volume. So if we had 2 to 4000 megawatts, you multiply it by 4 to 5. And you would talking 8 to 10 million tons. Now I would point to you very quickly that some of those plants will likely replace existing older, less efficient, higher-emitting plants, so it's not total new capacity. It is simply replacement. So, not all of it is new.

Okay.

But the total number of megawatts will be more than just the ones that out there now. We think (indiscernible) built in the next several years as far as business (indiscernible) we will break ground, so it will be a bigger number.

And then the timing is in the next several years type of a --? (multiple speakers)

Exactly.

Yes. They vary from plant to plant -- everything from going into 2004, we could expect some of the plants that are under construction to be starting in 2007 to 2008 and just going from there.

Thanks very much.

Our next question comes from the line of Ross Payne with Wachovia Securities. Please go ahead.

Yes, just two quick questions here. If you can kind of expand on the conveyor problem that you had? And second of all, what you think maintenance CapEx will end-up for 2003 and any thoughts you may have on that same number for '04?

The conveyor problem is one of those unexpected problems that anybody in a capital-end intensive business has. You put all kinds of safeguards in place and somehow it manages to happen. In this case, a pry bar somehow made it past two magnets that are intended to catch it, past screens, and then lodged itself in a way to cut two and a half miles of conveyor belt. And on top of that the module in the program logic controller that monitored that kind of thing for rip detection, was disabled and somehow it did not work. So we put all of the safeguards in place, and it still didn't happen. It's behind us, and we are happy to have it behind us. It was somewhere in the range of $3 to $4 million. But Rick, do you want to answer the question?

Yes. The maintenance CapEx, Ross, usually runs about $100 to $125 million, and we expect that number to be pretty consistent going forward.

Okay. Great. In terms of pricing, I guess things have been moving up here recently as well. Does that bode well for your -- what you have left on '04 and as you look to '05? And as it relates to '05, how much of that production is already in place -- is contracted for?

Obviously, it is going to -- it plays well into where we have positioned ourselves from the sales standpoint, Ross. And you know, we have got -- as we said earlier, we still got a 25 to 30 million tons left to sell into '04 which will be right in the right -- in the prime markets where the prices are moving. As we look forward into '04 and '05, we have 110 to 120 million tons in place. So we think we're really situated very, very well for improving market conditions.

Okay. Great. Thank you.

Our next question comes from the line of Bill Burns with Johnson Wright. Please go ahead.

Good morning. On your refinancing -- you're now expecting savings of -- it looks like 20 million per year, which is up from what we had originally thought. I was just wondering, is this additional savings due to the extra interest rates swaps you put in place?

Primarily, Bill, we have done a couple of swaps most recently, and we did one in the last quarter. So we think we will end-up saving roughly $20 million per year. I think we initially estimated $15 million -- that may have been a little bit conservative. But we are pretty comfortable with $20 million of savings right now.

Sounds good. Thanks.

Our next question comes from the line of Paul Forward with Legg Mason.

Hi. Good morning. I was just wondering if we could have a status update of the Black Mesa Mine and Mohave plant. And if it the mine is forced to shut down at the end of '05, should we be concerned that that shutdown would have a meaningful impact on earnings despite the fact that it is only about 2.5 percent of your coal production -- considering that the contract I guess may be somewhat favorable?

I think you have pretty well answered your question about the impact on earnings. It is a relatively small percent of our output total, though it is a contract that has a slight improvement on the margin basis to our average. It's too early to tell. We see a great deal of activity in time attempting to resolve the issues involving Mojave. It is a plant that is low-cost electricity for the citizens of California and the Southwest. It is logical for it to continue to run. Yet it requires an investment in emission-control equipment to run. It also back through the mine provides a great deal of loyalty income to both the Navajo and the Hopi tribes. So it's important to them, and it also provides a large number of employment opportunities with well-paying jobs for the people that are members of the tribes. All of those things say it should run. On the other hand, it continues to linger as far as this resolution. However, there is a great deal more activity, and I'm optimistic it will be resolved. It should be resolved. It's good for people to be resolved. But at this point, it is not. As we get closer to the 2005 date, we will just keep you posted as to where it stands. And in the meantime, we will do our best to resolve the matter.

Okay. Thanks.

Our next question comes the line of Steven Zeppelin with Bear Stearns. Please go ahead.

Hi, good morning, guys. For 2004, that's 15 to 20 million ton increase -- I know that you said that most of that was going to the P.R.V, but could you be more specific? Is that 50 percent -- P.R.V. 50 percent East or --?

The increase comes through several factors. Most of it -- 80 to 90 percent of it is P.R.V.. The remainder of it is simply the Vermillion Grove and Highland mines operating at the levels they were supposed to operate -- other than the difficulties that Rick explained in his remarks. So most of it is Powder River, and most of it is already committed. The market has largely absorbed it already.

Okay. And that large increase for P.R.V., is that you taking market share or that utilities switching to the subbituminous products?

Well, there is an ongoing switch to the Powder River Basin. And we are simply -- we don't view it as taking market share. We're simply taking profitable opportunities. Whether we have taken market share or not, I do not know, to tell you the truth. We see some good business that has a good profit margin, and we are signing it up.

Okay. And then -- final question -- on 2005, any indication -- I know that you said planned production -- you have 111 million tons planned production. Do you know what the production is for 2005 or you can give us any percent (ph) on that?

Well, we have not disclose what that is. I think to be conservative, you could probably just take the range for 2004. And you should be on a conservative basis there.

Okay. Thank you.

Our next question comes from the line of John Bridges from J.P. Morgan. Please go a head.

Good morning, Irl, everybody. There has been some commentary about logistical problems (indiscernible) out to the Powder River Basin. Given your increase in tons, do you see any problems there? Could you sort of give us about a bit of background on that?

As you recall, what occurred was customers were drawing down the stockpiles in the first half of the year. And they were really not taking all of their orders. In the second half of the year, there was a big surge of demand after the stockpiles were down. The railroads have done a good job of putting new train sets in place, hiring new people. By and large, the mines have loaded well. Some of the competition has had some operating difficulties with high-wall failures and handling large rainfalls. But, largely, the system is operating pretty well. However, there is a practical constraint, and I believe both the operators and the railroads are trying to get the customers to take their orders on a more ratable basis. And that would improve the efficiency of the whole system.

Okay. Okay. And maybe Rick -- looking at your quote of three numbers. I think you have used-up most of your tax business that you were forecasting. Is that correct?

That is correct. We expect about $50 to $51 million of tax benefits for the full year.

Okay. Excellent. Thanks a lot.

Our next question comes from the line of Wayne Atwell with Morgan Stanley. Please go ahead.

Thank you. If we could stay on that tax issue. Could you give us some guidance as to what we should expect in tax credit for '04?

What I would suspect, it will probably be in that same 40 to $50 million range. We will continue to give you -- when we give our guidance for '04, we will continue to give you a more refined estimate as part of the RegG disclosures that we keep on our website. But, as we have mentioned, a lot of that is driven largely due to the advantages of percentage of depletion, tax deductions which usually runs for Peabody around $40 million per year in benefits. So we will probably be in that $40 to $50 million range again.

Okay. And reading the press -- it sounds like -- and listening to what you have to say -- prices seem to be moving North. Can you give us any kind of guidance on realization per ton for '04 versus '03 -- maybe up 50 cents to 1 dollar -- any thoughts?

Well, as you know there are a large number of people that listen to this call. And we really cannot talk about pricing, other than to say that some of the -- I mean the business that we have signed-up has been attractive to us. I think a good indicator -- you can just in general direction -- if you look at the Lindbergh or the other published wire services, you can see the traded market, and it generally gives you a directional view of the market price. Not particularly the exact market price but a directional view.

Of what you're signing up now how would that compare to supply? Would that be much less than spot (ph)? Above or below?

I really cannot answer that. Normally, we take a long-term view. And it has to be an attractive price versus our other market opportunities.

Thank you.

Our next question comes from the line of Stuart Glickman with Standard & Poor's.

Good morning, guys. Just a quick question on operating costs per ton. The costs seemed relatively flat sequentially, although obviously a lot better year-to-year. But I'm wondering if you have the capacity available there -- I guess to both East and the West -- to generate further operating-cost improvements there. I just wanted to get your comments on that.

I think the answer is yes. Number one, we have been operating without a COO for about a year now, and our COO that has joined us is -- has a proven record of managing good operations. But, more importantly, I believe if you followed us for the first half of the year, you saw that we were operating at less than our true capacity. And we are operating at a better capacity level now. I think Rick ran through a number of less-than-perfect areas of performance just for purposes of full disclosure. He ran through those in our operations. Simply getting our Vermillion Grove operation up to full capacity, getting the equipment problems solved with Highland, and a few other straightforward issues like that, will give us continued improvement. And yet we continue to see all types of process improvements or technology improvements or equipment improvements that will help us in the long-term. So there is more to come.

Okay. Just as a quick follow-up the 110 to 120 million tons of unpriced production -- that's leveraged more to the West than the East?

Yes. It generally would be.

Okay. Thanks, guys.

Our next question comes from the line of Steven Tanull with Imperium Capital. Please go ahead.

Thank you. I just had a brief question. On the pricing, I know that you are a little bit hesitant to give specifics. But can you comment as to whether or not there is a general belief in the market price -- that the spot market that's being reported is in fact the real price these days versus just some imaginary illiquid price of years ago?

Repeat your question and expand it a little bit so I can understand what you are referring to specifically.

Do you think that spot price at this point is more indicative of actual price than in previous years? (Multiple Speakers) How do you see the liquidity of the spot market right now?

Well, the liquidity of the traded market-- if you're talking about OTC markets -- is far less than it was in the past because of the credit issues among the trading companies and some of the other counterparties. In the past, you have heard us talk about the tight credit and the risk management controls that we have in place. And we've worked our way successfully through the credit maze that has occurred without any problem -- any significant problem or even any problem. So there is less liquidity because there are fewer trading counterparties. That is a simple fact. Regarding your question of -- is the published market price accurate? I cannot answer that. I think within a range for the specific quality of coal that they are talking about, it is an indicator of what you could do for a small quantity of coal for a very short period of time. And if you understand that definition, that's okay.

And how that differ -- to differentiate that from what Peabody sells traditionally is that we are selling larger quantities of coal which -- that comes with larger capital requirements therefore shifting (indiscernible) as well as reliability issues. And we're more reliable, and so all of those items go to what we believe to be our premiums to what you see for short-term, small shipments. Next question?

Okay. Thank you.

Our next question comes from the line of Mark Reichman with A.G. Edwards. Please go ahead.

Good morning. I just have three questions. First of all, as I look out at 2004, I see, you know, increasing production levels, more favorable pricing, and the company seems to be holding the line on expenses, so I guess I would expect improved gross margins. Are there any obvious items that might cloud that thesis vis-a-vis favorable contracts that might have been signed in 2001 that could roll-off or increasing health care expenses -- if you could just comment on that?

Is that all three questions? Or is that -- (multiple speakers)

No, that's actually the first one. (Multiple Speakers) (laughter) The other two are a little shorter.

Okay, good. We sometimes are asked the details of models with the parties trying to put the model together based upon a building-block approach. Our industry and our business is so complex that frequently our answer is to simply say, check the track record of the company and the guidance they provide versus whether they hit their guidance or not. Because it is complex. The answer very simply, is we are improving markets. We do have some contracts that roll-off from 2001. But, on the other hand, we're signing some business that is better than other contracts that roll-off. So that's a complex question. We have no major contracts that have rolled-off this year. And nor do we think we have one next year. We have -- like all of big business in the country -- pressures on us in energy costs, health care, the discount rate, and the performance of pension plans on their investments. It hits us just like everybody else. So we have those kinds of pressures on us. We roll all of those factors into the guidance we provide because we are a complex company. But we are focused on all of those kind of issues. Is there one that is a terrible issue for us to -- not that I'm aware of.

The second question is on the tax benefits. I think I have $40 to $50 million into '04. Remind me, if you could, on the amount of remaining net-operating-loss carryforwards so we can maybe get a sense of the longevity going forward -- you know how long -- ?(multiple speakers)

On a gross basis right now, we have in excess of $600 million of NOL carryforwards. And they don't expire -- they have primarily about a 19-year life on those NOL carryforwards. Obviously, we are going to use them up much faster than that. So, we still have a substantial asset there.

Okay, and then third, if you could just comment on Prairie State and some of your other generation projects?

Sure. Well, Prairie State and Thoroughbred are both quite large. They are both -- Thoroughbred is in Kentucky and Prairie State is in Illinois. Those are both states with Democratic governors and administrations that are processing our permits within the combination of state and federal rules. Both are proceeding very well through the permitting process. We receive opposition from various parties, as you would expect -- certain parties in the environmental community don't like the fact that the plants are being built. And, nevertheless, there is no technical or other reason that we should not receive the permits and move forward. The interest is quite high from parties that would buy the power and quite high from parties that would be partners in the plants. So we're just working our way through getting all the elements in place for successful business deals. And when we have them, we will move forward. Unless we have them, we won't move forward.

Great. Thanks very much.

Our next question comes from the line of David Connie with Friedman Billings Ramsey. Please go ahead.

Yes, hi, guys. A quick clarification on your contract that is -- did you sign any contracts in the third quarter?

Yes, we did.

You did. Okay. And going into, I guess, the beginning of '04, what would you like to be contracted at -- sort of what kind of range without being too definitive, I guess, for your competitors?

Well, we are happy with where we are right now. And what we do is monitor the market conditions and try to take a forward view of where the market is moving too. And then we take the appropriate action. So without being specific, I would just say we're very pleased with where we are the moment.

I guess now that it looks like maybe -- I guess, Triton (ph) will probably will be consolidated -- I guess it hasn't passed yet. Do you see pricing benefits yet at all or any kind of change in some of your customer bases and how they look at Peabody because now there is one less competitor?

We don't. We have had no reaction from the market related to Triton. Nor have we asked. We simply view that as something that may or may not happen. And related to the impact of Triton on pricing -- I have no comment on that. I simply cannot comment on that.

Rick, I guess this is a question for you. Credit issues with some of your customers -- is it improving versus say maybe six months ago?

Dave, it's a little bit better than it was six months ago but at the same time, it's still a challenge for us. I mean we're -- we watch it very closely, and we have been very, very successful so far -- knock on wood that we have navigated through all of the landmines or the credit issues that are out there. You know, we still have a substantial percentage of our customers -- almost 85 percent of our customers are still investment-grade. So that's the good news. And then the ones that aren't, we try to get credit enhancements. We've been building that into all of our new contracts. So if there's any deterioration in their credit standing, we are able to ask for letters of credit, COD payments, escrow amounts (technical difficulties) successful managing it, and we will continue to watch it very closely.

Okay. And I guess one last one on production growth for next year. Is part of the growth also the fact that you bought out some of your working interest in Black Beauty? Is that additive to your growth?

No, we are already own them. Basically, we're already adding the production up a bit for Black Beauty. Some of the growth is coming from Vermillion Grove -- which is one of the Black Beauty operations (indiscernible) getting ramped up. But if you recall, what we told you probably in last year's conference call and probably the first part of this conference call -- the first part of this year -- our Caballo mine was running at a less than optimal capacity so that's -- we got a lot of growth out of that by running it at a more optimum level. So it's really not the Black Beauty issue.

Okay, great. Thank you, guys. Good quarter.

Our next question comes from the line of David Tameron with Stifel.

Good morning, everyone. Quick question for you. How much -- I guess you can call it swing production, do you have going into next year? Do you have the ability -- if coal markets respond that you can kick that up -- or what's it look like on the capacity front?

Well, we have not given the exact guidance on where we plan to be but you can see there is a range of 190 to 200 million tons. And that's probably a good indicator of swing for us.

Okay. So just to make sure -- so roughly a 10 million ton flexibility to play with going into next year?

I think that's a good way to think of it.

Okay. And everything else was answered. Thank you.

Other questions?

Thank you. Our next question comes from the line of James Crum with Morgan Stanley. Please go ahead.

Good morning. When you went through the new power plants, most of them seem to be out East. And I know that said you were going to add more color later but are you seeing a similar level of development out West?

Well, I think you heard a variety of states -- Wisconsin, Iowa, Illinois, Kentucky, South Carolina, Arizona -- so they're scattered. Right now the plants that are in various stages of development in the United States are in 33 different states. There is quite an interest level. Essentially what we've seen in talking to CEO's of utilities around the nation is in the past, the public service commissions had not focused as much on coal, they were more focused on natural gas. And now a question that is frequently being asked is why coal is not included in the resource plan of utilities. In other words, in the generation mix, new coal is not included. So it is a much more favorable environment, and it's due to the lessons of energy shortages, high prices, and even blackouts. Reliability is a much bigger issue now.

And just briefly, in your experience, are those more high heat facilities like 12,000 BTU or is it by region or are they more flexible in the type of -- ?

They're being designed to burn a product that is logical from a delivered-fuel price to arrive at their plant. And so Wisconsin plants are generally looking at Powder River Basin coal. Arizona River plants are looking at a accommodation of Southwest and Powder River Basin coal. The plants out East are looking at either Pittsburgh 8 or Southern Appalachia or Eastern Kentucky coal. So it depends on what moves to them in the lowest cost way.

The next question would be, capital spending in 2004. Production is up -- I don't know if you have figure out where the capital spending is coming in 2004. Should we expect an increase given the higher production levels?

Well, we are in our budgeting project process. At the moment, we have good visibility of our revenues -- fairly strong visibility of our costs. A lot of the increased capacity that we have mentioned is simply increasing capacity that was already there. Caballo and Rawhide, and to a certain extent Rochelle, North Cantalope (ph) and Powder River Basin were running at lower levels than their full capacity. Vermillion Grove and Highland have had the money spent already on them, and all we have to do is get them up to full capacity so it's not necessary that a lot of capacity -- capital has to be spent to bring this capacity online. On the other hand, we have capital needs just like everybody else. After we get a better read our budget for this next year. we will provide that guidance.

Just real quick, I know you have talked about pension, health care. And you're like a lot of companies. But are you able give us any thoughts on what you're assuming on in terms of your health care costs percentage increase for '04?

We will give that to you in the context of the overall guidance for '04 once it is nailed down. It is, again, three months away from the beginning of '04. At this point, we are in the budgeting process. If we give you an answer, it's likely to change. So let us answer that one in January at the end of that conference call.

And last question is more strategy. You have looked at Colbert Methane. You also have assets that are non-U.S. -- also maybe acquisitions. Can you just update on any strategy changes on any of those possible areas for growth that you might have?

Well, if you have monitored the company, you've watched us grow over the last few years through a combination of small acquisitions and just organic growth -- I would describe it. We have a bright future related to organic. And you have already heard that the volume increases just for next year alone -- and our reserve base really supports that organic growth. At the same time, we throw off a lot of cash flow. There's hardly anything in the world that we do not look at. I think we have explained that in our presentations in the past that we are very acquisitive company. We're also a company that will sell something that somebody else is going to place a higher value on than us. We're just being patient, making sure we buy the right asset and making sure one that truly adds value. But we're quite focused on the acquisition front.

Our next question comes from the line of Paul Forward with Legg Mason. Please go ahead.

Yes, hi, just quickly on the share count. Could you go through the calculation behind the increase in the share count this quarter?

Two things happened, Paul, and part of it was just the way you calculate fully diluted shares in the first two quarters because of the large charges that we have related to the refinancing costs. We did not count the options in our fully diluted cost because it would have been anti-dilutive at that point in time. So when you add those back in -- that raised the number. In addition, we also had a number of shares -- of options that were locked up for two years post the IPO that came free. And now people exercise some of those options and that increased our outstanding shares.

Okay. And then, also, do you have any comment on the really sky-rocketing ocean freight rates and how that might impact both your volumes in pricing for met coal next year?

Well, I think our view of the ocean freight rates is that it's largely demand-driven. It's demand-driven by the large imports of raw materials into China. Just a tremendous amount of volume going into that country right now. Second, it is driven by -- to a certain extent -- the use of vessels to supply the ongoing Iraqi situation and what initially was a war and now is whatever it is. So the combination of the two are driving that price up. Our situation is that a very small amount of our coal moves offshore. And it is primary metallurgical coal -- just a few million tons. That primarily goes to Europe -- a little bit to South America, but very little. Most of our metallurgical coal goes to domestic steel makers or Canadian steel makers. So that ocean freight is not big on us in the United States. It has a small impact on us in Australia but that is not significant to our total company in size. So we got a view on it but it's not big for us.

And I would add, Paul, that the thing that probably has an impact on the U.S. side is that people have always been looking for import coal to come into the U.S. and take away market share from us. And imports have been pretty small here to date. I think that will put even more pressure and competition -- make it much more difficult for those import coals to get into the U.S. competitively with those high freight rates.

Good point.

So not a whole lot of a ripple effect on the tightening of the Atlantic markets for met coal based on the difficulty of the Australian exporters to bring in volumes the way they have in the past with freight rates lower?

Well, it helps the U.S. somewhat. But the U.S. Met market generally is the area where there has been the contractions in the production base because of depleting reserves and high-cost mines. And so it is simply not -- not a big factor for us.

Okay. Thanks.

Our next question comes from the line of Dan Rolling with Merrill Lynch. Please go ahead.

Thank you. A couple of questions -- actually a suggestion, Irl. You and some of your competitors never want to give out pricing on coal contracts, and I completely understand why. But would it be that hard to set up an index and just give us an index on changes in coal prices. That is the suggestion. And, Rick, from your answer making -- it led me to leave that because of higher capital costs, the stability, the reliability -- that you would believe -- I would be led him to believe that you would be signing above spot. And I find from tracking coal prices over a long time that unless something has changed, that is unlikely. Am I just way off base here?

I wasn't going to put it that way, Dan, but -- (multiple speakers)

I can be, I don't mind.

Traditionally, we think that we have signed price -- full prices -- for contract coal in excess of spot and what the spot market would indicate, depending upon the timing -- unless the spot market is overheated because of short supply. But it's just reliability issues, volume issues -- you know, just like anything else. Small quantities are easier to get than large quantities delivered over a long period for time. With that, that's about all I can really say about it -- in that area.

Okay. As long as it's not an overheated market, okay. And lastly, what will be the length of some of these contracts that you're now signing on average? One year? Three years? Five years?

Two to three years.

Thank you.

Our next question comes from the line of Wayne Atwell with Morgan Stanley. Please go ahead.

Thank you. Could you give us some guidance to us for your estimated interest expense for next year?

We've broken our interest expense out, Wayne, as you can see on our income statement -- down within debt-related interest charges and surety bonds. And we would -- rather than giving you the exact number what I will tell you is that we expect -- if you go back to what we were incurring in the first quarter and annualize that, we would expect savings of about $20 million from that number.

So, you will save 20 million versus the annualized -- ?

Annualized first-quarter interest expense. The second quarter hasn't -- we will be carrying two sets of bonds during the second quarter so that would not be a very good quarter to use as an example. Because we still had not retired the older, higher rate bonds yet.

Right. Okay. And it sounds exciting that you're making progress with Thoroughbred. Any thoughts on when you might be able to break ground on that project? I realize there's a lot of wood-to-chop before that happens but any early thoughts on when that might take place?

It's too early to really say. And we're hopeful next year -- late in the year, but we are not absolutely sure. A lot of things have to line-up, including getting all the final permits and partner agreements, etc., so -- The progress is quite substantial. Again, you have to be cautious with a project like that, and simply make sure that you have everything lined up properly before you move forward.

I realize it's early days (ph) but the dialogue that you're having with potential partners -- are they at a level that makes you happy and that you would proceed --?

Serious discussions with good partners.

But the terms that they're being discussed -- are they sufficient to encourage a go-ahead with the project on that basis?

They are good discussions. We're happy with whom we're talking to and what we are talking about.

Thank you.

Our next question comes from the line of David Schneider, Hoover Investment Management. Please go ahead.

Yes, hi, I was wondering if there was any way to quantify natural gas versus coal as far as -- call it megawatts of new power plants that are on the drawing boards in various stages of fruition? Perhaps my suggestion will show-up in a future sale-site research report. But I was wondering if you folks at Peabody might have any statistics on that or where we could find that kind of thing?

Vic, you might answer it. We have a group of slides that we use in many of our presentations to the analyst community. Is there one that's readily available on our website or anything?

There is. And what we've seen is 120,000 megawatts of gas capacity come on in the last three years. Now that was all based on very low gas prices. So within this new environment, what you're seeing is people mopping up with the construction projects that they already needed to. But at the same time, the actual capacity utilization of these new plants have fallen because of the high underlying fuel costs, obviously. So what you're seeing is a new wave of coal generation which, in the aggregate, amounts to the 70,000 megawatts per total plants that have been announced. And obviously some fraction of these get built at the end of the day. But that gives you a relative comparison.

Also, there is a report that has recently been issued by the National Petroleum Council. It's still in draft form but you might want to look at their web site on natural gas supplies -- what they are advocating to the Department of Energy regarding natural gas.

And one other component that I will add to that is that with the new source review that Irl mentioned in his remarks, there is also a study out there that says -- allowing the utilities to put maintenance into their units should unleash about 40,000 additional megawatts over the next probably seven to eight years and that's roughly 116 million tons of coal equivalent.

Now, I know various states are suing the EPA or George Bush or his daughters about the new source review. Any thoughts on that?

I think his daughters are safe. I really don't have any relevant thoughts other than most of the states that are suing are the ones that don't have significant quantities of coal in their fuel mix. And they have high electricity prices.

Okay. Thank you.

At this time, there are no additional questions. Please continue.

Okay. We want to thank everyone for your attention and your interest in BTU. And we will strive to meet all of the targets that we have set forth. We look forward to look at talking to you on our next conference call.

Ladies and gentlemen, today's conference will be available for replay beginning this afternoon at 1:30 p.m. Central time and will run through the 16th of November at midnight. You may access the AT&T Executive Playback System by dialing 1-800-475-6701. For international participants, dial 320-365-3844. And for either number, enter the access code 698202. That number again is 1-800-475-6701 or 320-365-3844 with the access code 698202. That does conclude our conference for today. Thank you for your participation, and also for using AT&T's Executive Teleconference Service. You might now disconnect.