Peabody Energy Corp (BTU) 2004 Q1 法說會逐字稿

Welcome to the Peabody Energy quarterly earnings conference call. At this time all the participant lines are in a listen-only mode. However, there will be an opportunity for questions. (OPERATOR INSTRUCTIONS). As a reminder, today's call is being recorded. I would now like to turn the conference over to the Vice President Public and Investor Relations, Mr. Vic Svec. Please go ahead sir.

Good morning and thanks for taking part in the conference call today for BTU. We've had a great start to the year, and we welcome both newcomers and long-standing investors to the call today. Executive VP and CFO Rick Navarre will discuss our results and outlook, and Chairman and CEO Irl Engelhardt will review the energy markets as well as our recent acquisitions. We will be making some forward-looking statements today and 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 release, and those documents that we file with the SEC. For reconciliation schedules and other financial information, we refer you to PeabodyEnergy.com. There you will also find a replay of our call.

I will now turn the call over to Rick.

Thanks, Vic. Good morning, everyone, and welcome to our first quarter earnings review.

As you can see from our press release, this has been a much improved and productive quarter. In addition to reporting higher earnings, we were active in the capital markets, raising funds for attractive growth opportunities, and completing the planned exit of a major shareholder through a secondary offering. These capital market transactions allowed us to also increase our float and liquidity and lower our overall borrowing costs. With our added financial flexibility we are well-positioned to continue our industry-leading financial performance and deliver ongoing growth. Let me take you through the first quarter results.

Our income statement on page 6 reflects the benefits of improving customer demand and market conditions. Our revenues were 16 percent higher than last year, leading to 7 percent growth in operating profit. Interest expense was $5 million lower than the prior year, reflecting the benefit of last year's very favorable refinancing. First quarter net income was almost $34 million higher, and excluding 2003 non-recurring early debt extinguishment charges and the effect of accounting changes, our net income improved 12 percent. The efforts of the entire Peabody team again delivered strong results, with EBITDA of $109.8 million, net income of 22.6 million, and earnings per share of 40 cents.

Moving to the supplemental data on page 7. Our first quarter sales set a record of 51.9 million tons, as most of our operations performed above or at last year's production levels to try to keep pace with high customer demand. Increased volumes also reflect higher output from mines that were under development and completed during 2003. In Appalachia, we produced 650,000 more tons than last year, with more than half of the growth shifted into the higher priced metallurgical markets.

The combination of higher volumes and higher pricing for our steam and met coals lead to an 8 percent revenue improvement in the East, and our Western revenues per ton also increased slightly. On the cost side, Western costs were comparable with last year, absent 12 cents per ton related to the increasing cost of diesel fuel and explosives used at our surface mines. You will note that the Eastern cost per ton of $23.30 ere $2 per ton higher than the per year, driven primarily by a change in mix and sales-related taxes and royalties on higher pricing. Specifically, the change in mix to higher cost, higher priced Appalachian coal, and cost to upgrade to metallurgical coals, adds $1.22 per ton. Higher sales-related taxes and royalties and higher steel pricing added an additional 29 cents per ton. And the remaining 49 cents per ton, a 2.3 percent increase over last year, was associated with temporary geology issues at two Midwestern mines and two dragline repairs in Indiana that are largely behind us.

Peabody's trading, brokerage, and resource management areas added almost $19 million of gross margins. The trading and brokerage group continued to optimize contracts, allowing us to free up production for resale into the higher priced markets. It also benefited from the price volatility in both the domestic and international markets.

Moving to the other operating cost line. The net improvements reflect medical cost inflation, offset by our ongoing health-care management efforts and the estimated benefits of the recently enacted Medicare prescription drug legislation.

As we turn to the balance sheet, our cash balance of $779 million includes the recent offering proceeds and was reduced by $432 million on April 15, when we closed the RAG acquisitions. Currently we are examining a number of other growth opportunities to utilize the remaining cash, including a small amount for the pending Venezuelan transaction. With our current cash balance, our net debt to net capital ratio is quite low. Our targeted leverage, though, is in the mid 40 percent range.

I will now turn to our improved targets for 2004. We are targeting higher sales volume due to strong sales demand and benefits from the new Australian and Colorado mines. We continue to have significant upside to improving markets around the world, with 55 to 65 million tons of 2005 production yet to be priced and 110 to 120 million tons of 2006 production on price.

Looking to the second quarter, we expect the favorable market conditions to continue. The combination of customer demand and contributions from our newly acquired operations are expected to overcome the timing impacts of recent rail difficulties and the shifting to the second quarter of the coal handling facilities upgrade at our North Antelope Rochelle mine. As a result, we are now targeting second quarter EBITDA of $120 million to $130 million and earnings per share in the 35 cents to 50 cents range.

We expect to have even stronger results in the second half of 2004. For the full year, we are now increasing EBITDA guidance to 525 to $550 million, a level 28 to 34 percent higher than 2003. We are also targeting earnings per share of $2.10 to $2.50. With the recent closing, we will work to rapidly integrate the new mines, including preparing detailed budgets, and we will provide any additional guidance if necessary after we complete the integration of the new properties.

In summary, the year began on a strong note and fundamentals for the industry and Peabody remain outstanding, allowing us to significantly raise our guidance. Our acquisitions should begin to contribute immediately, and we are in a great position to capture domestic and international growth opportunities.

With that, at this time I'll turn the call over to our Chairman and CEO, Irl Engelhardt. Irl?

Thank you, Rick, and good morning, everyone. Rick has discussed our solid start to the year; I plan to offer our perspective on coal markets and discuss our plans for the new mines in Australia and Colorado.

In January we offered a view of the markets of strong coal markets throughout the world. I'm pleased to report that those conditions continue, lead by a huge appetite for steel and electricity as economies improve around the world.

On the international scene, metallurgical and thermal coal markets remain very positive. Steel demand is growing at double-digit rates in Asia Pacific countries, triggering high demand for met coals. Many steelmakers are running with low coal inventories due to tight supplies, and some have switched to lower quality coals.

China, the world's number two coal exporter, is limiting exports of both coke and coal to satisfy its domestic needs, and problems at ports in Australia and production issues in several countries are also complicating the met supplies.

Global power generation is also strong, creating both near and long-term growth opportunities for coal. Near term, higher capacity utilization of coal plants in Asia Pacific countries is creating strong demand for thermal coals. Longer term, we see up to 70 new coal generating units around the world that will come online in 2004. They present around 100 million tons per annum of additional coal demand, and much of this growth is in the Asia Pacific region, where China plans to increase its annual use 150 to 200 million tons by 2006.

Turning to the United States, we see all forms of energy showing high prices as the economy improves and supply issues become more (indiscernible). Our country experienced a milder than normal winter, which has helped us avoid major problems with natural gas supplies. We currently see U.S. consumers of all forms of energy working very creatively to establish reliable energy supplies for the future. We believe the U.S. supply/demand balance for coal is very fragile. It's complicated by growing export and domestic demand. Eastern coal supplies are affected by well-documented production problems in Appalachia, and Western supplies are experiencing rail service issues. We believe U.S. coal stockpiles are at such low levels that reliability may be an issue at some plants.

The largest customers for U.S. coal, electricity generators, are operating their plants at higher capacity levels than last year. We expect power output from nuclear units to rebound slightly and for nuclear plants to run near capacity. Hydro power output is expected to drop due to low reservoir levels in the West, and we also expect most natural gas units to be dispatched as a last resort due to high gas prices.

Progress on new coal generation in the U.S. is being announced on almost a daily basis. There are five coal plants under construction in the U.S. at present and several dozen are progressing rapidly through the permitting and regulatory process. The new plants are creating long-term growth opportunities for both Peabody and the U.S. coal industry.

So it's against this backdrop of improving near and long-term fundamentals that Peabody continues to grow. We are growing organically by increasing the output from our existing mines some 10 to 15 million tons this year, and we are growing our production base through acquisitions; an additional 14 to 15 million tons will come on board through the newly acquired mines. The new surface and underground mines includes (indiscernible) at high-quality metallurgical products to serve steelmakers around the world. We are expediting the construction of a small surface mine at North Gundilla (ph) to improve its cost structure and its reliability. And we plan to use our production base in Australia to expand our trading presence in the Pacific Rim markets.

The 20-mile mine in Colorado adds new products to serve generators in the U.S. and in Mexico. 20-mile employees have an excellent reputation for their longwall expertise, and we expect the output from 20-mile to increase approximately 4 to 5 percent versus 2003. We are also making progress on the purchase of RAG's 25 percent stake in the Pasa Diablo mine in Venezuela. The purchase will expand Peabody's product lines, improve our ability to serve our customers, and extend our trading capability in the European and U.S. markets. We currently have a memorandum of understanding in place and we will announce the purchase price and other details when a definitive agreement is signed. We look forward to immediate contributions from the new operations, and we will continue to pursue other growth opportunities.

In closing, I want to thank all of the investors for your continuing support. We also express our gratitude for the partnership and very wise counsel of the Lehman Merchant Banking Fund, which has exited its successful investment in Peabody. Peabody is very proud of its tradition of strong performance in all market conditions and in all ownership structures. We look forward to performing well for a host of new investors in BTU.

So with those remarks, Rick and I are happy to open the call to your questions.

(OPERATOR INSTRUCTIONS). Dave Gagliano, Credit Suisse First Boston.

Just a couple of questions. First of all, on the shift to the planned upgrade at North Antelope Rochelle, in terms of the loading facilities, to the second quarter. Could you give us just a little more color as to why you shifted it from the first quarter to the second quarter? That would be the first question.

Sure. We were experiencing some -- well, first of all we experienced some severe weather in the first quarter, and then also we were experiencing some rail operating difficulties. We looked forward at the timing of it, and saw an operating difficulty with one of the railroads that made it desirable to move it to the beginning of April to coincide with some repairs that they needed to make.

Are those rail difficulties now behind that?

They are moving. I think they have completed most of the repair -- their repair. We are close to completing most of our upgrade at the facility.

Just for the follow-up -- the CapEx in 2004 looks like it went up to, I believe, I think it's 280 to 300 million. I'm wondering if you could give us a break down as to what -- where the money's being spent?

Sure, this is Rick. The increase from our original guidance (indiscernible) of 220 to 240 is in part -- is largely due to the acquisitions of Colorado and Australian properties. That largely added $60 million of additional CapEx. We are going to be purchasing a longwall system for the 20-mile line, and we'll be putting some advanced capital in place to get that system in place by '05. And we're also lengthening the face panel down into Australia, which will have a little bit of capital. And we're also opening a small surface mine in Australia as well. That is largely the increase of $60 million, and the remaining components of capital are largely related to equipment and purchases that we had already talked about earlier in our first call, and some strategic property acquisitions that we will be making this year as well.

So what would you say your sustaining CapEx is at this point, after '04?

After '04 including RAG, I would say it's going to be roughly in the 220 to 240 range. But roughly 175 to 200; I would say that goes up a bit in that range. 220 maybe.

Bill Burns, Johnson Rice.

Going back to North Antelope. Did you give any estimates about what kind of temporary loss in production you might have there?

We thought in the first quarter we probably lost 500,000 tons, not only between the West and the East due to rail difficulties, derailments and weather-related issues, that we could have produced and sold in the first quarter. As we look forward for the second quarter at the planned outage at North Antelope Rochelle, we're going to lose roughly 15 to 20 days of production.

Okay.

We hope to make that up, obviously. As we put in the installed capacity we'll be higher capacity, so we'll catch up, hopefully, by the time the year is out.

Rick, one little quick follow-up on the cost in the West, cost per ton in the West; they were like $6.78 a ton compared to 6.65, up about 13 cents. Did I hear you say most of that was just higher cost of diesel and explosives?

Exactly all of it. Essentially (indiscernible) look at about 12 to 13 cents a ton was related to diesel fuel costs which are obviously much higher than they were last year, and our cost for explosives which are correlated very strongly with natural.

There's more exogenous cost versus internal cost.

That's right. So everything else was pretty flat.

Michael Dudas, Bear Stearns.

Irl, (indiscernible) in your prepared comments you talked about the fragility of the supply situation in the U.S. that could occur as we move through the year. Could you share a little bit further your thoughts on some of the real issues? Anecdotally we have seen some much greater service reliability issues in the West and the East than I think people would have anticipated. How best can Peabody handle some of those issues, and how are the customers that you sense feeling about some of the tightness we're seeing in the marketplace?

I think, Mike, I referred to the supply/demand balance being very fragile. There are just a culmination of factors that are all swirling around at the same time, and its unique from my experience in this position. But we have export, and domestic demand is quite strong. We have metallurgical demand is extremely strong, we have supply difficulties in Appalachia, we have the international markets largely sold out. And at the same time we had some rail service issues. And you put all those factors together, it creates a very fragile situation. And when you couple that with the very low stockpiles that exist, in total we are low for the industry, and some plants are extremely low. I'm raising the issue just from a reliability standpoint. Reliability of a few of the plants.

My follow-up is relative to your committed tonnage for this year and next. Is it more of a function of -- can you give a sense of how your customers are thinking about locking in long-term? Are they starting to negotiate a little sooner in the cycle than they have in the past? And how comfortable are you with the exposed tonnage that you have over the next 18 months?

We are extremely comfortable with our book of business at the current time. And I have to be careful since this is -- this call is listened to by so many people on what I say. I think the customer base is very sophisticated compared to what it was a few years ago when we had the influx of less experienced traders that were in the industry. And I see customers who have a strategy, customer by customer, as to what they will do related to their coal plants and their stockpiles. And each one is working their strategy very carefully, and the strategies are all different; it is fascinating to see. So we will see who gets it right and who doesn't over the long term, but a sophisticated group of buyers at this time.

Just on the customer, a follow-up there. How much product can you shift from the high-quality steam market to the met market?

Our preparation plants in central Appalachia are set up to produce a steam or a metallurgical product, and to blend different grades within those parameters. The exact amount you can switch is a function of how much replacement coal we can buy. And like many others, we have been into the market or dealt with others to develop alternate supplies to fulfill some of our (indiscernible) contracts or our thermal coal contracts, and then shift that coal to the met market where possible. By and large we are about a 5 to 7 million ton a year met producer here in the United States, and another 6 to 7 in Australia with the acquisitions. So we're about 14 million tons all told around the world.

David Khani, Friedman Billings Ramsey.

Can you give us an update maybe on what is going on with mercury, because we keep reading conflicting opinions on what is going on? And you guys are in the front seat there.

Where we are right now is the regulations have been promulgated in draft form by the EPA. They call for much more stringent mercury emissions standards for both existing plants and new plants. There is a public comment period where inputs will be submitted -- I think it's roughly by the end of April. And all kinds of parties -- the users of coal, the environmental community, the producers of coal, those that construct plants -- all are submitting their inputs to the EPA. Then the regulations will be redrafted. The final regulations will go into effect by the end of the year.

What the proposed regulations do is, for existing plants they are largely what's called a co-benefits approach. They require you to -- well, other regulations require the installation of scrubbers or selected catalytic reduction equipment, and that in turn will lead to removal of mercury. So you will see a major investment in the existing plants to comply with those other standards that the EPA also promulgated, plus to achieve this mercury standard. So that seems to be going well.

There will be some special exceptions to the rule and special rules for (indiscernible) coals and Powder River Basin coals, because it's difficult to remove mercury from those coals. For new plants, the standards are very stringent. And there will be a lot of public comment about whether the EPA has been too harsh in its regulation there. The net result of all of this, though, will be that the combination of the mercury and other regulations that the EPA will promulgate will lead to significant reductions in nitrous oxide, sulfur dioxide particulate, and mercury emissions from coal plants. And that is to build upon some of the toughest environmental standards in the world at the current time. So it's a good thing for the country. Long answer, sorry.

You guys are well versed and understand this better than all of us here. Is this -- on your Thoroughbred plant, does this affect it at all?

We are certainly submitting public comments on Thoroughbred and Prairie Estate, because the mercury standards will be difficult to achieve for any new plant, any new coal plant in the United States. We don't think the EPA intended that -- those mercury regs to stop the construction of new plants, and we're hopeful they will simply make the adjustment as appropriate.

John Bridges, J.P. Morgan.

Congratulations. Just following on quickly from that -- SCR plants are pretty sizable investments, so do you see that sort of sterilizing any significant part of the coal burning fleet as a result of these regs?

I think the regs that we talked about, which require the installation of scrubbers and selected catalytic reduction equipment and some bag (ph) houses in certain places, what they will do will give the utilities or the generator an opportunity to move to multiple supply regions for their cold. So if we would have a shortage in central Appalachia and we would install scrubbers and SERs, we might be able to take the coal out of the Pittsburgh 8 market, or if it is on the inland waterways, move it up the river from the high sulfur markets producers downstream. So it not only cleans up the air but it will result in some changes in the supply sources for these plants. In a situation where you have Appalachian production problems, especially central Appalachia, that diversity of supply would be very good for the generators. So we are quite comfortable with all of that because we have coal reserves in all of the producing regions, and we are relaxed and sort of neutral on what those standards might be.

You're not concerned that there might be a gap between the new plants coming on such as your own two and regulations timing up on the smaller coal plants, which perhaps (indiscernible) not economic to put these SCR plants in place.

What we think will happen, John, is that there will be some older, very small plants that were built in the '50s and early '60s that are not very economic, and it really isn't justified to put the investment in to retrofit those plants with this emission control equipment. The amount of coal that they consume is not significant, and what we expect will happen is the utilities will make investments in their larger, more efficient newer plants, and they will actually expand the amount of coal that they use in those plants. And so net net, we'll have somewhat of an increase in the use of coal in the existing plants. We think it's going to be beneficial. We'll see some shifting from region to region.

Just as a follow-up, with your investment in Australia now you must have a view on what is going on in the Chinese coal industry. People are asking me about it, and I sort of tried to figure it out, but you're obviously in a better position to have a view.

I wouldn't say we're in a better position to have a view. (indiscernible) need a train to haul around the crystal ball (indiscernible) China. Our view is very simplistic, and that is that if you simply look at the major construction activities that they have underway in coal generating plants and new steel facilitate, other heavy industry of all types, if they simply would complete those projects over the next several years, that means that there is three to four years, or five, of growth in coal use, simply to complete those projects and bring them onstream. Now, that's a pretty good crystal ball, but once that money is being invested then things look pretty good. Now, they are announcing some thoughts about whether they slow down the growth in their economy, and that's probably a realistic thing to do. Every company or household has to figure out how to pay for things, and they also have to avoid high inflation. So it sounds like a pretty prudent approach to me.

Barry Hames (ph), Sage Asset Management.

Quick question. Could you elaborate a little bit more on the rail problems? I guess they were mostly in the West. And in terms of what the problem is, when it will get solved, and if you guys have taken a shot at estimating what the financial impact from that might have been in the first quarter or could be in the second?

The rail problems, you will recall -- I don't know where you are located -- but you will recall that we had the huge snowstorm and ice storm that lasted in the East, Northeastern and Central Atlantic states for a week to 10 days. And it really had a pretty big effect on some of the railroads in the East. They have largely worked their way out of those, but it did affect our ability to deliver during that first quarter. In the West, there's been an unusual number of derailments that have occurred on some of the rail carriers that just in total was just highly unusual. And the net of all of that was to affect our sales. We had the output and the production affected us by about 550,000 tons or so in the first quarter. We expect the Western rail issues to continue for a month or two. We are hopeful that they will be behind them and things will move very smoothly.

Jay Turner, BMO Nesbitt Burns.

Good morning, gentleman. I had a question on your Australian acquisitions, just in terms of the contract structure for the met coal sales. Are you sold out this year and are you under sort of evergreen long-term contracts, or are you going to be seeking to put all your tons into the market next year?

We have a combination of contracts. Some are three-year contracts and some are evergreen year by year. I don't have the exact statistics, and probably shouldn't provide them for competitive reasons. But, Rick, do you have any (multiple speakers)

Yes, what I was (indiscernible) is that certainly we are sold out largely for '04 on the contracts, unless we can get some more production out with the new surface mine that we are adding down there, which we might get a little (indiscernible) -- an incremental amount of production that could go into the met market, but just a small amount. A we look out to '05, we'll have some contracts rolling off in the typical timeframe, April 1 timeframe, which is the cycle they use for the Japanese fiscal year down there. So we'll have some volume available that's probably -- out of the total met sales, maybe half of our sales will be available in '05, and then most of them largely will be repriced again in '06 at above -- 100 percent of the met product will be repriced by '06.

Just a follow-up. There's been a lot in the press about port and demurrage problems over in Australia. How exposed are your operations to that sort of risk, and have you this year -- do you know of any incidences where shipments were delayed, that sort of thing.

I think you've read the Wall Street Journal article about the port problems at New Castle and the large demurrage issues that existed there. The coal demand remains very strong in that thermal coal market, and New Castle is a major supply region from there. And demurrage remains quite high. We have very small amounts of coal going through there that measured in the low hundreds of thousands of tons, so that doesn't really impact us. The one that had the potential to impact us was the problem with Dalrymple Bay, which is where -- which is the largest met port in Cleveland. And that's where the coal from the mines that we acquired moves through. They had a loader stacker reclaimer collapse, and that has been largely repaired. They're back up to about 95-plus percent of the capacity of the port. So we think that was largely behind us. So far so good.

David Lipschitz, Merrill Lynch.

What are you seeing in the PRB, in terms of pricing going forward?

I can't answer that, for obvious competitive reasons. I know you need it for your model, but we simply can't answer it.

Even in like the spot market, you can't even just sort of say what direction it's going, or anything like that?

I think you can look at the OTC and the other indices there and make a judgment there, but I just simply can't cover specific market prices. It's not right.

And the other operating costs, what percent of that was the other legacy costs and things like that, Rick?

A percent of the total, I --

Can you just give me the number, what the dollar amount was?

Yes, I can, just give me one second. Just to kind of give you an estimate of what the improvements were, and I (indiscernible) and I'll come back to the total (multiple speakers) but from the improvements year-over-year, we had probably 8 to $10 million of improvements related to retiring health-care because of the prescription drug legislation that came through, offset a bit by higher inflation costs and so forth. In total, most of those charges relate to PMO, or past mining obligations. It's not all just retiring health-care, (indiscernible) it has some elements of working compensation and those types of charges as well.

Paul Forward Legg Mason.

I'm not sure if this has been asked, but what is the regional mix of your unpriced tons for, say, '04, '05 and '06?

We should not provide that for competitive reasons, but it's pretty close to proportional to our production in the various regions. And you will recall that we said that we keep about 95 percent of the Southwestern and Midwestern business under long-term contract. That has been documented for a long time. And then the rest of it would be Appalachia and Powder River Basin, primarily.

Just thinking about the cash balance that you've got, I'm just wondering what sort of principles will guide you in any decisions for new acquisitions?

You've watched us for a period of time be very disciplined on our acquisitions, and I hope that you were satisfied with the transaction we have just completed. By and large, we have a criteria that it has to be accretive to earnings in year one or two. That's pretty tough to do. And it has to have a high return and it's commensurate with the risk that you take on. So for a transaction like Venezuela that is out there in front of us, when we announced the transaction -- assuming we get it complete -- we think you will be satisfied that the purchase price and the potential return justifies the country risk that is involved there. So just because we have the cash doesn't mean that we lose our discipline.

John Woodbury (ph), Cobalt.

Thanks. My question has been answered.

Patrick Taylor (ph), Westminster Securities.

In the context of discussing the fragile markets in the East, you had mentioned some real issues with surface mining. I just was wondering if you could elaborate on what exactly those issues are and how we should view them going forward? Thank you.

I don't know that I mentioned surface mines, I hope I didn't if it was related to the East. I think what I was pointing out is when you look at all of the variables involving the supply and demand situation, you have got a number of variables that all lead to high demand including the need to run generating plants that use coal, because of high gas prices and constraints on the other fuels. You have low stockpiles, and some are dangerously low. And then we have the issue of supply problems, production problems at a number of mines in Appalachia, and those are pretty well documented. And combine that with some rail delivery problems. All of that makes us have a very fragile supply demand equation, and I raise it because it's important to our country, to ensure that we have reliable supplies of electricity from coal. It's low cost and it helps fuel the economic recovery. So that's my motive in raising it.

Richard Rosen, Seligman.

Just another question on Australia. You talk about your acquisition criteria being that the deal has to be accretive in year one or year two, and my understanding was that the RAG deal was going to be accretive in year one at the time of the acquisition. That's correct?

That's correct.

As I look out -- and someone asked the (indiscernible) try to get at the profitability of those mines in Australia earlier on, my understanding is that the price of met coal has gone up sharply from the time you entered into the transaction to now. That's what -- how many dollars per ton in the spot market are we talking about?

Again, even though it affects an international market I'm still constrained from talking about a specific price. Probably the best way to get a feel for that, there are all kinds of published indices. I think Barlow Jonker has one that you might look up to get a feel for it, or some of the Australian trade publications will give you a read on the pricing.

I guess my understanding was it was somewhere in the range of -- help me understand whether my math is roughly correct. My understanding is that it -- at least at the peak it was 15 to $20 higher than where you entered into the transaction. Next year you're going to go from what? 7.5 to 8 million tons of met coal, is that right?

No, we'll be roughly in the 7 million ton range in Australia.

Okay. So 7 million. But that increase in the spot price, that would be applicable over a two-year period of time. That's about how long it takes to cycle through those increases? Is that about right?

Generally you've got to --as I said earlier, you'll have some of the business that was -- some of the business was locked in at favorable met pricing because it was locked in in January and February at what was the agreed-upon pricing as far as the Consortium pricing improvements that were had down there, which was probably roughly up 20 percent (inaudible). But nevertheless, then you get into years (indiscernible) say a third of that rolling off in '05, and then the rest of it rolling off in '06.

Okay. But in other words, some of the increase in met prices in Australia was already factored in when you made the acquisition; is that right? Or some of that is just going to be in the results this year, is going to be accretive to results this year?

I think in the information we have provided to date, it showed the results for 2003, which was largely pricing in 2002 and first quarter of 2003. There will be improvements this next year or in '04 as a result of business that was entered into in December, January and this first quarter. And it will be significant. Again, you can get a read for that by going to those publications that I talked about, and so on. I would point, though, that all of these factors are considered in the guidance that we provide to everyone. We're a very complex company and many things go on, but we pride ourselves on providing guidance that is fairly reliable. And we've got a record of meeting or exceeding our guidance. So there are numerous variables that are all into it. That doesn't help you prepare a model or someone in your shop prepare a model, but it does give you a good start.

I had one another piece of information that probably complicates it a little bit further; is that when you look at what we did -- what these properties turned in (indiscernible) earnings and EBITDA last year, it was based upon an average exchange rate in the 60s. The average exchange rate now is 74. So that will have a dilutive impact. They're still accretive transactions for us even at 74, but you have to consider the exchange rate differential.

As long as we're on the subject of currency, do you have any intention to hedge the Australian dollar, or what is the policy there?

Sure. We're partially hedged going into this year already with hedges that were in place as part of the (indiscernible) that we bought, as part of the Company. As we go forward we'll do a number of things to hedge the Australian properties. First we'll hedge the balance sheet by pushing debt down from a translation standpoint. And then as we move to the transaction standpoint, we will implement a strategy where we will have hedging, part of the exposure through FX contracts, and then part of the exposure through option contracts. We will have some hedging program as we move forward.

Michael Lukacs, Appaloosa.

I was wondering if you could -- you've touched on some of the issues on catalytic reduction systems, etc, but I was wondering if you could -- if you think that there is a change or an inflection point where you could have App coal and Illinois coal to where you're coal gets priced let's say more aggressively; i.e., that if you had $22 cost into the Midwest market, that somewhere if you had $50 App coal, that you guys would have to be in the 14, $15 range with omissions, etc., taken into account. If you guys look at it that way.

We don't quite look at it that way, but what we see happening right now due to the shortages in Appalachia -- we see a number of customers that are buying; they purchase Pittsburgh 8 coal and have consumed a great deal of that capacity, and they are buying coals on the inland waterways along the Ohio River that are higher BTU and moving it up stream. And these are higher sulfur coals that they go out and they purchase S02 allowances. I believe you'll notice that S02 allowances are at very high levels right now, and that's because of the purchase of the substitute coals, partially because of the medium sulfur Pittsburgh 8 and the higher sulfur Midwestern coals. So both are good for us because we have a higher Pittsburgh 8 mine and we've got -- we're the number one producer in the Midwest. So a great situation for us.

Let me rephrase that. How much does it cost for you guys to get coal into that market on rails?

On rail?

Yes, for transportation.

Most of the coal that moves from the Midwest into the markets that are traditionally served by Appalachian suppliers move by water. They move on the Ohio River to plants located along the water. Because most of the Appalachian mines -- most, there's always exceptions -- are located on rail systems and away from the water, whereas if you have some mines in the Midwest or on the Pittsburgh 8 that are located on the water, then they are a good substitute source because movement by water is much cheaper transportation wise then movement by rail.

Did you think that there will be a change from utilities buying it. It just seems now that they would -- it's not that they are indifferent -- that if you were to look at spot prices in the PRB at 650, and spot prices in the Central App at 50, that they would want to buy PRB coal if they can get it.

They are buying PRB coal. I think there have been a number of announcements of PRB coal moving to utilities in the Pennsylvania, New Jersey region, to North Carolina to New York; places such as that, to Florida. (Multiple speakers) because of the short supplies in the Appalachian region. And it's a function of needing to replenish the stockpiles that are fairly low right now.

Would you mind just quantifying the cost for me in terms of transportation together from PRB into those three different markets (indiscernible) the Midwest, the East, and down into Florida.

Michael, I just don't have it at my fingertips. It's a quote -- it's a movement that is handled by the utilities, and I would really be talking about the revenue stream of railroads, which I shouldn't be doing. But I will say that the utilities have found it to be attractive. That's why they are doing it.

Mitchell Golden (ph), RH (ph) Capital.

I was wondering if you could explain the gross margin decline in the Australian operations off of higher revenue? And just one more time since we have talked a bit about it on the call, how to think about the contribution next year.

Sure. If you look at the Australian operation that we're looking at right now, it's the Wilkie Creek operation, a small operation that we have in Queens (indiscernible) doesn't include the new operation. We had some favorable currency movements in '02 and in '03, rather, that we didn't have in '04. We think that will get flipped around as we go forward. We expect higher profitability as we go forward from that particular operation for the rest of the year, as pricing is better, obviously, this year than it was last year. So that will turn around.

The improved pricing for the Australian, the Wilkie Creek operation, really starts around April 1.

(indiscernible) even though it's a thermal coal it's still the thermal coals are up as well. We'll get some improvements for the last nine months of the year.

John Hudson (ph) with Bricalore (ph) Capital.

Rick, can you just discussed discuss the big jump in the trading assets and liabilities sequentially?

Sure. A couple of factors. As you look at it, we have a lot more volume in trading this quarter, but a lot of it's mostly related to the volatility in the pricing. The Eastern prices were up substantially. And so if you look at it from that standpoint, probably 2/3 of the increase relates to just pure price increase. So rather than having a central Appalachian $28 contract, we've now got a central Appalachian $50 contract, as an example in the (indiscernible) market. Just to -- so that has a substantial impact on the assets and liabilities on both sides. And the rest of it is just our position that we were in at the end of the quarter.

So we should expect this kind of level to persist for a few more quarters?

Probably -- you know, we're flat (indiscernible). The position will move around as we flatten out different positions and sub positions (indiscernible). But yes, you will see as the prices stay up, traditionally -- or you should expect to see higher assets and higher liabilities. So the net of the two is kind of the embedded gain or unrealized gain.

Rick, you might explain what period of time that these transactions settle out.

Sure? As you look at these transactions, if we were to stop everything right now and just -- we would be able to -- we would settle 88 percent of the transactions in the next twelve months. The rest would mature in the next twelve months after that.

But they're very short term.

David Khani, Friedman Billings Ramsey.

Just one quick question. On your inventory on hand, how much coal do you actually have right now?

A large component of the inventory we have is, obviously, work in progress, which would be deferred stripping that you see on our balance sheet related to the large surface mines. I can tell you in just a second what our total on hand coal is, but it's not a very large amount. Frankly, if you look in the West we do not have very much salable coal; and we have probably just several million dollars worth of Eastern salable coal. So I would probably say the number is under $10 million worth of product, that's in the salable state.

There's very little stockpiles at most producers around the country right now, whereas a year ago there was quite a bit.

I just figured, because I saw the number go up from December to March, and I thought it was -- I figured it would be price.

It really wasn't price, because that would go to cost. And I think there was a little bit higher inventory in our Western mines, just due to some -- we had a pipeline outage, so we built a little bit more inventory out at Black Mesa, which actually has a little bit higher inventory traditionally anyway, because we get reimbursed for the inventory that's out there. And the other thing was just really more of a re-class, if you will. As you recall, we bought Black Beauty's remaining interest last year (indiscernible) 18 percent. So we had to true-up to their deferred stripping accounts to get -- a year to get all the purchase accounting situated. And we raised the deferred stripping balance for Black Beauty by about 8 to $10 million in the first quarter. The offset goes to coal reserves. So it was just a reclass.

No further questions in queue. Please go ahead with any closing comments.

Once again, we thank everyone for your interest in Peabody, and we look forward to performing very well for the new investors. Thank you very much.

Ladies and gentlemen, this conference is available for replay. It starts today at 1:30 PM Central and will last until May 20 at midnight. You may access the AT&T executive playback service at any time by dialing 1-800-475-6701. International parties please dial 320-365-3844. The access code is 728042. (OPERATOR INSTRUCTIONS). That does conclude your conference for today. Thank you for your participation, and you may now disconnect.