Peabody Energy Corp (BTU) 2004 Q2 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 time. If you should require any assistance during today's call, press star, then zero on your touch-tone phone. As a reminder, today's call is being recorded. I will now turn the conference over to our host Vic Svec, vice president public and Investor Relations. Please go ahead, sir.

Thank, Janine. Good morning and thanks for taking part in the conference call for BTU. We made the turn at the midway mark of 2004 in very good shape, and we're looking forward to the second half. Today, executive VP and CFO, Rick Navarre, will discuss our results and our outlook. Chairman and CEO, Irl Engelhardt, will review the energy markets and several growth highlights. We will be making some forward-looking statements today, and they're consistent with our press release. We would encourage you to consider these along with the risk factors that we note at the end of the release, and those documents that we file with the SEC. For other financial information, we also refer to you Peabody Energy.com. There you will also find a replay of our call. Rick?

Thanks, Vic. And good morning, everyone. Welcome to Peabody's second quarter earnings review. I will begin with a recap of what has been a busy quarter of accomplishments. Peabody set new records for sales volume and revenues during the quarter. We completed two acquisitions, and signed a definitive agreement for a third. We expanded our low sulfur reserves in the Powder River Basin and again increased our financial targets for the full year. I will take you through the results beginning with our income statement on page 7.

Peabody posted record sales volume to beat strong global demand for coal, improved volume and pricing lead revenues 33% higher and operating profit was up a robust 61% compared to the same quarter last year. Year to date interest expense was $9 million lower, reflecting the benefits of our recent refinancings. Our tax benefit for the quarter was $16 million, in part driven by the 20-Mile Mine asset acquisition which improved our profitability outlook. Our strong operating results led to EBITDA of $131 million, which was 35% higher than last year and earnings per share of 63 cents. Moving to the supplemental data on page 8, Peabody set an industry record during the quarter with 57 million tons sold, as every operating region posted year over year increases. Our operations ran very smoothly and at higher utilization rates to satisfy strong demand. Shipments would have been one million tons higher absent transportation issues. We experienced rail slow downs which reduced shipments in the eastern and western United States, while port congestion hindered Australian volumes and led to higher demerge costs. Without these issues, second quarter EBITDA would have been $7-8 million higher.

Eastern U.S. sales volumes were higher for both med and thermal coal products and our western operations produced an additional 3 million tons, led by the new 20-Mile Mine and increased output from our Powder River Basin Rawhide Mine. We also set production records at 20-Mile during the quarter and daily shipment records at North Antelope and Rochelle. In Australia our volumes were up largely due to the new -- the recently acquired operations. With these new metallurgical mines, Peabody's net coal capability has increased to approximately 13 to 15 net million tons per year. Our revenues per ton in the east were 12% higher than last year. While strong pricing for both thermal and met coals. Western revenues per ton were also higher. And in Australia, per ton revenues doubled due to the strong markets, and the high price met coal from the new mines. Moving down to page eight, you will see western U.S. costs per ton continue to be stable with the prior year. That's after considering 11 cents per ton of higher diesel and explosive costs, and the mix effect of adding in the higher cost of Colorado production. As with the prior quarter, eastern costs of $23.90 per ton are higher. With two-thirds or roughly $1.25 per ton due to a combination of a change in mix to increase Appalachian volumes for higher priced coals and cost to up grade to metallurgical coals. Replaced the steam coal purchase to free up committed production so we can resell the other production to the higher price met market and increased fuel and fuel expenses. The remaining increase of about 65 cents per ton is related to higher contract miner costs coupled with geologic conditions and additional repairs. Our per ton gross margins for the quarter increased 27% in the east and 9% in the west. This result is particularly strong considering that more than 90% of our production at the beginning of the year was priced in softer market conditions, and we also incurred an additional $20 million of higher steel and energy-related costs that we had to absorb in the first six months. Our Australian margins were $14 million higher than the prior year due to the contribution of the new mines and the better pricing.

You will see our trading and brokerage activities contributed $21 million of gross margins for the year. The value of this segment for Peabody continues well beyond the margin contribution. Our sales and trading group aggressively manages the contract portfolio to maximize our sourcing flexibility, and to achieve the highest profit. Our capital expenditures during the first half were $116 million, and we continue to target 2004 capital expenditures of $280 to $300 million. The targeted cap ex includes the acquired mines, and the first payment for the new Powder River Basin reserves. During the quarter, we also opened a new service operation in Australia to supplement the new met coal production from our North Queen Yellow Mine in Queensland. Turning now to balance sheet on page 9, you will note the effect of our recent acquisitions, you will see our strong cash balance of $329 million, and our net debt to net capital ratio is at the lowest level in recent years. We've posted excellent results for the first six months and continue to position the company for growth. Looking forward, Peabody has strong upside to the excellent markets. We have 45 to 50 million tons of 2005 production unpriced. And 95 to 105 million tons in 2006. We have high confidence in our operations; we expect strong demand in pricing, and contributions from new mines to overcome external cost pressure, and transportation issues. As a result, I am pleased to report that Peabody is once again increasing its EBITDA targets for the full year to 540 to $565 million, and our earnings per share targets to $2.25 to $2.65. And we are targeting third quarter EBITDA of 140 to $150 million. And EPS in the 45 cent to 60 cents per share range.

In summary, we expect a favorable markets to continue. And we look forward to an even stronger second half of 2004. At this time I will now turn the call over to our chairman and CEO, Irl Engelhardt. Irl?

Thank you, Rick and good morning, everyone. I plan to briefly cover a few thoughts about the coal markets and then discuss several Peabody growth initiatives. Beginning with the markets. Our earnings release describes the higher year on year demand in prices for all forms of energy. The booming economies in industrialized countries create that demand and those high prices for those other forms of energy, and the high prices motivate buyers to find a reliable low cost energy solution. And they're increasingly finding that coal is that solution. In 2003, we all began to realize that the very large economies in both China and the United States were beginning to strengthen. And we later found that those improving economies also boosted other economies. In 2004, we now see steel mills and generating plants in Pacific rim countries operating at high capacity levels. In China, we see increasing coal use of about 15% per annum, and that is largely due to new and electric generating plants and also due to the very strong industrial market demand there. China's ongoing investments in industrial plants should continue at a very strong pace, and we expect those investments to boost Pacific rim economies for many years to come. The U.S. economy is also very strong. And the U.S. industrial sector is expanding faster than the economy as a whole. That point is important since the industrial sector consumes low cost electricity from coal on an around-the-clock basis. We are nearing the first 12-month milestone of the Chinese and U.S. economic rebounds, and many markets around the world are having difficulty meeting the coal demand. Many reasons exist; overloaded rail and port systems, uncertain environmental rules, court decisions restricting Appalachian production, very low customer stockpiles, and some producer bankruptcies. All of those issues create very tight market conditions. We see buyers responding in very innovative ways. They are using nontraditional coal supplies for their plants. For example, new Pittsburgh 8 coals are being considered for steel plants and steel-making purposes. Powder River Basin coals are moving to New York, New Jersey, the Carolinas, and even Chile, very nontraditional markets for them. And sulfur dioxide emission allowances are being used to substitute mid and high sulfur coals for Appalachian coals and there are numerous other changes that are occurring in the international markets.

So where are all of those market issues taking us? Well, we believe there are several developments that provide near and long-term promise for the coal industry. First, customers are relearning the value of reliability. Reliability of individual coal producers, and reliability of the coal industry as a whole. Second, customers are experimenting with new coals in many of their units, and that activity may open new markets for certain products. Third, we see large investments being made in the U.S. coal plants. And that insures that our country will benefit from cleaner, low-cost electricity for many decades. And fourth, we see coal gasification that is receiving new attention. It is receiving that attention because parties recognize the need for energy independence in America, and it is receiving the attention because owners in natural gas generation are looking for ways to be profitable.

We believe there is an increasing recognition that coal is the key to solving America's natural gas problems. Generators are investing billions of dollars in emission control technologies, and new generation, and that will reduce some of the demand for natural gas. Policy makers from both parties are supporting the funding of new clean coal technologies, and that will ensure that coal is used in an ever-increasingly clean way. We see significant investments in coal gasification technologies that are beginning to take place and we are encouraged by general electric's purchase of the Chevron Texaco coal gasification technology. We view that as a major vote of confidence. And for Peabody, the prospect of gasifying our 9.4 billion ton reserve base and unleashing an energy resource that is comparable to Exxon's is a very exciting prospect indeed.

Rick mentioned the accomplishments at Peabody during the first half of the year. They arise from the implementation of our three key strategies. Two of those strategies, namely running safe, low-cost operation, and adding value through world class sales and trading skill, those two strategies helped us post the earnings improvements for the past four years. They also helped us perform very well this past quarter. The third strategy, managing our vast resource position, is helping us to implement our growth plans. During the quarter, we expanded that resource position by completing the accretive purchase of mines in Australia and Colorado. The purchase gives Peabody a larger international footprint and new products and markets. We serve 18 countries on five continents. The integration of those operations is going very well, and we expect to exceed the results we targeted at the time of their acquisition. We have also announced an agreement to purchase a 25.5% interest in the number one mine in Venezuela, and this transaction would further expand our ability to serve international customers. We're using that vast resource position to also develop coal/fuel generating plans. This activity is expected to provide longer-term earning growth for Peabody. In the second quarter, Peabody's generation development activities progressed on a number of fronts. A letter of intent was signed with the group that would purchase one-third interest in our prairie state energy campus in Illinois. We also solicited proposals from EPC contractors for prarie state, advanced its air permit and moved forward on its transmission access. The thoroughbred project in western Kentucky also made progress on its air permit and its transmission access and we continue to see keen interest for long-term power sales from the projects, and also keen interest in potential partners. In summary, the good work of our employees and the successful implementation of Peabody's strategies allow management to again increase BTU's financial targets for 2004. I would end on -- with a final observation.

As a veteran of the industry, it is quite satisfying to see coal meet very high demand levels when other energy forms are struggling. It is even more satisfying to see Peabody's operations perform well when our customers need them the most and to see Peabody maintain its reputation as a profitable and very reliable supplier. So that concludes our comments, we thank you for your interest in BTU, and we would be pleased to answer your questions at this time.

Ladies and gentlemen, if you would like to ask a question, press star, then one on your touch-tone phone. You will hear a tone indicating that you have been placed in queue and you may remove yourself from that queue at any time by pressing the pound key. Also, we would like to ask that you please limit yourself to one question and one follow-up question. Again, if you would like to ask a question, press star then one and we will first go to the line of Michael Dudas with Bear Stearns. Please go ahead.

Good morning, gentlemen.

Good morning, Mike.

The question is, surrounding the Illinois basin, what kind of capacity -- you've been growing that business for quite a while, what kind of capacity do have to take advantage of some of the scrubber issues that are coming about and also some of the short falls that we're seeing out of central Appalachia production, and do you think that the high sulfur credit pricing is going to significantly limit the demand for that product over the near to intermediate term.

Mike, as we've said at various conferences, we believe that the Illinois basin products will be one of the big winners moving forward over the next five to 10 years. We expect very strong growth from that industry. What we have done, as you know, is to install a number of mines in the midwest. Most are locked up under a multi-year sales contracts. We recently completed the Willow Lake and Cottage Grove mines in southeastern Illinois and recently entered into a joint venture for a mine named Dodge Hill in western Kentucky. Those mines serve the river market and have a very high heat content. We're seeing very strong demand for those mines to substitute for the coals from Appalachia that are in short supply. And we believe that the customers are buying those SO 2 emission allowances to allow the higher sulfur coals to be burned. We also see a very strong demand for a number of the midwestern generating plants and that's good for our Black Beauty unit in Indiana and parts of Illinois, because their logical customers are running their plants very hard to wield power to parts of the country that are more dependent on natural gas. So the bottom line is the midwest is participating very well in the overall market improvement.

and my follow-up, irl, is, you know, touching on the short falls in central ap, how troubling is it for the industry to see the environmentalists, of course with the recent court win in the district courts in southern West Virginia on the nationwide permit, how much is of a difficulty is that going to be going forward to meet the energy needs of the U.S. because as you pointed out in your release and your discussions, we are going to need the coal?

Well the recent court decision is a continuation of the attack on mountain-top mining in Appalachia. As we've explained, we do very little mountain-top mining. We're largely reclaiming one mountain-top mine at the time -- at this time, and we have very little, if any, production from mountain-top mines, so the financial impact on us is very limited. Our company overall supports a return -- supports the reclamation law that says that we will return the land to an approximate original contour. And so we continue to believe that's the right thing to do. If the courts are enforcing that -- that law to accomplish that goal, generally, we support that. It does restrict additional coal production coming on stream, but this country has vast resources, and other supplies can be made available.

Thank you, Irl.

Thank you, Mike.

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

Thank you. Irl, in your press release, you reiterate that you've got a memorandum of understanding to acquire the Paso Diablo mine in Venezuela. This morning in the paper, it came out that the United States overseas private investment corporation, ruled that the expropriation of Science Application International's properties in Venezuela, basically was -- the properties were expropriated. What does that mean for you? And will you guys be trying to get OPEC insurance? And is this something that you are still committed to?

Our exact status of the purchase, first of all, we have signed a definitive agreement related to the purchase of a 25.5% stake in Passo Diablo. The state government in the state of ZULYA is one of our partners, and ANGLO is the other partner. Where we stand with the acquisition is we're continuing to do due diligence and some of the due diligence is related to the government situation. We believe that we will be received very well in that country. We've had partnerships the Peda Vasea in the past in connection with our power trading unit. I realize the government is owned by -- or is different at this point. However, we think it is a country that has great promise, and we would like to participate in. We won't do anything silly. We've announced the purchase price, and we indicated to everyone that it is a small enough price that if we would lose it all, it would not damage our company. The purchase price of 2.5 times EBITDA reflects the country risk, we believe.

We are taking some other steps to mitigate our risk that we cannot be public on. We have investigated OPEC insurance, haven't chosen to use that. The other steps are more fruitful for us. We believe there is a difference between a software and services company with a small contract with the government, I mean an agency as large as Peda Vasea and a partnership with a natural resource company that adds value through markets and through mining skills, and we will actually will have an ownership position and be a partner as opposed to a service provider, as in the case of that company. So we continue to be committed to the company. If we get it totally wrong, which we don't think we will, I believe you will find that our damage is minimal.

Okay. And then on another related question, being overseas, how do the Australian markets -- how do the Australian mines look, and we know the markets look strong, but you said in the release that 7 to 8 million of EBITDA due to railroad and port congestion. Can you break that down between railroad and port congestion, IE, how much of it is was Australia, how much of it was the U.S.?

First of all, the nature -- those that read our release and heard Rick's comments know that our mines ran very well during this last quarter. Unfortunately, they ran so well, that we actually stacked up some coal. We have some high stockpiles at locations like 20-mile and Colorado and Appalachia. And we have customers clamoring for the coal, but that's an aside. The rail and port congestion contributed at least a million tons to our lower sales. The difference between the two was several hundred thousand tons in Australia, and some demurrage, and all in all, that was somewhere in the range of 3 to $4 million related to Australia. The rest of it was here in the United States. And it probably could have been a calculated to be a higher number. But the bottom line is the mines are running very well. We have the stockpiles of coal in our mine, and that the customers need them, and the rail system can get it, give us the service, we will do very well.

Thank you.

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 about the third quarter, what you're assuming in terms of rail disruption, production, tax benefit?

Wayne, this is Rick. I mean with respect to the rail disruption, I mean it is a difficult number to pin down. We've just kind of -- you know, assumed that we won't get, you know, complete service from the rails going forward, and try to just, you know, be cautious with respect to that, Just like we did in the last quarter. We made an estimate with respect to what the rail service is going to be. With respect to the income tax benefit for the third quarter, we're looking at being fairly flat for the third quarter. I mean if you recall, our income tax benefit estimate for the year was around $20 million for the whole year. We probably are estimating now about 20 to 24 for, you know, the whole year now. It is only up about 4 million for the whole year. So it will be pretty flat next year, next quarter on the tax benefit.

And production?

We haven't given out the production guidelines by quarter. It is going to vary by region. And you know, it will be consistent with what we had this past quarter, overall.

Okay.

We expect basically to have production roughly in the same range of 56, 57 million tons, and hopefully it will allocate it roughly the same area, but you know, we will probably be a little bit higher in this particular quarter, as we catch up for some of the short falls. As you recall, we had -- we had a 16-day outage in this quarter related to the Powder River Basin. We upgraded the coal hamlet facilities, so we will catch up some coal there. So we may be up in the low 60s in total for the quarter.

Might be in the low 60s?

Uh-huh.

And as a follow-up, any timing on the Mine Mouth projects, when you might actually pull the trigger on those, and I guess Prairie States is probably ahead in the horse race?

Well both of them are moving along very well, and it is a little too quick to call which one will get over the finish line first. Basically, we are well along the in that engineering is largely done. We have bids for Thoroughbred, we're taking bids for Prairie State at the current time, we're going through the final permitting process in both cases. In the one case, for Thoroughbred, we've been going through and a very long appeal process, where environmental groups are challenging the appeal. We expect to prevail on that, and it will be ready to go. Simultaneously, we are working on transmission access for Thoroughbred which is a big project, and one where numerous parties are working very cooperatively with us. I think one of the two is likely to have the trigger pulled in the second half of next year. And as we take -- meet various milestones and take certain steps we will just keep you posted. Again, I will repeat the oft-repeated criteria; we will have a large percentage, above 80%, of the power sold under long-term power sales agreement, and we have -- will have a partner or other parties with strong skills in the construction and the management of a prep plant like this. So we will keep you posted.

Great. Thank you very much.

Thank you.

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

Hi, just a quick follow-up to the last question. In terms of Thoroughbred I think we've heard about the, you know, the search for a partner for a fair amount of time now. I'm just wondering if you happen to have a sense as to when we should expect to hear anything new on the partner. That would be just the first question specific to the partner.

Most of the partners that we're talking to are simply waiting for the appeals process to run its course or the air permit process to run its course because because those are such hard things to achieve. So my best guess, and it is purely a guess; in the next six to nine months, we should hear something.

Great. Thanks. And then just switching over to something that you had mentioned, the stockpiles at the mine, I'm just wondering if you could give us a sense as to how big those stockpiles are at the moment and if those stock piles suggest that are you going to -- it doesn't sound like it, but I'm just wondering if it suggests any changes to your production profile over the second half of the year in order to pear down the stockpiles.

Most of the stockpiles occurred, is in Appalachia, which sounds crazy because there is such shortages of coal to the customers in Appalachia, but in Appalachia, 20 Mile, and we actually will have some advanced stripping that was completed at our mines in Powder River Basin. In Appalachia, unfortunately, the rail system is largely operating on the squeaky wheel theory and you have to squeak very loudly to ensure that you get good rail service. They don't let us ever get to a stage where we're going to have to shut down the mine, but we are carrying much larger stocks than are normal. In Colorado, the same situation exists. When the service improves, we will be ready.

It is probably pretty tough to quantify the size of the, you know, the stockpiles versus normal both in Appalachia and Colorado?

It is a little difficult to call because we were taking some miner's vacation last year, I think we had four to five days of miners vacation that had already been taken in the second quarter last year. This year, most of that occurs in the third quarter, and so the stockpiles were built somewhat to help us with the shipments during the miners vacation.

Okay. Thank you.

Thank you.

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

Hi, guys. With horizon I guess up for bid, can you also give me a sense what else is out there for sale? And then is Peabody sort of outlook in the acquisition market going forward?

Well, as you might imagine, we are not allowed to, with confidentiality agreements and things of that sort, to talk about what else is for sale. There are other assets for sale, and some fair value, and some overpriced. And you would expect that there is a lot that comes on the market during a period of strong pricing like we have right now. Related to horizon, the exact outcome of all of that is very complex. We have explained to everyone that we look at everything, and I think you can tell that we're disciplined buyers, and buy at the right price. We have the luxury of growing through the acquisitions, but more importantly, we have a record of growing organically, where our large reserve base allows us to invest in greenfield projects and do very well, so we will look at everything. If we can find a good value, we hope to give you a good announcement.

And maybe just a sense -- not specifics, but is there a lot in -- up for sale in Appalachia? Or in -- or abroad? You know, if you can -- beyond horizon?

I really can't comment. If I focus on Appalachia -- I really can't comment. There is a fair amount abroad that is available. It is a big world out there, as we know.

Just to shift gears a little bit, could you give us an update on what's going on in the mercury world? Because given that you're looking to put a power plant -- you guys seem to be the best position of all the coal companies to focus on this.

Sure. As you know, the EPA proposed its mercury standards as it was required to do. Those standards have gone through a public comment period, and the EPA is probably digesting many semis of paper and public comments that have been made, and they have announced that they will push back their decision on the final standard until roughly March of next year. Generally, where the standards are, is that they use co-benefits for the existing plants, meaning if you install scrubbers or other equipment, you largely can meet the standard that's required for mercury through those. For the new plants, there is a much more stringent standard, and a number of parties like us are busy working with equipment manufacturers, and engineers, to figure out if we can meet that standard, because it is quite stringent. So all of those comments have gone in, of course you can't build a plant unless you can comply with the standards. So we're going to be careful to make sure we can. But we expect something in the first quarter of next year.

Great. Thank you very much.

Thank you very much.

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

Good morning, gentlemen.

Good morning, Steven.

Quick question for you. On the -- I wanted to address the tax asset -- the NOLs, it was a pretty big reason for you to beat this quarter. What are your NOLs look like going forward for -- and your guidance for the remainder of the year and how many years of NOL's can we look forward to?

Sure, let me just start with the big picture, Steven. We have about $700 million on a gross basis of net operating loss tax assets to utilize over the next several years and obviously how quickly we utilize those will be based on our profitability going forward so we hope to use those fairly rapidly. What happened in this particular quarter is really we had estimated that we would be able to true up some of the benefit of those tax assets during this year. We just had it focused more on the later portion of the year, but with the 20-Mile acquisition and its profitability prospects, it gave us a better view toward the future and allowed us to take essentially fully value those tax asset, and so that was about a $10 million adjustment that was, you know, in part going to be in this year's numbers anyway. So in total, we had estimated for the year $17 million roughly to 20 million of NOLs for the year, and now we're roughly estimating $25 million of NOL benefit for the year, or tax benefit really in total.

And from my perspective, this is Irl, it is a high-class problem. If you can make more money faster, and you can shield it from tax payments, it is a great thing.

And they don't expire until 2020 so it is not an issue from that standpoint. So it is a good problem to have. And once again, from a pure --as you said, from a quarter standpoint, that benefit was not the entire driver of the $16 million. So if you kind of scrape out the piece that was related to that piece, and it was positive news, you still ended up in the very high end of the range for our guidance, on EPS.

Okay. Thank you very much.

Thank you.

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

Hi, good morning.

Good morning.

If we look at the high end of your EBITDA guidance for say both the third quarter and the year, I back into an estimate about of 175 million EBITDA for the fourth quarter. I guess first of all; is that correct? And secondly, what would be the behind the increase quarter to quarter from third to fourth quarter? Is that -- would you be assuming that rail and increased shipments would be the main driver for that increase? Or would it be pricing as nearer contracts roll on?

Well, it is a combination of issue, and your math is right. It is in that neighborhood. Really, if you look at it, there is four, five issues. First, you've got the full-year contribution from the new acquisitions, in the second half.

For the full quarter.

Yeah, full second half, basically, we only had 2 1/2 months in this quarter. We also have higher volume coming out of the Powder River Basin, as I mentioned earlier. We're at a 17 -- 16, 17 day shut down at that mine, where we upgraded the coal handling facilities, so there would be some more volume. Also, if you look at the coal that we had to sell at the beginning of the year, which was very little frankly, we had sold 90% of that but most of that coal that was available was available in the back half of the year so we were able to sell some of that into the better market conditions. And we will have some additional -- we expect to have some, you know, pipeline of property transactions, as you know we usually have property gain, 10, $15 million a year, and that's what we had last year, and we're running a bit behind on that but that is just lumpy from a timing standpoint so we should be in pretty good shape.

I guess looking at 2005, given the weak PRV pricing, do you see much of an increase in volumes out of the whole region? For '05.

For '05, the region as a whole, we expect to continue its growth in '05, '06 and beyond. There were an enormous amount of test burns that will take place in the second half of the year and beyond. And that bodes very well for the demand for the region. Related to the pricing, we can't comment about that other than to note that if you're focused on OTC pricing, the very thinly-traded market, the percentage of the coal that is traded on that marketplace is de minimus when you consider that it is roughly 360 million-ton per year marketplace and growing. So there are numerous transactions going on outside of that -- that price indicator. But you can tell we -- we have a strong belief in that marketplace, as evidenced by our recent federal call acquisition, and also our upgrade in our rail loading facilities in Rochelle, North Antelope, so we think it will do very well.

Okay, thanks.

Thank you.

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

Hello.

The enormous price jump in the last couple of weeks quite sharply. Was the driver for that this sharp limit in Appalachia? Or limit on the size of trucks that were allowed on the road?

I don't know exactly why that happened. I couldn't comment on it exactly. But the -- I will just focus on the truck weight limit. That has been in place for quite some period of time. So that should not have been a driver.

Okay. But they are apparently enforcing it again?

I think it is -- well, they have been enforcing it all along. Maybe one or two parties got caught, I don't know.

You speak in your accounts of buying in tonnage to displace contract -- or to satisfy contracts. Is that fully represented in the trading? Or is that not shown at this stage? I'm just trying to get a sense as to what sort of tonnage you did replace with bought-in tons.

John, that is what I was talking about earlier. That really goes into the actual production book, for the most part. What we're doing is essentially, we have sold thermal coal that we can upgrade to metallurgical coal, so with the flexibility in our contracts we can go out and buy -- use our trading group as our -- it does the work, essentially but they go out and buy steam coal in high priced market of course and we have to take a charge to do that but at the same time we are able to sell our production into the high-priced metallurgical market.

But that 2 million ton increase in the trading brokerage doesn't really reflect the amount that you were able to --

It is not in the trading and brokerage line. It is in the production line.

Okay.

Our production coal, in our increase in metallurgical coal sales if you look at the footnotes so part of that is driven by our ability to replace what was thermal coals and transfer it into steam coal market, into the met coal markets.

Okay. Thanks a lot.

So it is all in the production value line.

Okay.

Our next question comes from the line of David Tameron with Stifle. Please go ahead.

Good morning. Quick question for you, and maybe you covered this. I apologize if you have. But in the Powder River Basin, what type of premium are you guys getting over spot there due to the sulfur content? I mean I assume you're still getting some type of premium; is that correct?

We are. You're on the borderline of talking about price information. It is a calculation, I think that everybody in the industry knows, that as the price of sulfur dioxide allowances go up, and now they're up above 600, where they were in the 250 to 300 range a year ago, as they go up, there's -- and you're shipping a .3 or 4-pound product versus .8, which is sort of the standard out there, there is a significant premium one gets so it is has risen dramatically.

$300 additional premium -- additional cost of SO 2 allowances just mathematically represents about 90 cents a ton. So a $600 price, it is $1.80 a ton, if you think about that. That's how the math works.

Okay. Very good. All my other questions were answered. Thank you.

Okay. Thank you.

Our next question comes from the line of Michael Lucas with Appaloosa. Please go ahead.

Yeah, how are you doing? This is probably pretty basic to you guys and I'm not sure you will answer it but I'm trying to understand the pricing differential in the west. You are looking at these markets and emissions that are truly trading at 600 or 500 and the comparable heat rates, I'm trying to figure out why your coal is not priced north of $10. If one of you guys could address that?

Well we can't talk specifically about pricing. But I think we have demonstrated to everyone through the -- that we feel that that marketplace is going to be very strong, and is very attractive to us through several hundred million dollars that we've invested in the latest lease acquisition, and also in the recent upgrade in our loading facility at Rochelle North Antelope and we produce the lowest sulfur coal in the region, and have an excellent view of how it is going to do in the future.

Okay. And furthermore, you guys got me pretty excited about this met coal, I was just wondering what is the amount of thermal coal you can wash in total that you could sell as thermal

Well --

I mean thermal that you could sell as met.

It is probably 6 to 7 million tons in total out of Appalachia and could go as high as 8, but it's probably 6 to right now is a good number that we really -- really has the option of being either a thermal coal or a metallurgical grade coal and right now in these markets it is a met coal.

So the total in a given year that you will be able to switch over can be 6 to 7.

Yes. Plus we also have just pure metallurgical coal in Australia of another 7 million tons.

Yeah, so it is a total of 14?

Right.

How much is it to actually wash that? What's the actual cost to actually get thermal wash and make it -- In the U.S., the product that we wash it down, it probably costs us an extra 6 to $7 a ton. So it is a no-brainer. Where are you guys seeing the current spot market, to the met coal market;is it 90 or so?

We can't say, but it is very attractive.

It is more than 6 or 7 dollars higher than steam coal.

Thank you. Thanks guys.

Our next question comes from the line of Andrew Shirley with Ivory Capital. Please go ahead.

Your EBITDA and tax benefit guidance doesn't seem to tie into your EPS guidance. And I'm wondering if there is anything unusual I might be missing? I'm using a --

It is on the back of the release that we sent out, we have the reconciliation of the EBITDA to net income for the 2004 targets. Which is required by SEC regulation G.

That is on page what, Rick?

Page ten of the release.

Yes it is, thank you very much. One other question. In your 2004 cap ex guidance, how much acquisition dollars are in that number, the 280 to 300 million?

There is not - the actual purchase price for the company is not included in the 280 to 300. It is the capital that is required to -- for the companies after we've purchased them, so the answer is zero.

Okay.

Or small reserve acquisitions I would say. Like the Powder River lease acquisition is $55 million this year, so that's the reserve acquisition, obviously, that is in there. So maybe in that regard, it is 70 to 80 but it doesn't include any of the RAG properties.

Is the 280 to 300 million a good number going forward to maintain your production levels?

I would say that is a bit -- that is probably a little higher than we would expect it to be going forward. I would say it is probably -- I think we've given guidance, you know, 220 to 260 on a go-forward basis.

For maintenance cap ex?

Maintenance and a little bit of -- you know, there is always a little bit of things that is more than just maintenance but on average that's the number.

For example, there was capital in there to expand at Rochelle North Antelope the loading capacity by roughly 5 million tons per annum. And we explained that we built the Eagle Field surface mine adjacent to north Goonyela in Australia to allow us to be reliable and also increase our shipments in these very strong met markets. So those are some of the things that we did. There were other, but those are of the two examples.

Okay. Great, thank you.

Thank you.

Our next question comes from the line of Edward O' Kinney with Vessel Capital. Please go ahead.

Hello, yes, I was just wondering if you could give us what your production levels are going to be for 2005 and 2006?

I don't believe we've announced it. I think as we have explained to people in the past, you could -- to be conservative, you could assume it is flat. Although when you look at our record over the years, it's seldom been flat. It has always been growing. So -- but if you want to be conservative, assume it would be flat.

Which is 200 to 205 million tons.

And if you look, you have a 45 to 50 million terms on price for 2005. I guess that by that price - I mean not significant, but (indiscernible) in the second quarter, could you indicate on what prices you are able to get it at relative who what the spot prices are at then?

NO. We're not allowed under the federal trade commission regulations, to talk specific prices. But we cover the marketplace as well or better than most, and tend to capture prices at the top of the price curve.

Okay. Thank you.

Next question comes from the line of Daniel Rolling with Merrill Lynch. Please go ahead.

Thank you. Irl, going back to the international market, clearly China continues to be a very big player. Their exports were down last year, year over year, they're back in the market now. Could you give us any guidance on what you're seeing in the Asian market as far as China, exporting and importing coal?

Well, our view on the -- as you know, in the country of China, it is huge, and part of their physical problem is that the coal fields don't serve the consumption base well from a -- they don't -- are not positioned well from a geographic region. So you can actually get oversupply in a coal region and be under supplied in a consumption region. And therefore, that's why you see some exports occurring when they're importing at the same time. So what we expect in that country, and we do not have a perfect crystal ball, by any means, but what we expect is that they are so short of coal at the current time with their brown-outs and black-outs and constraints on their industrial growth, due to lack of coal, that they're going to be a giant sponge for a number of years of their own production. And probably some production from throughout the Asia-Pacific region. And then the secondary effect from their strong economy is the rollover effect into the other economies of Korea, and Japan, and so on, who are providing steel and other products and services to them, and that will help their -- those other economies remain strong for quite some time. That's our belief. That's our crystal ball. Which may or may not be right. But that's what we believe.

I'm sure it is right. On DTA, has that moved back in the black? And what do you see as far as the future of dominion terminal?

Dominion terminal, for everybody's benefit ,is a large coal export facility at Newport News, Virginia. Peabody owns 30% of it. And due to a drop in the exports of the U.S. coal in the past, it had gone into a loss position, -- not huge but a loss position. It has improved dramatically due to the surge of exports out of the country. I'm not sure if it is exactly in the black or it is just simply improved dramatically, but we're very thankful that we own that stake, because as you know, port capacity in many countries is the constraint as opposed to production capacity. And having a stake in DTA, we think will be good for the long term.

Thank you.

Thank you.

Our next question comes from the line of Vladimir Josevik with Long Acre. Please go ahead.

Good morning, gentlemen.

Good morning, Vladimir.

Just a question, given the declining stockpiles in utilities and the high capacity utilization of East Coast mines, you know, it appears as though, you know, in the state, it is set for continued migration of PRB coal from west to east. Obviously, there's currently rail infrastructure issues. How do you see the bottlenecks and the infrastructure issues, you know, you know, being cleared up, just to enable increased migration of west coal out east?

We agree with your view that there will be a continued migration of Powder River Basin coal to the east. And that will create additional demand on the Powder River Basin. The railroads several years ago established a handoff from western railroads to eastern railroads that was very efficient at the time. And that procedure is still in place. The problems that the railroads are experiencing are within each of the rail systems, and relate to a number of different issues, but simply, the improved economy and all the industrial activity is putting a huge strain on them, and that causes congestion, and the service issues we're talking about. We expect they will clear that up. We expect that they will continue to be able to execute that handoff from the west to the east efficiently. And as they clean up their congestion over time, that that will allow a move from Wyoming to New York or New Jersey, which we see right now to be fairly efficient. But since we're not in the railroads, we can't predict exactly when that is going to happen. But you're -- we agree with your premise. We think it will be efficient for the long run. Maybe not the short.

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

Thank you. The sulfur credits have gone to very, very high levels as you mentioned earlier. Can you explain that impact it has on you? Presumably there are some pluses and minus, could you sort of go through whether that is good for you or bad for you or maybe both?

Well on balance it is good for us. Because we capture it in the Powder River Basin pricing that is on price. Generally, most of our high sulfur production goes to scrub units or units where the customers provide the credits. We have one small case where we provide the credits. And of course, it is bad and reflected in our overall guidance. I think on balance, though, it is always worth reminding you that 80% of our output in our sales are in low sulfur. So on balance, it is a very good thing for us.

Okay. If I could follow up, that makes a lot of sense, but so far, the Powder River Basin coal has surprised us by not having been very responsive on the price end. So with the price having gone from 200 up to 600 for sulfur credits, the PRB market seems to be ignoring that. I know you can't talk about pricing, but can you talk about concepts?

First of all, I will remind everyone that the OTC market is generally for a .8 pound SO 2 product, 88.8 pound. We ship a .3 or a .4 pound. So we have a premium we receive. But more importantly I would remind that you that price is in a very thinly-traded market. And is -- as that overall market is 360 million tons, so there is a huge amount of business that is taking place outside of that marketplace.

And also, what you see, Wayne, in the pricing right now for the OTC is for '04 delivery, but if you look forward in that same published OTC market, as to what the pricing is for '05 delivery, when it is expected that the folks can get the coal to the transportation system, you will see a substantial increase. That market is in pretty sharp contango, even in the OTC market looking out towards '05 which is really much more important to us than what is happening today in the '04 market.

Great. Thank you.

Thank you.

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

Hi, good morning, guys.

Hi, Steve.

Quick question on Australia. The government, I guess last March, instituted a test system in the New Castle port to try to get some of the demurrage down and get some production out. It seems that the system is keeping back production from the market. I just wanted to get your comment. I think EHP was complaining about it a little. I just wanted to get your comment os than.

First, we ship only a few hundred thousand tons per year through New Castle. Our primary ports are Gladstone and Dalrymple Bay up in Queensland. So it is not a big issue for us. And I think the -- it really doesn't apply to us. So I think BHP is the best, or the others that ship through Rio or some of the others that ship through New Castle to answer your question.

All right. And then --

I wouldn't give you an accurate or a proper answer.

Okay. What can your Australian production do next year as far as increases over 2004?

Well, we haven't provided specific guidance about individual mines or segments at this time. We have owned the assets for about two -- going on our third month right now. We've done this -- we've focused very hard on the safety issues at north Goonyellla and making sure that we can -- we know it is the absolute safest mine in that part of the world. And as we do that, there is a natural improvement in the production, and in the last month or so, it has performed its best for the year. We have added the Eagle Field surface mine. And we did that to make sure that groonyellla was reliable. Assuming we get north groonyellla improved then that provides us excess capacity to sell into the marketplace. So once we get a little better handle on how they're going to perform, we will provide you with that guidance. We're taking steps to improve. Just too early for us to commit to you that we can do it.

Thank you.

Thank you.

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

Yeah, high. I know this issue really didn't affect you too much, because you talked about, you don't mountain-top mine, but did you get -- did you have any of your permits revoked from the district judge ruling last Friday? No. And we have had -- in the last five years, very few problems ever getting a permit in Appalachia. It is because of our environmental record there. Which is quite good. Maybe you can patent that and sell it to the other guys. Going forward, into next year; there any -- is there any big mine, or any production, major production that is going to be exhausted into 2005?

The only -- in 2005, the only question we have is whether the Black Mesa mine in Arizona continues to operate past 2005. But we have no major mines -- wait, we have the Harris mine, excuse me, in West Virginia that is going to run out of reserves, and we're busy trying to figure out how we follow along in another reserve area with that. That's the only one. It is about 3 million tons a year.

Is that met or steam?

It is met.

Okay. Great. Thank you.

Thank you.

At this time we have time for one additional question. That will be from the line of Daniel Rolling with Merrill Lynch. Please go ahead.

Hi, Irl. With all the questions on railroads, it has been a while since we've heard any commentary about the third line, the new railroad out of the PRB. I know they're having permitting problems, and just wondering if have you any kind of update on it or any thoughts on it?

I have no new information on it, Dan. I'm sorry.

Okay. Thank you.

Thank you.

Mr. Vic Svec, please go ahead with any closing comments at this time.

This is Irl Engelhardt, and I will wrap up by simply thanking everyone for your interest in BTU and your strong support and we look forward to achieving the targets that we've laid out for you, and hopefully exceeding them. So thank you for your support.

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