Peabody Energy Corp (BTU) 2006 Q4 法說會逐字稿

Welcome to the Peabody Energy quarterly earnings conference call. (OPERATOR INSTRUCTIONS). As a reminder, today's call is being recorded. I would now like to turn the conference over to the Senior Vice President of Investor Relations, Mr. Vic Svec. Please go ahead, sir.

Good morning everyone. Thanks for taking part in the conference call for BTU as we discuss another record year. Today CFO and Executive Vice President of Corporate Development, Rick Navarre, will review our results and outlook. President and CEO, Greg Boyce, will discuss the markets and several key initiatives.

Forward-looking statements should be considered, along with the risk factors that we noted at the end of our release, and the MD&A section of our 10-K. I will now turn the call over to Rick.

Good morning everyone as well. Today I will review 2006 results and our outlook for 2007, before turning the call over to Greg.

2006 was Peabody's fifth year in a row record results, and we are targeting our sixth for 2007. Let me review some of last year's highlights. Our full year earnings, excluding the new Excel operations, exceeded $600 million, or $2.29 per share, a 45% improvement.

We increased our earnings from all business activities. We began integrating and benefiting from the Excel acquisition, which greatly raises our access to the growing, high margin global markets. And we were added to the S&P 500 Index and recognized as one of Forbes Platinum 400 Companies for the second year in a row.

I will start the financial overview with a high-level look at our income statement. Full year revenues climbed 13% to $5.3 billion on higher volume and pricing in all regions. Our EBITDA rose 24%, and operating profit increased 28%. And our net income rose 42% to just over $600 million on earnings per share of $2.23.

All of those income statement metrics established new Peabody records. You'll recall that we offered earnings targets last quarter which excluded Excel. For the last two months Excel contributed sales of 2.1 million tons, $105 million in revenues, and $20 million in EBITDA, with just a slight offset to earnings per share of $0.06 driven by interest and debt retirement charges.

I will now move to the supplemental data. You will see our significant revenue increase was turned by both increased volumes and pricing in all producing regions. As we have said before, we believe there is an optimal mix of pricing improvement and production growth, and Peabody was very successful in achieving and balancing that in 2006.

Last year at this time we estimated that U.S. costs, excluding growth in sales taxes, would increase approximately 5%. The overall U.S. costs increase on this basis was in the 7% range, but would have been less than 5% after the non-recurring equipment challenges we discussed in October and record high fuel prices. Those equipment challenges are behind us, and fuel prices are moderating.

With the Eastern United States our cost per ton increases were driven by production taxes and ongoing industry challenges related to mix changes, fuel and contractor performance. Looking to the West, we remain very pleased with our cost performance. In fact, cost would have been down absent higher sales-related taxes and the challenge we mentioned earlier at Twentymile.

Our capital for the year came in at $478 million, well in line with our expectations. You will see that we are exercising capital discipline as we target 2007 capital of $450 million to $525 million, which includes the $100 million of developmental capital to complete the buildout of Excel operations in Australia. This level is comparable with last year, but for a much bigger company.

In addition to the Excel capital, some of the larger projects this year include a new dragline, an overlook conveyor system, and our largest operation, North Antelope Rochelle. These systems will increase the mine's productivity more than 10%, while lowering annual needs as much as 16%.

Now turning to the balance sheet, you will see that it reflects our fourth quarter acquisition and financing of the Excel purchase. The financing includes a mix of prepayable term loans, medium to long-dated bonds, and low-coupon, high premium convertible bonds.

Now I would like to turn to our outlook. Peabody entered the year in an outstanding position to continue to create the long-term shareholder value you have come to expect. We have a number of initiatives in 2007 to enhance our growth, which Greg will discuss further.

As many of you know, Peabody's business model is designed to make money in all market conditions. And we accomplish this through a low-cost operating platform and contracting discipline. As a result, we are once again targeting strong and improving results for 2007. We expect increased pricing in the United States based on contracts that we've signed in recent years. This is occurring mostly in the West where the realized price per ton will grow as much as 20%, led by a 30% rise in our premium PRB coal pricing year-over-year. This impact will more than offset $175 million of lower met coal pricing, labor expenses and post-retirement benefit charges.

As the year progresses, Peabody will increasingly benefit from the Excel transaction, with EBITDA contributions of $160 million to $180 million. Much of this will come in the second half as we complete new mine development and expansion projects. We expect Excel to be slightly accretive to earnings in 2007, and much more meaningfully accretive to earnings in 2008.

Overall Peabody it is targeting 2007 EBITDA as much as 34% higher, with EPS growth of up to 23%. Our EBITDA is targeted in a range of $1.2 billion to $1.45 billion, with earnings per share estimated at $2.10 to $2.75.

Our results will be sensitive to transportation, the ramp up of production and operations in Australia, and the timing of production and shipments of high margin business, particularly met coal. Our quarterly results in 2007 are likely to be shaped by planned customer outages in the spring, and the ramp up of the benefits from Excel in the second half. And finally the realization of potential tax benefits will have some variability in our numbers.

In summary, we delivered record results in 2006. We're targeting even better results for 2007, and we have a tremendous platform for ongoing value creation. With that summary, I will now turn the call over to our President and CEO, Greg Boyce.

Good morning everyone. Rick has reviewed our record year, and we're targeting even better results in 2007. The global markets are strong, long-term U.S. fundamentals are compelling, and Peabody is best positioned to deliver the results as the only pure play global coal investment.

As we begin a new year with the acquisition of Excel Coal, it is worth noting that Peabody now has a major global presence. So going forward you will see us discuss separately the seaborne thermal coal, international met coal, and U.S. coal markets.

Our analysis of today's energy markets leads me to emphasize several points. First, global energy needs and an increasing interest in energy security are driving more economies to expand their use of coal. Coal has been the fastest-growing fuel in the world over the last five years, and we anticipate this trend will continue.

Second, global coal pricing for most products is well above the levels of a year ago. And third, the near-term U.S. fundamentals actually create long-term opportunities for a strong Company like Peabody.

Now let's look at the various market segments. China's thermal coal prices have shown sharp recent increases. And China may cease to be a net exporter of coal within the next several years. Overall, coal demand continues to grow throughout Asia. As a result of these two factors, Australian thermal coal pricing continues to rise, with the Newcastle Index prices up more than 20% in just the last three months.

Global thermal markets will be even tighter but for the mild start to winter in Europe. But even so, third quarter electricity from coal rose 25% in the UK, while power from natural gas fell 11%. Global steel demand grew another 9% in 2006. This resulted in hard quality coke and coal reference prices remaining near triple digits, while the PCI coals appear stable with last year.

Long-term coal growth will come on several fronts, generating plant running at higher capacity, new plant that are under development, global steel demand, growth in expanding markets for coal-to-gas and coal-to-liquids. All these trends increase the value of our recent investments, as we are well-positioned to benefit from global coal growth. Peabody has now established itself as a major player in Australia, the world's largest coal exporting nation.

Now looking at the U.S. coal markets, clearly the near-term markets reflect the high inventory levels that have been reported. In recent years we have seen how quickly coal inventories can build or drain based on the economy and weather. We all remember the reduced stockpiles of 2005, and we can now see the difference a year makes.

Looking to 2007, EIA expects more than 20 million tons of added demand, yet a decline of more of 30 million tons of production, providing for a draw down in inventories by year end. These cutbacks are already underway. And we agree with EIA that the U.S. markets will strengthen through the year as the full effect of announced production cuts and a return to normal electricity demand patterns take old.

Turning to the long-term U.S. market, the U.S. EIA continues to forecast that coal's long-term share of electricity should grow to 57% from approximately 50% today. And bipartisan support is growing for coal conversion technologies. These are new markets for coal that could dramatically increase demand.

Now in response to these very different market conditions, Peabody is taking a number of decisive steps. We are expanding where markets and margins are the strongest. On a global front in 2007 you will see us complete the late stage developments in Australia and expand our trading activities in Australia, Europe and China.

We have a much stronger operating base following the investments of recent years. And we're tightly managing our cost structure through a formalized operations improvement program. We are limiting production growth. You will remember, we lowered our growth plans in the PRB by 7 million tons last October. And we continue to evaluate production levels across our U.S. portfolio to match demand.

We are exercising capital disciplines. As Rick noted, our CapEx this year will be similar to 2006, even though we are a much larger Company. We're using our sales contracting strategies and coal trading opportunities for optimal results. Our backlog of business offers great sourcing flexibility as we maximize value.

In closing, Peabody's outlook remains outstanding. Our international presence is growing at precisely the right time. We are intensely focused on operating improvement, cost control and capital efficiency, and we're taking the necessary steps to address near-term U.S. market conditions and position ourselves for the long term.

I would like to thank Peabody's 9,000 employees around the world for another year of record results, and a new year that we're targeting to be better yet. At this time we would be happy to take your questions.

(OPERATOR INSTRUCTIONS). John Hill, Citigroup.

Just a quick general question. In taking steps to address near-term imbalances in the U.S. market, what would it take for you to consider significant cutbacks in Powder River Basin production, not just the ratcheting back of growth, but really sending a strong signal to the market? And how do you approach that?

First, let me say that all of our planned Powder River Basin production for 2007 is already under sales commitments for this year. When we took the step to reduce our growth last year, that was really the unsold position that we had. Our plan right now is to meet all the sales commitments that we have and not to expand beyond that in 2007.

Understood. I still think that would -- even in any out periods -- send a very, very powerful signal that has been to some degree lacking, as there is a perceived competition between basins for market share.

I might add, I will also remind that we did defer the development of School Creek as part of that announcement. And we will obviously continue to watch the market conditions and see how they develop as we go through the engineering and permitting scheduling for School Creek.

Very good. Then just a quick follow-up. The Resource Management or asset sales numbers included in EBITDA guidance ranges for the year?

This is Rick Navarre. As we look forward, obviously that is a continuing element of our business. It has been for a number of years. And we had a pretty strong year in Resource Management in 2006, driven in large part by higher demand levels and higher reserve evaluations, of course.

As we look towards '07, it is always difficult to predict this area because it is a little bit lumpy at times. But I guess if I was to give you an estimate for the guidance for Resource Management, I would use about $15 million a quarter, so $60 million to $70 million in total for the year.

David Gagliano, Credit Suisse.

Just quickly on the 2007 -- on the 2007 $1.2 billion to $1.4 billion EBITDA, can you provide a little clarity in terms of the operating assumptions that are behind that target range? I know in the back there is below the operating line some assumptions, but I am wondering regional price expectations, regional cost expectations, volumes, etc.?

It is Rick. I think some other things -- the guidance that we have given you in the press release with respect to pricing expectations from an operation standpoint, I think you heard us say that we think the Western cost will go up -- Western prices, excuse me, will go up 20%, driven by as much as 30% increases across the PRB related to contracts we signed earlier. So I think you can take that and use that as a guidance for the West.

On the East, obviously the prices are a little bit driven by what is happening in the market today, as well as metallurgical coal pricing. So I would have to think about that a little bit differently. But I think a couple of areas that I would have you take particular note of, as you are trying to figure out the model numbers, is that what we have seen is why some of the numbers are a little bit higher on the consensus side is because of DD&A will be much higher than it has been in the past because of -- for two reasons.

One, capital costs have risen some 20 to 25% over the last three years and that is driving through DD&A, coupled with the acquisition of Excel, which the purchase accounting allocation will drive DD&A up over $100 million over prior year levels. I think that a something to focus on.

I think your interest costs are something that you need to make sure you get focused on to get that correct after the acquisition of Excel. And, of course, we mentioned in our release that we will have higher health care charges as well as retiree healthcare cost of some $75 million.

Fair enough. Let me just try and -- another way. You said you priced 12 million tons of '07 production in the fourth quarter. I realize you had commitments in place for the PRB. Was any of that -- can you give us a little more breakdown on the 12 million tons that was priced for 2007 in the fourth quarter, regional and prices of the commitments by region?

Obviously we were selling -- it is a mixed bag. Most of this was under price reopeners. And I can, without naming particular contracts, we were fortunate that one of the price reopeners was at a very nice $17.50 dollars for 5 million tons. So in other cases the price reopeners may have been different pricing, but it is a mixed bag, and that is what is leading to our higher 30% overall for 2007.

Just the last question. Can you expand a little bit on the $38 million benefit that flowed through the results in the fourth quarter?

$38 million benefit as a it relates to -- which line item are you talking about?

I believe it is on the net gain on disposal or exchange of assets.

That is just the ongoing Resource Management business. Obviously, as you know, and you have followed us since our IPO, we are both a buyer and seller of coal reserves. And we are portfolio manager, and we basically sold some reserves that we felt were worth more to someone else than they were to Peabody. And we didn't expect to mine those particular reserves anytime soon, so it was just a normal sale. And as the market -- the band has increased -- the value of reserves has increased as well. So it was a good sale for us out of Western Kentucky.

Michael Dudas, Bear Stearns.

Greg or Rick, do you still believe that spot PRB prices are divorced from what current contract terms should or could be?

Absolutely. From our perspective I can tell you they clearly are. Not only is that our marketing strategy, but it is also the actual results that we have obtained in terms of the contracting business that we have done throughout the entire course of 2006.

The volume our of Wyoming certainly increased quite dramatically in '06. Can you comment a little bit about rail embargoes, or lack thereof? Would you anticipate that the basin is set up -- like you indicated examples of a 10% productivity growth out of the North Antelope Rochelle I assume with some of the investments that you're making. Do you anticipate that is going to happen throughout the basin, or will we continue to see those types of volume numbers out of the Powder River Basin to penetrate some of those Eastern markets?

A couple of points in your question. First, I think is how the rail performance -- we sought a markedly improved rail performance in the fourth quarter last year. We anticipate that that performance should continue during the course of 2007 as the railroads do complete some capital improvement programs during the first half of this year, leading to higher rail performance in the second half of the year. We clearly have built all of that into our production forecast for the year.

As it relates to the capital improvements in North Antelope Rochelle and those productivity improvements, when you get those kind of improvements you have two choices. You can, if the markets are strong, produce obviously more coal and increase your sales. Or at times like this, you focus on taking that productivity and translating it into much lower cost. As Rick talked about, we will be reducing our field burnout there because of the new dragline and the overland conveyers. And in addition by increasing our productivity, holding our volumes essentially at our forecast, we are able to translate that productivity improvement into cost reductions we should see through the course of the year.

So you anticipate better margins on whatever commitments you get out of that?

Absolutely.

When you look at 2007, I would expect, even if you're at the midpoint of the range, the Company should generate a significant or healthy amount of free cash flow. Could you maybe portray how Peabody, given the leverage that was taken on Excel, and that you do have I believe a share buyback program -- I don't know how active -- I'm sure you weren't active at all in the fourth quarter -- how the Board is looking at that -- those opportunities through 2007?

Yes, it is a balance. We have to balance all those opportunities, dependent upon where we see the value, where we can create the most value for the Company. Clearly we took on some debt in the Excel acquisition that put us at a bit higher leverage. Certainly a very manageable number, but one that we had told our debt holders that we would like to bring back down our debt to cap ratio into a more flexible range, more in the 40% debt to cap than where we are at in the high 50's today. So we will be responsive to that.

At the same time we have also -- we will look for opportunistic times to buy back stock. We did buy back last year roughly $100 million under our share repurchase program. We were mostly blacked out in the fourth quarter during the Excel transaction, so we couldn't do much activity then.

But we will look for opportunities to do that as well. And of course we will continue to look for opportunities to put capital to work in the acquisition side. If the right transactions are available, at the right prices, and if this market creates some bargains, we will also look at it.

My final question is, Greg, could you share your thoughts on some of the indications relative to production declines that occur east of the Mississippi? How aggressive do you think the market will be relative to putting some of the tonnage and shutdown some mines, given that where spot and and term prices for central/upper Eastern coal are right now?

My own view is that we will start to see those types of production declines accelerate. During the end of 2006, you would have seen people continuing to ship under the sales commitments that they had, would have been shipping under higher prices that they would have booked in earlier timeframes. But once the clock turned January 1, if you look at the most recent data, we are already starting to see loadings and shipments fall off in the first couple of weeks of this year. Expect that trend to continue. We are seeing people and we're doing it ourselves -- reducing the amount of over time, not working the weekends. Basically taking the steps, in addition to shutting down units, to reduce the volumes and make sure that the stockpiles continue to stay managed.

As we look at what is available, or what inventory levels say at the producers side throughout the East, we do not see builds up of inventories at this point in time. And that also comes at a time when production levels are declining.

Jim Rollyson, Raymond James.

Greg, can you talk about, I guess, in relation to the PRB you're trying to be somewhat moderate and working with the market conditions and scaling things back. And obviously some of your competitors out there have said the same in the last quarter. If everyone sticks to that, if conditions stay where they are, and the rail ramps up like it is projected to do, do you think they will go back to taking test burns on the East Coast?

In fact, I think -- I will say that during the fourth quarter we saw at least one of the Western railroads actually delivering a number of test burns into the East Coast, upwards of close to two dozen test burns that we're aware of. That has already started, which is a very encouraging sign, not only in terms of rail performance, but also for the continued strong long-term additional growth in the Powder River Basin. The railroads continue to forecast significant increase in coal demand our of the PRB over the next five years, and there building up the railroads to handle that volume.

The second question, I guess, [Kasaw] on the previous call here an hour ago kind of quantified roughly what the impact to unit costs were going to be from their UMWA negotiations. Can you talk about where you see your costs relative, number one, to the UMWA contracts, but just in general kind of cost inflation for '07 versus '06?

I don't have the benefit of their knowledge, as they negotiated specifically that agreement. I will say that clearly we're still in discussions with the UMWA. It wouldn't be appropriate for me to talk specifically about cost, timing, where we are at or the impact. Suffice it to say that with all of our budgets and all of our forecasts we have built in what we believe were appropriate levels of labor and health care and retiree benefit costs across our entire platform, both in the U.S. and Australia. So we believe that in terms of our guidance and forecast and plans we are well covered.

Rick, you mentioned positively being in a position for some tax rate benefit help through '07. It is kind of hard to gleam much from the Q4 number. Any thoughts on a tax rate for '07 in your numbers?

Sure. As we look forward to '07, and obviously we had -- some of the benefits we received in '06 were driven by the fact that we were able to more fully value tax assets as we have had more visibility to future profits. That was driven because we signed two major contracts in the fourth quarter. The TVA contract being one of those, which was $1 billion contract, a ten-year agreement. And the one I mentioned earlier in the Powder River Basin having signed. So that gives us greater committed visibility to profitability, which allows us to realize the tax benefits that we have in our portfolio.

As we look to '07, there's a lot of moving parts of course as to whether we will be able to realize that same level of benefit. But assuming that the markets cooperate, and the operations run well, and a number of other things we could be in a position to actually have the benefit. As you saw, our Reg G guidance is attached to our press release. And that would show that we expect a benefit in the fourth quarter to drive an overall benefit of between $61 million to $135 million benefit for 2007. Now we would say after 2007, if we achieve those results, we would expect then to, from a tax standpoint, probably be about 18% tax rate in '08.

Thank you.

We will have exhausted those [guidance] benefits.

Shneur Gershuni, UBS.

Greg, just I guess a follow up question to John's earlier question. Just with respect to inventory levels, based on your prepared comments and so forth, it appears that you believe that production costs in [Easter] are going to help bring down inventory data. And if we choose to believe EIA's forecast of consumption, that will help bring down the surplus.

Do you think, not specific to Peabody, but there needs to be some sort of a production cut from some of players in the PRB? I understand that you're committed for this year, but does it need to come down a little bit to help make PRB a little bit more competitive and tighten up supplies a little bit?

I think as we look at going through the course of this year, if we see, which we believe we will, the production cuts in the East, we see the demand return to normalized levels based on electricity demand returning to normalized levels, we see the situation across all of the coal markets strengthening through the course of the year. So with what has already occurred we believe -- and we have already seen that, I think, in terms of what is happening and some of the market indexes, we are seeing the markets begin to rebound.

Just with respect to cost, I know that you said that you're going to target productivity improvements and so forth to help drive down cost, but net net do you actually see the cost inputs flattening or declining over the next year or so?

I think it would be have it in a declining mode. While certain variables in our cost structure will -- certainly we will be able to improve through our initiatives that we have going forward, we're going to be challenged like any other company. As we look to our Western operations, you will see all the companies in the Powder River Basin are moving towards increasing ratios. Obviously, that drives up your cost structure, your consumption of commodities, of course everything along those lines.

It will be difficult to see a year-over-year decline. But I certainly think in the West that we can do a pretty good job if we do our -- to probably hold things, with productivity pretty flat in the West, and on overall basis within a 5% range or under, because it would move forward for the whole portfolio. Subject to, of course in the West we will have higher royalties and taxes related to our 30% price improvement. But that is a good cost.

Just with respect to the buyback, how much is left in your authorization for shares to buy back?

We have $400 million roughly. It is more of a percentage authorization, but in dollar terms it is about $400 million of a $500 million program.

Given the fact that you're holding CapEx flat, does it make sense to go back to the Board to seek a higher authorization this year?

It is something we continue to look at. I think right now as our focus in the fourth quarter was getting all the financing in place to complete the Excel transaction, and if you have followed us for a long time, you know we don't sit still for very long. So we will probably have some things moving and shaking in the first quarter and the second quarter as well. We will be talking the Board about all those things.

Justine Fisher, Goldman Sachs.

I just have a couple of questions, first about the Australia operations. I know I ask about this all the time, but it just seems that the numbers fluctuate pretty wildly there. And if we look I guess at the revenues and the cost in this quarter versus previous quarters, the revenues are down, I realize because you're selling more thermal coal out the acquired Excel operations. But the costs also are lower than they have been in previous quarters. I was wondering if these are levels that we can start to be more confident in going forward, regarding where the revenues and more specifically the costs would be?

I think as you look at that cost side of the equation with Excel, if you remember we said with Excel we were buying a larger surface -- primarily surface operation group of assets. They are inherently lower-cost, and will continue to benefit the cost structure in Australia as we ramp up the production levels from these larger surface operation.

So the low $40 per ton is where we can expect it to stay versus -- I think in previous quarters it has been significantly higher, obviously pre-Excel.

I think there are a couple of things there. I think one is getting the North Goonyella operation back on track from the earlier points, with broad cost structures back in line for the metallurgical operations in Queensland.

And you're absolutely correct, that we have lower-cost operations, mostly surface operations, that we acquired in the Excel transaction, which will bring our cost structure down into -- certainly probably once we get operations in full stride, probably we would expect that number to be slightly under $40 potentially, so just slightly south of $40 on an overall basis for the cost.

But under $40 though is kind of an '08 event?

In '07 we will be $40 to slightly less, I hope in '07, if things ramp up according to plan, on time. Because these operations, once again are significantly -- they are low-cost assets that we acquired. For example, the Wambo Open-Cut mine is the second most productive mine in Australia. The new Wilpinjong operation that we're opening up -- it is already operating, but it is not at full stride yet -- has a very, very low stripping ratio and we expect it to be very low-cost operation.

And then again on Australia, I know that your press release said you had 14 million of uncommitted tons to sell out of Australia in '07. I'm realizing that that is just because most of the sales that go on there are spot sales, but could you break that out between met and steam coal please?

Yes, it is probably roughly about 6 million tons of thermal coal and about 7, 7.5 of met coal.

I think I would like to follow-up on your point, which you're absolute right. We call it uncommitted and unpriced because the way the business transacts in Pacific Rim, you have a general frame agreement for multi-year placement of tons. But until you go through the annual negotiation, you don't define the exact number of tons nor the prize until you conclude that negotiation.

While we know where all of those tons are likely to go under our pre-existing agreements, the exact volumes and pricing we have not set yet, because we have not yet concluded all of those negotiations. That is why it really shows up as that level of unpriced and uncommitted.

But for sure it is a different market dynamic.

I guess I would make just one other point just on the uncommitted component of it. Obviously, as you look at the thermal component, and you start looking, and you look at what is happening there -- since we acquired the operations the prices for thermal export coal out of Australia was in the 40s, now we are seeing a number that is in the low 50s. So we're pretty pleased with the pricing levels for thermal export coal right now.

With regard to the U.S. met coal market, where are you guys seeing met coal sales in the U.S.?

We've got -- most -- a significant portion of our U.S. met coal sales have already been committed for the year.

Just as a benchmark. Those aren't numbers that are published all the time, so I guess we just ask most of the producers so we can get a roundabout of where they appear to be taking place.

Yes, I would think you would see them comparable with where we have been, you know, that $75 to $80 range.

David Khani, FBR.

Rick, it is the end of year, so I'm going to ask you the standard question on discount rate and medical inflation rate. Where does it stand, I guess, heading into the new year?

6% across the -- is what we have used -- we had to use for a national standpoint. That is up from 5.9% last year, with just a slight movement frankly in the discount rate on all of those actuarial estimates.

How about medical inflation assumptions (multiple speakers).

It is at 7.5%, consistent with the past. And our actual costs have come in pretty close to those volumes. Actually, if you go back three or four years our average for the last three or four years has probably been significantly less than 7.5, probably more in the 3% range. We have probably -- we have outperformed the market in cost control. This past year it was just more near the 7.5% rate. I guess on pension returns -- do you want me to keep going?

Yes, you might as well.

Our assumption continues to be 8.75% our investment returns. This year we had a 14% return in the portfolio.

How does that new FASB ruling impact you?

The 158?

Yes.

Just for the folks on the call, the 158 is the new requirement that requires you to fair value post employment liabilities, such as retiree healthcare. From our standpoint, what it did for Peabody was it required us to, because of all the discount changes in the last three or four years, we had unrecognized or unamortized liability. And so the $375 million, the $376 million number -- it is in a footnote on page 9 of our release, but it is --.

It is. Okay.

But it is $376 million of increase in other liabilities on the balance sheet, with an offset of about $225 million to equity, and the rest going into deferred taxes.

Could you give us in the fourth quarter the breakout U.S. versus Australian?

We also have that. You'll see it is in the footnote on our supplemental financial data, where met sales totaled 3 million tons for the fourth quarter, 12 million tons for the year.

Footnote 1 on page 8.

But do you give the U.S. versus Australia?

We don't, although we are now a little more heavily weighted toward Australia, particularly with the Excel acquisition. So if you look at us as having, for instance, in '07 probably 10 to 12 tons, 1 million tons of met out of Australia, whereas we're in kind of that 6 to 7 range in the U.S.

Are you -- in this environment are you experiencing any push back on shipment deliveries?

I think as you -- right now we're moving everything that we're producing. Obviously when you go through these early stages of negotiations there is always a little bit of positioning, but we're moving our product and not seeing any major push backs at all.

Moving over to acquisitions. Now obviously you just did a big one, but if the balance sheet was in great shape or you would want to use your equity, in either case, where would you go next, U.S. or international?

We continue to look for good acquisitions anywhere we can find them. We don't necessarily say that we've got a preference for either Australia or the U.S. The opportunities for us have been in the Australian marketplace of recent. But again, without getting any more specific other than to say, if we can find accretive acquisitions in either marketplace, we would pursue those. And I think our balance sheet and all of our financials are certainly strong enough for us to look at any opportunity that comes before us in the near term.

Last question here. Mongolia, what sort of -- what do you think you're going to get out of Mongolia? I know it is very early-stage, but we don't know much about Mongolia, so --?

Mongolia is what we would call an emerging player in the coal markets. I would liken the situation in Mongolia to looking at, say, the Powder River Basin of this country 25, 30 years ago. Significant quantities of very good quality both thermal call and to some degree met coal. Primary markets would be the Chinese marketplace for both coal deliveries into China, as well as potentially mine mouth power stations in southern Mongolia to feed into the Chinese grid.

So what we are doing is obviously early days, becoming a player in the Mongolian prospects. But as you point out, these would be longer term. It would be participating in what potentially on a global basis would be the equivalent of a Powder River Basin or an Australian coal field.

The quality of the coal out there, could you give a sense of -- is it high-btu is it low btu?

It is high-btu coal, and it is also a significant amount of metal -- high-quality metallurgical coal. And it is also surface mineable. So it is low -- it should be low-cost extraction at the end of a day. We are continuing to look at it very, very closely. And we're having lots of meetings with a lot of the government officials over there to talk -- to discuss how they're going to actually allow this resource to get extracted and monetized.

Paul Forward, Stifel Nicolaus.

What overall shipment levels do you think we should see from Peabody in Australia in '07 and '08? Any changes to your -- just based on recent performance? And what is the risk that the port infrastructure issues in the way there?

Certainly the port infrastructure issues are a wild-card, with 55 vessels in the queue off the port of Newcastle, and 20 at Dalrymple Bay, which all leads to the conclusion that there is significant demand obviously for the product. So that is a wild-card for us. And obviously we will try to navigate through that, because we have entitlements to be able to move our product. But I think in total our estimate for this year is about 25 to 27 million tons of coal coming out of Australia. And that number should go up a bit more up into the 35 million ton range by the time we get into '08.

I think the other comment on the ports is right now one of the bottlenecks is the rail infrastructure leading to the ports, in particular in the case of Newcastle port down in New South Wales. They had just at the end of the last year completed a fairly large upgrade to the rail system. The old system had the coal trains crossing the commuter tracks just before they went into the ports of New Castle. They have completed a separation of those track systems, and we're starting to see deliveries to the port increase fairly rapidly. And the view is that that will, through the course of their first half of the year begin to work off that build up of vessels offshore.

In the case of Queensland and the port there, we're starting to see some buildup in vessels really related to other producers having production problems and not yet being able to get enough coal at the port to load their vessels. We're not in that situation. We've got coal that we're able to move. Actually it allows us to take advantage of shipping some things early. So we think through the course of the year, with improving rail, particularly into Newcastle, the ports will stabilize.

Maybe turning to the Illinois Basin, you sold some reserves in the fourth quarter. We are seeing some interest in other miners redirecting some of their long-term strategy toward increasing their presence in the Illinois Basin. What is the risk that the industry has gotten a little too enthusiastic over planning for adding new tons to the Illinois Basin? Is there a risk that we're going to overdevelop the region in advance of the market? What is your take on that?

My sense is I think that we will see a logical development in the Illinois Basin. Clearly there are operations that start up potentially slightly ahead of their time. But I think on balance, a couple of things. First, we sold some reserves in Western Kentucky and the Illinois Basin, but we also bought reserves in Illinois in the Illinois Basin.

I would also remind everybody that we have been the largest holder of reserves in the Illinois Basin for more years than most of us can remember. And I will tell you that we believe we have got all of the quality reserves in the Illinois Basin. A lot of people are trying to look at what they can do to put together reserve blocks that we have looked at for a lot of years.

But to the root of your question, timing of development, it would appear that most of the development comes along with when contracts are let with utilities to baseload those developments.

Certainly in our case that is true. We have held the number one position in the Illinois Basin for some time. And as you saw us when we acquired our gateway assets in Illinois just a couple of years ago, we did that with a ten year contract before we actually made the investment. You'll see us following that same discipline as we move forward. If others choose to make investments without contracts, that is their call at the end of the day and that could -- but we will be very disciplined about it.

Pearce Hammond, Simmons & Company.

I know the PRB prices that we see out there in the sore spot market, excuse me, are not necessarily reflective of where contracts are. But if those contracts -- if those prices languish for the rest of the year at these levels, and you sit down with the utilities toward year end to commit some term coal, is there a number at which you'll just -- you won't sign contracts at? And can you give some indication of what that number might be?

Yes, there is a number, and no, I can't give you any indication as to what that might be.

I thought it was worth a try. On the joint line itself, last year what did the joint line ship? What do you think it can ship this year and more --?

It did about 374, 75 million tons last year. It probably can go -- can it go 400 this year? It is very possible.

Where do you think underlying utility demand is as far as potential utilities that might want to test burn, but have sort of held back?

I think there is 25 million tons that is certainly out there that to meet that excess -- to meet that 400 million ton capacity. Now you see some growth as well on the Northern line as well to get to, I think the total shipments out of the PRB were 427 million tons for the year.

That is no great prediction in that we have seen year-in year-out growth of 20 million tons going back to 1990 when PRB was doing 200 million tons, and now as Rick noted, it is over 400.

How is Twentymile operating?

Twentymile, I will give you a bit of an update there. In terms of the equipment at Twentymile, I would say -- I would give it maybe a B or a B- right now. We are operating. We're backup to what I would call average levels. We're still doing some fine-tuning on the equipment with the manufacturer to get it up to its top operating performance.

Through the fourth quarter we had, again as I said, average normalized levels, and would look to continue to increase those during the first quarter of 2007. Although I will say that we do have a longwall move planned during the first quarter, so that will impact our total volumes.

In addition, in terms of we have been going through an area of the mine that has higher ash levels than the mine reserve average has been over the last number of years. So we're working through those issues as well. Looking at maybe doing some changes within and expanding our wash plant capacity out there. But all in all on balance I would say right now Twentymile is rocking along at average levels. And we're working to get it up to the top levels that it should be at.

Just one last question. How do you all see the truck tire situation this year -- large truck tires? Is it worse than '06, or do you this is going to be -- it is going to start to improve this year?

We're not seeing availability of tires any better than they were. We, as a operating team, are very focused on continuing to increase our tire life. We had another year of significant tire life increase. We have inventory of tires. We continue to look for adding to those inventories. One of the reasons you saw our inventories build to a certain degree was because of purchases of tires for our planned activity this year. But it is still a tight situation on a global basis.

Jeremy Sussman, Natexis Bleichroeder.

Following up on Australia, I'm interested in your thoughts on the reported $98 a ton contract that BHB recently signed, or was reported. If that is true, will this roughly be in line with your expectations?

Yes, as you know -- as I mentioned in my remarks, the hard coking coals were coming in this year at approximately that triple digit $100 number, $98, $96, that very upper tier range, which was very close to our expectations.

Excellent. Following up, in the U.S. can you tell us about how many tons you have priced for 2008 this quarter? And sort of just walk us through the way you would look at this, given weaker spot prices? Obviously you would sign at above spot, but just curious as to maybe the thought process there?

Basically other than contract reopeners or carryover business that we had to reprice, I would say that we did not price any 2008 business on a new sale during this period.

Excellent. Then lastly, just to follow-up on the last question about Twentymile. I think you said -- if I heard you right, you said that you have been running through some higher ash levels there. I am just curious, if something on that continues is it possible that existing contracts you have could get repriced or is that not an option?

All of the contracts -- any of the coal contracts we have have quality parameters in them, and they have price adjustments based on whether it is sulfur, ash, btu content. So we are seeing -- we would see total revenue impacts to the higher ash that we're shipping under those contracts. Longer-term, we're looking at the full impact on the remaining reserve, as well as expansion of the wash plant so we can mitigate the effects from the coal that we're mining, so that we can recover those revenues.

Brett Levy, Jefferies & Co.

Most of my questions have been asked. First one is, it looks like Russia is going to put a large number of reserves up for sale. Do you think that destabilizes supply at all globally in terms of coal?

And then I know when you guys did your road show you spoke of a decided distaste for buying any more Appalachian assets. Given that the valuations have sort of pulled in even further, have you changed your tune in terms of whether or not you would look in that region for potential acquisitions at this point?

Maybe I will take the Russian piece of that equation. I guess it is my view, if you look at what happened in the energy sector, particularly the oil and gas sector, all of the people that rushed in and bought assets when the Russians said they were for sale, and then had the Russians take them away from them after they bought them, I don't think we're going to see a land rush into the Russian coal fields. And certainly you are not going to see us getting on any airplanes going forward. That is number one.

Number two, the infrastructure is just nonexistent for significant areas of these Russian coal fields. And about the time that you get one of these mines running, they decide to consume the rail capacity for some other purpose. So it is way early to see any significant changes in terms of volumes and/or investments in Russia, in our view.

I guess I will address the Appalachian question. As we look at it, it is a management of risk and a management of where our dollars should be deployed. And we continue to believe that we have better opportunities to deploy our assets and funds in other coal fields in regions in the United States, as well as internationally, to getting a more secure return. So that is why you see us not making significant investments in Appalachia, although would acknowledge and agree with you that the valuations have come down significantly.

In spite of that you are not starting to look in that area?

We're still looking at areas where we think there's a better risk return balance.

[Joe Lamanawitz], Prudential.

Rick, just a quick update. How are you looking at your debt ratings, and what kind of objectives do you have there? You guys are high BB credit. I think in the past you have talked about trying to get to investment grade.

I think over time, and certainly I would argue that if you look at the statistics and the metrics and how the market actually rates us when we go out to the market to borrow funds, that the market considers us essentially near investment grade, if not investment grade anyway. Would we like to get the official tag from Moody's and S&P, that would obviously be an added benefit. It hasn't hurt us in the market per se.

We think that we're going to continue to improve our financial cash flows. As we being to pay down some of the debt from Excel transaction, we think that will drive an improved outlook from the rating agencies. The most recent convertible offering that we did was giving us 75% equity credit, which was very helpful with Moody's and S&P. Moody's changed their outlook essentially at the time we did that transaction. Obviously, we are doing everything we can to continue to improve the balance sheet. And that is all driven by outlook and performing and driving cash flows, and it will all fall in place eventually.

Just a quick follow-up. When you say you want to get to a 40% debt to cap, are you including the convert that you did in the equity bucket for purposes of that calculation?

Yes.

[Gill Alexander], [Darfield Associates].

Could you give us an idea of your unanticipated startup costs at Twentymile in the fourth quarter?

Say that again? Unanticipated startup costs?

Yes, at your Western mine?

Most of those costs were incurred in really over the tail end of the second quarter into the third quarter is when we had most of the equipment challenges at Twentymile and the --.

I was just trying to get what your operating cost would have been in your Western area. Could you give us for the second and third quarter?

Probably not at this point.

Second question, could you update us on the progress your are making towards setting up a coal-to-liquid plant?

We've got a number of initiatives that we're working on there. Obviously, we're still working with Rentech, a company that we signed an MOU with earlier last year. Looking at a number of locations, both Western and Illinois Basin locations. As well as we are also working with other potentially interested parties at sites for what would be even larger coal-to-liquids facilities out West and in the Illinois Basin. I really can't give any more specifics than that at this point in time.

[Wayne Atwell], North Street Capital.

Could you share your thoughts on the market for coal in Kazakhstan? My understanding is the cost structure is incredibly low. Obviously there's infrastructure and transportation issues, but what are your thoughts? If you could put something in place there, I think the returns could be colossal.

To be honest with you, we have not been focused on what is happening in that part of the world, what all of our activities in Australia and China, Mongolia, and of course here in the U.S. We have been watching clearly what is happening in Russia, in South Africa, in Columbia. But we will take another look at Kazakhstan.

David Gagliano, Credit Suisse.

Just a quick question on the -- since we are in the world of quarterly earnings, the tax benefit for 2007, can you just give us a little more -- if you have it -- what your best guess is in terms of how these things will flow through the results on a quarterly basis?

Sure. As we look at the quarterly results and the tax benefit of that, I think -- and I mentioned it briefly earlier that how we have focused on these in the past is that when we complete our budget and get a little bit more visibility and certainly towards our outlook, which gives us the ability then to realize the tax benefits that we have, it is usually an adjustment that is made in Q4. And that is as you saw in this particular quarter.

If things play out in a similar passion fashion, and our prospects continue to improve as they have, and as we expect them to, and hope to, we would see a larger credit in Q4. And you would see just a kind of normal tax rate in the first three quarters. You would see kind of a 15% tax expense on taxable income for the first three quarters, and the possibility for a credit in Q4, to drive you to the overall number that we have in the Reg G, which is a $61 million to $135 million credit.

David Khani, FBR.

I don't think anybody has touched on this, the sulfur credits. Do you have anything locked in for '07 and '08 on your pure PRB, ultra low PRB?

We have a mixture. We have some contracts that we signed that had -- they were indexed to sulfur credits. And obviously we had the positive benefits when the credits were at $1,600, and then we had -- obviously it has come down a bit.

But at the same time we saw a lot of contracts that were just purely based upon the credit in place at the time. So they were locked in at prices that are significantly higher than where they are today. We just basically had a fixed-price, but embedded in that fixed-price was the value of the credit for [0.5] product that we may have been selling.

The answer -- we kind of got a mixed bag, so we don't see much down side from the credits. And frankly I would probably say the same thing for the existing contracts. I wouldn't expect if credits would double today that we would see a significant change in our earnings outlook, other than it would improve uncommitted sales substantially.

How much -- could you give us a rough percentage for '07, how much of your contracts are fixed versus indexed ballpark?

I would say that the majority of the contracts will be fixed. I guess I don't have the number off the top of my head, but I would probably just -- if I was going to just give you a ballpark would be 20 to 25%. It might be under some type of index, and that may be even a little bit high. But it is not indexed to -- publications index. That is only for sulfur, because we would not sell any coal tied to the OTC indices. As I know others have done that, that is something that we just haven't done and won't do.

Then the level of fixed price '07 versus '06, is it roughly comparable or is there much change?

Not a significant change, no.

Mr. Boyce, any closing comments?

Yes. I appreciate everybody's continuing interest in BTU. As we have tried to outline, with our business expansions in the global marketplace, and what we are seeing in terms of strong dynamics in the Pacific Rim, and firming dynamics within the U.S. marketplace, we look forward to a strong 2007, and when we report our results in the first quarter.

Thank you.

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