Peabody Energy Corp (BTU) 2013 Q2 法說會逐字稿

Welcome to the Peabody Energy second quarter 2013 earnings call. For the conference, all the participants are in a listen-only mode. There will be an opportunity for your questions. Instructions will be given at that time. (Operator Instructions)

As a reminder today's call is being recorded. I'll now turn the conference to Mr. Vic Svec, Senior Vice President Investor Relations and Corporate Communications. Please go ahead.

Thanks, John. Good morning, everyone.

Thanks very much for taking part in the conference call today for BTU and with us are Chairman and Chief Executive Officer, Greg Boyce, as well as Executive Vice President and Chief Financial Officer, Mike Crews. We do have some forward-looking statements and we would invite you to consider these, along with the risk factors that we note at the end of our release, as well as the MD&A section of our filed documents. We also refer you to PeabodyEnergy.com for additional information on the investor relations page.

With that, I'll now turn the call over to Mike.

Thanks, Vic. Good morning, everyone.

Peabody's second quarter results reflect ongoing cost containment actions that are yielding significant benefits, lower capital spending, and additional debt reduction in line with our previous expectations. We are executing well in these focused areas as we continue to navigate the current coal markets. Let's review the quarterly results in more detail, beginning with the income statement. Second quarter revenues totaled $1.7 billion on sales of 61 million tons. Adjusted EBITDA totaled $254 million and includes a $21 million charge from an adverse court ruling dating back to a 2006 issue and a $12 million impact related to a voluntary employee separation program in the US.

Adjusted EBITDA from US mining operations was largely in line with last year, as lower revenues were offset by cost reductions. Year-over-year Australia contributions continued to be affected by sharply lower prices; the effect of which was partially mitigated by lower operating expenses.

Moving down the income statement, you'll note that we took a $21.5 million impairment charge to write down a minority equity investment in Asia to its current trading value. You'll recall that we exclude impairments from our adjusted EBITDA definition. We also had $7 million of higher interest expense associated with the court judgment, as well as our early debt extinguishment. And we recorded a $148 million income tax benefit related to our revised annual earnings outlook. Diluted earnings per share totaled $0.39, with adjusted diluted earnings per share of $0.33.

Now, let's turn to additional details in our supplemental schedules. In the US, volumes were in line with the prior year with the modest mix shift toward more western tons. Revenues per ton declined 5% from prior-year levels, reflecting the roll-off of legacy contracts in line with our expectations. US unit costs were down 6% on average with improvements in both regions, where we continue to focus on maximizing margins through cost reductions and shifting volumes to the most productive operations. We continue to target full-year costs 2% to 3% lower than the prior year.

Turning to Australia, volumes rose 5% on the prior year on increased output from several mines, including the PCI operation. This was offset by more than $200 million [in effect] from lower settlements from both seaborne met and thermal pricing.

During the quarter, we shipped 4.1 million tons of met coal at an average price of $123 per short ton and we sold 2.6 million tons of seaborne thermal coal at average price of $77 per short ton. Our Australia team continues to advance our cost containment initiatives, reducing costs by 6% from 2012 levels to $73 per ton. The team also worked through impacts from geologic issues at two operations during the quarter.

Cost benefited from improved productivity at the remediated PCI mines and the recent owner-operator conversions. For the first time in a number of years, we would note that the Australia dollar is also providing some relief to our cost position. Based on the progress of first half cost cutting, we are again reducing our Australia cost targets to the mid-$70 per ton range for the full year. Now in trading and brokerage, half of the quarter's results were driven by the court judgment I discussed.

The remaining $20 million loss was largely associated with $14 million of unfavorable mark-to-market movements on economic hedges that will reverse at delivery of the related fiscal shipments in the third quarter. Trading results also continue to be affected by lower market volatility and reduced structure transactions. Resource management turned in a very strong quarter that included a sale of undeveloped reserves in the Midwest for prices in excess of book value. We will continue to seek opportunities to monetize surplus properties in the portfolio.

That's a review of our income statement and key earnings drivers. You'll note that operating cash flows totaled $60 million during the quarter, which includes semi-annual interest payments and a payment in Australia to preserve our tax position during an ongoing audit. During the quarter, we reduced debt by more than $100 million, while still retaining $518 million of cash at quarter end. Capital expenditures totaled $93 million, less than half prior year levels and we are lowering our capital targets for the full year by approximately 20% to $350 million to $450 million by continuing to trim our sustaining capital needs and reduced project spend.

Looking ahead to the third quarter, we're targeting adjusted EBITDA of $210 million to $270 million and adjusted diluted loss per share of $0.16 to earnings per share of $0.09. These ranges reflect expectations for increased US volumes, lower pricing, and carryover impacts from geologic challenges as we work to improve production at the North Goonyella and Burton mines. I also refer you to our Reg G schedule in the release for additional details regarding DD&A, taxes, and other line items. That's a brief review of our second quarter performance and outlook.

For a discussion of the coal markets and other updates, I'll now turn the call over to Greg.

Thanks, Mike, and good morning, everyone.

I'm proud of the work of the Peabody team in removing some $130 million from the cost structure in the first half. We view these cost reductions as sustainable and believe more improvements are coming. As Mike noted, in addition to cost controls, we continue to reduce capital and pay down debt. I'll first review the market indicators and outlook and then discuss Peabody's actions as we continue to take the necessary steps for these market conditions. Within global markets, both elements of the supply and demand equation have been at play during this period of market softness. Demand growth has been lower than originally expected, reflecting economic conditions both in Asia and Europe.

While at the same time, the overhang and seaborne supply represents follow-through from projects that were initiated in recent years when prices were higher and projections of demand greater. Still, we've seen favorable changes to both the supply and demand picture globally and we do not believe the current prices are sustainable in the long term.

Within the global coal demand, both China and India imports have risen year-to-date and are on a pace to increase 15% this year to new record levels, as the trends to urbanize, industrialize, and electrify continue. Japanese coal use is climbing and in Germany, coal market share's back over 50% as nuclear use declines and natural gas prices remain high. We expect seaborne thermal coal demand to increase some 50 million tons in 2013; the fuel existing plants, as well as the approximately 75 gigawatts of new generation that start up during the year. Metallurgical coal demand is also increasing with Chinese and Indian met coal imports expected to rise 10% this year.

Now, in regards to global coal supplies, output reductions are occurring in the two largest coal-producing nations, China and the United States. Industry reports note that some 45% of the Shanxi producers are unprofitable at current prices. US coal exports declined 30% in June, as contracts continue to roll-off. The Indonesian government is again discussing steps to limit coal exports and increase domestic use. Mongolian exports to China remain below prior year levels.

In longer term, the lag effect of reduced project capital may set up a sharp rebound when demand accelerates. That is the historic trend that often follows periods of significant underinvestment. Within the US coal markets, we continue to see improvement in both supply and demand fundamentals as we move through 2013. Natural gas generation is down 15% year-to-date as natural gas prices are up 50% over year-ago levels. Meanwhile, US coal generation is up 11%, with industry shipments down 5% this year.

These trends come despite a summer that has started in earnest only in July, with cooling degree days down almost 10% versus normal so far this season. What does that mean? It leaves customer inventories for Powder River Basin coal more than 25% below last year, at a bit over 60 days of supply. We think this should move into 50s on days use later this summer. Longer term, we continue to see a significant growth in Powder River Basin and Illinois Basin coal demand during the next five year period.

This occurs as some plants retire, primarily in the eastern US. At the same time, recovery continues from low gas prices, some new coal plants are coming online, basin switching is occurring and most coal plants can run at higher average operating levels. We believe these factors will combine to continue to boost US coal demand from the Southern Powder River Basin and Illinois Basin; the two regions in which Peabody leads in both sales and reserves. Now, looking to the second half, we continue to expect US markets to improve as stockpiles normalize and uncompetitive production is removed from the system.

That's a summary of market drivers affecting both metallurgical and thermal coal fundamentals. Against this market context, we believe that Peabody is well-positioned to succeed. At the beginning of the year, we said that we were focused on operational performance, cost improvement, capital savings, and debt reduction. And I'm pleased to say that we have had major successes in each of these areas. The team has continued to meet production targets and the results of both our PCI remediation actions and our conversion owner-operator status have been highly successful.

At our PCI operations, we reduced costs by more than 20% after major work to boost productivity, increase overburden removal, widen benches, improve equipment availability, and implement multiple process enhancements. While we clearly are not pleased with the changes in coal prices since our acquisition, the operations are running very well and the asset base is better than expected. And our owner-operator conversions are also exceeding expectations with costs now down more than 20% at the mines we converted.

Overall, in Australia, our productivity and cost initiatives will allow the team to reduce the contractor and employee work force by more than 20% since the beginning of the year, without affecting our production target ranges. I would note that we are targeting improved US costs despite lower volumes this year.

One of the major benefits to our capital program in our owner-operator conversions in recent years, is a modern equipment fleet and significant base of installed capacity. These allow us to increase our productivity and maintain our production, even with low sustaining capital spending levels going forward. As a result, our sustaining capital levels should be below the low end of our traditional range of $1.20 to $1.75 per ton for the next several years. And as to our level of project or growth capital, we will have market conditions dictate future project development timing and ultimate spending levels.

Finally, we continue to have what I believe to be the best reserve portfolio and project pipeline in the business. And our production base is aimed at the best growth market served from the US and Australia. Within the seaborne markets, Australia is looking increasingly competitive again, given its improving cost structure, proximity to the best end markets, and recent favorable currency movements. Peabody has worked through challenging market cycles before and we find that such conditions allow us to emerge even stronger during the upcycles.

We appreciate your continued support. And with that review of the global markets and Peabody's position, operator, we'll be happy to take questions at this time.

(Operator Instructions)

Mitesh Thakkar, FBR.

Congratulations on the cost improvements.

Good morning, Mitesh. Thank you.

Can you explain to us a little bit about the cost to begin with? How much of this is driven by the improvement in [aussie] dollar? My understanding was you have a fair amount of [aussie] dollar hedged.

Yes, we do. As we've talked about on previous calls, we have a sliding scale in terms of how much we hedge over a given one, first, second and third 12-month period. We're at about 75% hedged for the rest of this year. But having said that, that rate has been about 91. So for the hedges we put in place, they've been very competitive for us relative to where the market has just now come down to those ranges. On a year-over-year basis, the benefit of foreign exchange was a little over $1 a ton in the quarter.

Great. Can we assume that the remaining $4 on a full-year basis is more of productivity gains then just across the board belt-tightening? How much of that is manpower related and how much of that is supplies related?

If you're looking at our revised guidance to mid-$70s per ton on cost, is that what you're referring to?

Yes.

When you look at that, there's three primary components. There is the productivity improvements and the cost reductions. We're also seeing lower royalties with the lower pricing environment. We'll get some benefit from FX, which we estimate at about $1 a ton for the full year on a full year-over-year basis. Then some of that is partially offset by increasing level of met coal in the mix.

Great.

Just one follow-up, there is a comment in the release which says about 40% of the met coal is going to be priced on a shorter ton basis. Can you explain this? Why is that a departure from your historical normal? Just layering contracts on a quarterly basis? Also, is it fair to assume that for the back half of the year, it's only about 20% or so exposed?

This is Greg, Mitesh.

I think that is higher than historically we've been. It's higher than we normally would like to run. We had a number of expansion projects, if you'll recall; Millennium, we had the Burton widening project that were in place this year. We did not contract up to our normal levels to give ourselves a bit of flexibility.

Now what's happened is, the operations have been performing very well. We have a higher than normal level of short-term sales. We've got some of that through the back half of the year, so I don't think it goes down to a 20% level. We would expect next year to begin to return to our normal levels.

That's great. Thank you very much. I appreciate it, guys.

Michael Dudas, Sterne Agee.

Greg, your prepared remarks about a demand increase for global thermal 50 million tons and you talk about the excess of higher cost coal in China. Could you maybe share with us how long or where the dynamics you may see relative to production cutbacks not only in the global thermal side, but also on the global met side? Because of the Australian dollar and some the cost initiatives that you've portrayed and others in the Australian region, is it going to take longer for some of the higher cost production to come off the market in Australia and keep prices bouncing along the bottom here the next couple of quarters?

I think the pace of supply rationalization has been a bit of a conundrum here over the last six months. As we look at what's happening, we're starting to see announcements taking place, people beginning to rationalize their production, I think more and more of that is going to accelerate. We've got the thermal coal pricing settlements now for a year. We've got met coal, both in terms of a quarterly basis as well as what's happening in terms of the short-term market, that are all at levels that I think are going to drive people -- people that were waiting to see where pricing were going to go, now have it in problem, are now going to have to make some real decisions as to what they're going to do relative to their operations.

One of the benefits of our platform, which we've always talked about, is given the investments that we've made in our operations over the last four years and most recently with our owner-operator conversions, we had unique opportunities to move down the cost curve. When you can do that, obviously then, you're going to be able to survive in these markets and you move other people over to the upper end of the cost curve on the other side of you that are going to have to make those decisions. We think those decisions are going to increase through the back half of the year and we'll have to see.

The dynamics in China where costs are for the quality of coals, do you anticipate a quicker resolution out of higher cost Chinese production? Or will there be for more social other reasons, keep it going at a much greater rate and potentially reduce imports of coke and coal, say, in the next 6 to 12 months?

I think our own view, China has still got a very aggressive policy to try and consolidate, rationalize, close mines that have significant safety issues and the like. I think what we're going to see is while there's a fair bit of that production that's currently out of money, a lot of that's coming from the operations that the Chinese government has targeted to close and consolidate. In effect, when you look at some of that production and you determine what's the cost to get that production to the southeast part and coastal part of China, you're still going to have seaborne coal more competitive. So we expect to see some of that production consolidated and shut in.

Jim Rollyson, Raymond James.

Maybe following up on Michael's comments or questions -- when you look at the market right now, all of this seems to be taking place slower than in terms of responding on production cuts, slower than everybody was hoping for; maybe that because we had a quarter up and then back down. What do you think right now, from your intelligence, how much is the market oversupplied on the met side, roughly?

Yes, I think it's closer than people think in terms of where the balance is. Having said that, what's really difficult is to figure out where Europe and US and South America are going to go in terms of their met coal demand. China's been growing, but China does have some domestic met coal supply. When you look at Europe, when you look at South America, and even when you look at the US steel demand, it is down. The only place it's been up is in China. I think that's impacting a bit.

Obviously, we've got Queensland, which was not affected by any flooding this year and operations beginning to perform very well; not only ours but a few others. Mongolia is down in terms of their production levels. Mozambique is way behind in terms of any projections as to where people thought they were going to be. I think, yes, we're going to need a little bit more rationalization in order to get it to balance. But I think it is closer than we think it is and closer than it looks right now.

That's helpful.

As a follow-up, you mentioned based on this year's production levels carrying into next year for the US, you're in the 70% to 80% range for what's priced. Can you give us just some sense -- I know you guys don't, for competitive reasons, give us the exact numbers like most of your competitors actually do -- but maybe some sense of what's priced in for the various regions in relation to maybe what you realized in 2Q? Just kind of up, down, similar that kind of thing, just so we have an idea on what to model.

All I can tell you is for what we do sell, I've always said we sell it better than what the daily spot OTC market curves would indicate at the time that we do it. I would just say, in terms of the coal that we've sold and the position that we're trying to get to is, it's a fine balance between selling out your operations too strong when you think the market is on an increased strengthening pace versus making sure that you've got a level of operating certainty for the subsequent year, such that you can cost effectively manage these operations. So that's really why you see us doing what we do during the quarter.

Some of our sales were re-openers, some of our price times were re-openers that we priced. But some of it was multi-year sales over the next couple of years, just to make sure that we've got that operating base level within our operations. Without getting specific about pricing, I would just say we always -- the marketing team has always told that maybe do better than screen trading.

Paul Forward, Stifel.

I wanted to go back to Australia and definitely congratulations on those 20% cost cuts in the PCI mines and really elsewhere in Australia. I did want to ask you about across the Peabody Australia portfolio, when you consider how weak thermal and met coal prices have shown up for the third quarter, are there mines that are not generating positive cash at the kind of pricing that we see at those third quarter levels? What's the Company's process for deciding whether to ship coal at really thin margins or nonexistent margins or shut-in production?

Paul, I would say that we've got our operating platform structured such that given normalized operations, and I'll explain that in a minute, our operations are sustainable. Now, every once in awhile, we'll have some geologic issues -- North Goonyella, Burton, [Metrop] that are inherent in the business. In those particular quarters, we've got challenges at specific operations. On balance, our operating assumptions and plans would be that our operations, when they're running normalized, are competitive. Now that doesn't mean margins aren't thin and certainly we look forward to the day when prices get back to where they need to be.

Also, as you look at -- the question was asked earlier about, it seems to be taking longer for folks to make decisions around high cost or out of the money production. To a certain degree we might, maybe all of us, underestimated the impact of a couple of things. One, the exit costs, for instance in Australia, do have to take into account, take or pay port and rail charges, which are not catastrophic, but they're not insignificant if you're going to close on operations. So that probably had lowered the cost of the price of exit from what we would have thought it would have been if you were just looking at mine site cash costs.

And then in the US, I think the switch to shorter term pricing perhaps gave folks a view that if they could last another month, if they could last another couple of months, they might see something different at the end of the day, when in reality, there is just high cost production that's got to make decisions based on the markets that we have in front of us. We've come back and we've looked at our platform, seen the kind of cost reductions and capital reductions we've been able to make. We believe they are sustainable. We announced overnight some additional reductions in Australia as our productivity numbers continue to improve. All of that's designed to have as many of our Tier one assets at the low end of the cost curve as we possibly can and that's always been the nature of how you can succeed in the commodities business.

I appreciate that.

Just to follow up on this, looking across, you've done a lot of work in Australia in particular. I was just looking across items like the SG&A expense, which I think was $64 million in the quarter and it's tracking lower year-on-year, but maybe low single-digits. The other operating costs on expenses line, which was $57 million in the quarter, just wondering if you could discuss, have you pulled a lot of levers on the controllable cost in those areas or are there potentially more reductions on the cost side that you can structure the Company for lower cost going forward if this slack market is going to persist for awhile?

This is Mike.

For all the conversations that we've had around productivity improvements and cost reductions at the operating level, no one is safe at the corporate level, as well as when Greg gives direction around what we're trying to do for cost reduction programs. We've all taken it on board at the corporate level in terms of discretionary spending and the levers that we can pull. You made a reference to the SG&A, but of that $12 million charge that we talked about for the voluntary separation program in the US, $5 million of that ran through the corporate piece of the SG&A. So, in fact, we would have been even lower. I can tell you that it's something that we continue to look at and it's through all aspects of the business in terms of cost reduction. It's something where we would expect the trend on SG&A to continue going forward.

Meredith Bandy, BMO Capital Markets.

Greg, I was wondering if you could talk a little about all of the news we've read in the press about potential Chinese import restrictions? Is that something you think is going to happen and what impact do you think it could have on the seaborne thermal market?

My sense is, there wouldn't be this much discussion if there wasn't going to be something at the end of the day that comes out of it. I don't think it's going to be anywhere near the impact that people were first thinking when the initial restrictions came out. But I think that the Chinese are looking towards methodologies to improve the quality of the coal that they import into China. By that I mean, really reduce that very low quality, high ash-type of coals. They reduce the efficiency in the power plants and then the higher ash causes more emissions. I think the primary impact on that will be the lower quality Indonesian coals. They're really the only ones that will be affected.

Now, it's probably going to occur at same time that Indonesia is out telling everybody they're going to be short coal for their power plants that they're building, so that they were going to be restricting exports. Time will tell as to how well those two balance out. But net-net, we think the imports of the better quality coals, particularly out of Australia, are going to remain strong into China.

Okay. Then switching gears to met, what is the met mix for the next couple of quarters? Is the North Goonyella and Burton geologic issues over and what about the stripping and everything at the PCI?

Centrally, Meredith, we've got generally about, call it, 40% to 45% hard coking coal and then also, about 40% to 45% per quarter of the low ball PCI, with the remainder in that semi-hard range. That probably edges up a bit toward the hard coking coal side in the back half of the year, but that's a fairly fine metric to try to judge. Generally speaking, if you go with that 40% to 45% per quarter on both the low ball and the hard coking coal side, with the remainder in the semis, you'll be in good shape.

Okay. So, pretty much back to normal. Sounds good. Thank you.

Brian Singer, Goldman Sachs.

Can you discuss your commitment to the 45 to 50 million in ton goal for Australia output in '15 to '17? I think you mentioned in your opening comments that market conditions would dictate CapEx and pace of growth. I thought maybe you could discuss how things would change in either your base case outlook for prices or if we stay in this $145 to $150 a ton met price deck for a longer period of time.

Obviously, those targets were set in a much different market environment. As you look at the amount of project capital that we've taken out of our spend, those targets will revised based on current market conditions. We haven't re-established those targets yet. Suffice it to say, that those were set in a different market environment.

Are you already on track to be below that based on the capital spending reductions you're implementing today? Or would it be more forthcoming reductions in capital spending from here that would accompany a lower target?

We were on a pretty good track with the completion of the expansions in Wilpinjong and Millennium and of course, we're still opening up the throttle on all of these owner-operator conversions and seeing what kind of productivity improvements we can drive. I would say, as we come out of our budgetary process and our mine planning processes in the third quarter, we'll be in a better position to really look at what the next couple of years are going to look like and particularly, a one to five year view. Now that we've rescheduled the projects that we had, some of those projects were required to get up to that production range, which we have not spent any money on in the last year.

Great, thanks.

My follow-up also focuses on cost reductions, you mentioned in the comments that there are more cost reductions that are coming here. It looked like second quarter costs in Australia were already in your mid-70s range. Can you add more color where the incremental drivers of cost reductions are and would that take you below the mid-70s range in Australia or were you referring to other areas?

The mid-70s, you're right. When you look at a year-to-date basis, that's mid-70s range. We're saying that's going to continue for the rest of the year from a cost reduction initiative standpoint. There's a rather broad ranging program going on from idea generation to personnel that are being assigned to that to really refining it as to what we think we can achieve setting time lines and then executing against those targets.

That's why you're seeing benefits in the first half of the year impacting that mid-70s cost range. There's still a component that we think are going to continue to come through and perhaps accelerate in the back half of the year, which is one component, as I mentioned, with the other components around some lower sales-related costs and lower exchange rates.

Great. Thank you.

John Bridges, JPMorgan.

Just wanted to dig into the performance in the US, the cost cutting on lower volumes. How are you doing that? Where's that coming from?

Again, John, it's all productivity improvements. Part of the VSP that you saw in the quarter charge was a reduction and a separation program that we ran, which continues to take costs and some of those costs were coming out during the course of the quarter at the operating level. But really, it relates to what we're doing in the context of our mine plans or operating plants. In the Powder River Basin, we've shifted more and more tonnage down to North Antelope Rochelle where we have a higher margin. As we continue to add volumes to lower cost structure, we continue to look at shifting more tons from truck shovel and our overburden at our surface operations to either drag line and/or dozer operations, which are inherently lower cost.

John, it's just that day to day, looking at every dollar that's spent in the operations. We've spent a lot of time in our maintenance programs to where we're running condition-based maintenance programs now rather than time-based. What does that mean? It means you don't replace engine or drive axel or any other components of machinery until you've done the analysis on the oil, done the analysis on vibration and on thermography, to where you replace it when you need to, not just based on time. All of that just continues to take cost out of the operating platform.

We've spent some money in the past on some technology in terms of our equipment monitoring, in terms of our dispatching of trucks and equipment and our surface operations, and even underground, with the operation of our long [lows] and our miners. You add all of that up and the team just is now in a mode of every day looking for ways to improve productivity, reduce costs.

Are you able to borrow from the status of the mines anywhere?

I'm sorry, John. What was the questions?

Are you able to sort of pull back on the stripping of any of the mines?

We're maintaining the strip ratios that are required for the operations for the long term. But what we're watching very closely is to make sure that we don't get too far ahead at any particular operation. If the average strip ratio is say 4 to 1, we don't want to run for a quarter where we're running at 5 to 1 or 6 to 1; we make sure it's very tight. All of those things help to minimize the costs because you're levellizing things. You should remember at our very large surface operations here in the US and Australia, the best thing we can do is to reduce variability in the operations, because that allows us to manage that cost structure and to get the best productivity and, oh by the way, capital efficiency out of our equipment. Those are the things that the team looks for.

Okay.

The other thing there is we're making concerted effort not to make short-term decisions on cost that could have long-term implications. It's really, as Greg noted, a day in, day out approach to fundamentally taking cost out of the business.

That's what I was hoping to hear. Well done. Thanks, guys.

Brandon Blossman, Tudor, Pickering, Holt.

Vic, actually, I think you answered most of this question, but I'm going to take another stab at it. This is on met production, product mix, and actually total production. Nice uptick quarter-over-quarter with 4.1 million tons shipped Q2. What was the mix shift, if any, between Q1 and Q2 PCI versus low ball?

In the first quarter, we ran at nearly 50% PCI, a little over 40% on hard coking coal. That was not all that different than Q2. We were very much in line Q1 and Q2 on the mix shift there. As you get a little later in the year, again, we might have a modest edge up on the hard coking coal side. But it shouldn't be a notable.

That's reflected in the price; it looks like no real change quarter over quarter there. The 4.1 million tons, is the current operations, is that what it's essentially sized for? Is that a good expectation on a run rate on a go forward basis or is there a little bit more to come?

Couple things, we mentioned that we did have some geologic issues in the quarter and that was at our metallurgical coal operations on the hard coking coal side. We would certainly hope to recover from that as the third quarter progresses. Then the other thing I would remind you is that we're shifting over to the top coal caving technology in the fourth quarter of the year and that could bring in some additional volumes as time goes on at the North Goonyella mine.

Are you willing to quantify what the top coal caving might do since you're fairly close to that?

I think at this point, we'll get it in place and running well and be in a better position to give a read on that as time goes by.

Thank you very much. Helpful.

Lucas Pipes, Brean Capital.

My first question is for Mike.

Mike, I'm trying to get my head around the third-quarter EBITDA guidance, especially in comparison to second-quarter results. When I look on the pricing side, of course, we had a very sharp drop in met coal prices quarter over quarter, at least on the benchmark. Secondly, given that Australian cost were $73 if Q2 and that you're full-year guidance is $75, I would expect also a little bit of an uptick in cost generally in the second half of the year. In light of that, why is the midpoint of your third-quarter guidance only slightly below your second-quarter results?

You referenced the lower coal pricing, some of that will be tempered a bit in Australia around some carryover vines that we'll have from 2Q into third quarter. When you look at mid-70s, some of that could be a timing between the third quarter and the fourth quarter as were the ultimate second-half cost is going to come out. Then I think the other wild card here is the fact that we do expect, on a seasonal basis, an increase on our US volume. That's going to be an upward benefit to the third quarter.

In regards to the trading business, should that also reverse to more historical levels?

The trading business, we would forecast, we would have an expectation that it would improve in the third quarter relative to the second quarter.

That's helpful. Thank you.

Greg, more of a big picture question. There seems to be a tendency right now in the capital markets to essentially paint a lot of the coal assets around the globe with the same brush in terms of valuation. I was just curious to hear your thoughts in terms of where do you think premium assets continue to be out there and where you would put your money?

I think when you look at the seaborne market, go-to assets have always been Australia and I think what we're starting to see -- I mean, people had a view that the cost structure in Australia was going to stay where it was forever. We have to remember, then, when markets are very strong and pricing is very high, people will chase all incremental production and not be so sensitive as to what the cost structure is, number one. Number two, the Aussie dollar had a huge run. We're seeing both of that come back. We're starting to see Australia come back into the competitive range that it always held in terms of the global seaborne market. I think Australia is still a place that you want to have quality assets and that's why we're there.

I think in the US, obviously, in the Powder River Basin, southern Powder River Basin, Illinois Basin, we think that those are strong assets and those assets are going to be the ones that are going to continue to grow as the US shifts its coal use, particularly as we go through the next five years of some of the utility changes that we're already forecasting and that have already been announced.

Now you look at places like Indonesia, a lot of volume out of Indonesia, but it's a huge number of players. Uncertainty as to what's going to happen, both with their domestic demand as well as what happens into the China imports. At the end of the day, I still think mid-and western US and Australia are still the places to be.

That's very helpful. I appreciate it. Thank you.

Brett Levy, Jefferies.

Can you talk about -- you've got about $2.5 billion of legacy liabilities -- as rate goes up, is there any chance that the cash funding starts to change for those or maybe you just need the total size of the legacy liability down? The correlated question is, if rates back up, are you likely to continue to pursue bond buybacks?

I assume you're referring, on the legacy side, to more of the retiree health care and pension. On the retiree health care side, even with the fluctuations that we've seen in interest rates that have impacted the liability of the cash usage has been fairly consistent from period to period and very manageable. On the pension side, there were a couple of years ago we put about $45 million in. I think we're at zero to $3 million for this year and we don't expect a lot of funding going forward as we're about 89% funded on the pension plan moving more toward a liability-directed investment to match that up and limit that cash flow.

What I'd say and back to the prior comment around, I see what you're doing on the operations, what are you doing on the corporate side? This is another one of those things where we say we're going to control what we can control, we've seen benefit in the increase in the equity markets, we've seen some interest rates come down to pull down those liabilities and we take those opportunities to structure ourselves to limit the cash outflow on the legacy side.

Then on the bond buyback question?

Yes, we've said any excess cash flow, we're going look at that reduction as a priority. We have repurchased some bonds from time to time depending where the price levels were. It's a component of the opportunities for debt reduction that we'll continue to evaluate.

Thanks very much.

David Lipschitz, CLSA.

Maybe I missed it. Did you say what you saw in met and thermal for the second quarter? What the realized prices were?

We did. We had that in Mike's prepared remarks.

Let me pull it up for you. I think it was $123 on the met side. We had 4.1million tons at $123 a short ton. The seaborne thermal was 2.6 million tons at $77 a short ton.

Thank you. Sorry I missed that.

My second question is, with all the cost reductions that you guys and your competitors in terms of productivity costs, ramping up production in certain places. Does that mean that the benchmark price can stay at a lower level for a longer period of time? Because if everybody is bringing cost down, if everybody thought it was $180 to $200 -- we've talked to people in China that their costs are a lot lower, too, now. That we can have a $150 to $170 type of price and everybody is okay?

No. I guess my own view is what we are seeing is a steepening in the cost curve. By that I mean, there are a few of us that had the ability and part of our platform was the way that we had capitalized it over the last five years and of projects that we were just completing even in the first half of this year that we're able to make some long-planned significant shifts in our position in the cost curve. But there are still a whole part of the upper end of the cost curve that don't have that opportunity. They don't have the geology. They don't have the ability to put in the capital investments to modernize. They're not putting in new fleets in order to be able to get cost reductions and they're not able to drive their productivities down or up to the same extent the Tier 1 players are.

I think what we're seeing is a steepening of that cost curve and those folks are still going to have to make decisions in low markets. I don't think it fundamentally drives down the cost curve to the point where we're going to see long-term sustainably low prices. I don't think these prices are sustainable in the long term. Particularly when you start to look at project capital that is no longer in play right now. When this thing starts to turn, there's just not new capacity coming into this market for a three, four or five year period of time because all these projects have been cancelled.

You'll see that even in a place, Dave, like Shengxi where, again, reports are that you've got close to half of the producers there that are in loss making mode these days. The other elements to this is it really re-enforces the go-to nature of Australian met coal. It's always been closer to the port, always been closer to the growth end customer and now with some of those cost pressures easing on the A-dollar and some other elements, it just widens that advantage over the more marginal producers.

Quick, following up on that in terms of the growth, where do you see Chinese steel production over the next three to five years, in terms of what are you looking for?

We still see China as the major growth component for steel. If you look at and you model GDP, it's somewhere between 7% on the low side and up, in the 7%s range over the next five years. You're still going to have good growth in the Chinese steel consumption; their organization and their infrastructure is going to continue to grow. We still see that as the number one spot for steel demand, steel production globally.

Caleb Dorfman, Simmons & Company.

Thanks for taking my question. I guess I have a two part question.

First, obviously, the Australian dollar's shifted a lot and that's a nice benefit for you guys, but at the same time the Japanese yen has depreciated a lot. Do you see that, over the longer term, impacting you and making it so you won't actually be able to get a higher benchmark price like you did in the past? On the second part of that for Michael, how do you hedge against the change in the relative valuation of the currencies of your customers?

I'll take the second part first.

We have an acting hedging portfolio. We hedge over an extended period of time on a sliding scale with two basic approaches -- one is the limited volatility and the second is to not put ourselves in an uncompetitive position. It's something that's served us very well. When you look at what our hedge position is for this year, as I mentioned before, when you were in the low 90s, we've only seen recent market, A-dollar market movements come back down into those low 90s. That's the approach that we take. Again, it helps impact and then maximize the profitability that we can get out of the platform and it's not just limited to foreign exchange. We look at fuel and other opportunities to control our input costs.

I think on the first part of the question, to the extent that the Japanese steel industry becomes more competitive internationally because of what's happening with the currencies, even though they'll have to pay more in terms of comparative basis for the met coal, the fact that they're growing and they're increasing in terms of their demand, actually overall is very good. As you remember earlier in the call, I was talking about we like it when countries that have no met coal supplies increase their demand. That's a good net for the overall seaborne market. I think the positives of a healthier Japanese steel sector, even with a currency change, offsets any concern about whether that's going to limit their ability to pay more money for met coal.

Great. That's helpful. Shifting to the US market real quickly, you obviously brought your US increased current expectation down by essentially 10 million tons. Is that solely because of the milder than expected start to summer or are there other issues that you're seeing so far?

That was solely a reflection of the mild summer, the lower than average summer burn that we've got up to this point in time.

When you're looking into '14, how much do you think we could actually gain back of what we have not gained back so far in '13?

What we haven't gained back, really, is the eastern production in terms of where gas prices are and how competitive, say, cap coals are relative to the current gas price. In our focus in terms of Midwest and PRB coals, our view is we've gained everything back, essentially, that we've lost. The only thing that's really remaining would be the eastern cap production and its competition with natural gas and the southeast.

We continue to point out, too, that the existing fleet can run at much higher rates, assuming we have the economic activity and the electricity draw to warrant that, which we certainly expect to happen over time.

Jeremy Sussman, Clarkson.

The trading loss this quarter was related to the unfavorable mark-to-market hedges, which I believe will all reverse next quarter?

It was $14 million of the $20 million.

Okay, great. Appreciate that. In your press release, you mentioned 40% of your met is now sold on a shorter term basis. Should we assume this is mostly monthly? Similar question to your export thermal business, is that all quarterly, some monthly? How should we think of the mix there?

I think the mix on the thermal export hasn't changed from where it's been in terms of how much we sell under the annual contracts versus quarterly. I think the question on the met coal, we talked a bit earlier about it. Because we had a significant number of projects, the Millennium expansion and particularly the Burton widening, we did not contract as high a level as we normally would to be able to absorb the start up and the variability at the beginning of those project operations. The 40% level is not a level that we would use on a go-forward basis. We would still prefer to have a higher percentage of framework contracted tons and less on the short-term market.

David Gagliano, Barclays.

I've noticed the ranges between the low and the high on the EBITDAs for the quarterly guidance has gotten fairly wide. Over the last three quarters, it's gotten pretty wide, including this quarter. Considering everything's pretty much priced, including the benchmarks, I'm wondering what is the main driver between the variability between the low and the high?

Typically, what we've seen, we always have the potential for shifts that are going to fall in or out of the quarter end, so that's an impact there as well. You've seen some variability around our trading operations. I think those are two of the larger components.

And the natural variability in terms of the geologic issues at the operations. You add all of that up and you can even see it in the current quarter. There's a fair bit of variability that we have to plan for, so when we put that range together, we try and look at the low and the high end and come up with the best estimate that we can. I think we do see those variabilities, as Mike said, a couple of vessels, two or three vessels of met coal, even at lower pricing is a significant dollar value. Long wall or other geologic issues are going to have a major impact in terms of the operations EBITDA that's generated. We're comfortable. We're comfortable with the range that we use, even where we sit within the beginning of a quarter.

That range has expanded. It's been right along the lines with what has happened with the Australia pricing phenomenon. That widens out due to that variability and drives that ultimate range.

Okay. That's helpful, thank you.

Then just one last quick question. Can you give us a little more detail, in terms of 2014 incremental tons that were sold forward in the second quarter, how much did you sell forward and at what prices or at least if you can just give us a range or something like that? Specifically in the Powder River Basin, if you know that.

We sold some additional tons forward during the quarter in the PRB. But as you know and we reduced our end price by about 15% overall in our range. But as you know, Dave, we don't disclose the pricing that those were done at.

For 2014, we priced about 18 million tons and then we had another 9 million tons of re-opener.

Okay. Were they in spot market zone or above that?

The new business that we do, as we've typically said, is we hold the line in terms of what kind of pricing we're going to get relative to OTC and we've been favorable versus the OTC market. When you look at the re-opener, that's going to be a little different because it varies by contract with industries and dead bands and it's not really trying to compare that to OTC or current -- limited market pricing's probably not that helpful. The reason we have the re-opener is so there's protection for both the buyer and the seller and it limits some of that volatility.

Mr. Boyce, I'll turn it back to you for any closing comments.

Thank you and thanks to everyone on the call. I think what you've heard is a strong message around our commitment to cost reductions, cost control, capital discipline, making sure that we're responsive to the market in terms of project and growth capital. We're beginning to see the signs of market rebalancing, both in the international and particularly in the US markets. With that, I want to thank the Peabody team and we look forward to keeping you apprised of progress in the second half of the year. Thank you.

Ladies and gentlemen, that does conclude your conference for today. Thank you for your participation. You may now disconnect.