CNX Resources Corp (CNX) 2004 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by and welcome to the 2nd quarter earnings results teleconference. [Operator Instructions] As a reminder this teleconference is being recorded.

I would now like to turn your teleconference over to the Vice President of Investor and Public Relations, Mr. Tom Hoffman. Please go ahead sir.

Thank you, Operator.

Good morning, everyone. Welcome to CONSOL Energy's 2nd quarter earnings conference call. The call is also being broadcast on the worldwide web and we welcome all of those of you who are listening via the web. If there are reporters on the line, you will be in listen-only mode throughout the call, and as always I will be glad to talk with you about our results after the call has concluded. We're mindful that our colleagues at Arch Coal are having a conference call immediately following ours so we will try to conclude this promptly at 11 EST.

We're going to talk today about results for the 2nd quarter and discuss the outlook for CONSOLE Energy for the current quarter and for the remainder of the year.

The results that we expect to achieve are subject to business risks. We have detailed those in short form in the news release that we put out this morning at 7:30. We have a more detailed discussion of business risks that we have included in our most recent SEC filings, including our most recent 10-K filing and we would recommend that you read both documents carefully with regards to business risks.

With that, I have with me today Bill Lyons and Brett Harvey. Both Bill and Brett have formal remarks that they intend to make. And at the conclusion of Brett's remarks, we'll take questions.

With that, let me turn the mic over to our Senior Vice President and Chief Financial Officer Bill Lyons.

Thank you, Tom. Good morning, everyone.

For the quarter ended June 30, 2004, CONSOL Energy is reporting net income of $26.2 million or 29 cents per diluted share. This compares to $10.6 million or 13 cents per diluted share for the same period a year earlier. After excluding the $83 million benefit from an accounting change related to worker's compensation that we disclosed last quarter. Net income through the first 6 months of this year is more than tripled compared to the same period last year. EBITDA for the quarter just ended was $95 million. That's up 13% from the same period a year earlier. Net cash from operating activities was $92 million. And that's up 15% after excluding the effects in the June 2003 quarter from a tax case settlement and the securitization of accounts receivable.

Through the first six months EBITDA improved 40% compared to the same period a year earlier. Newt cash from operating activities through the first half of the year has improved 41% compared to the first half of 2003, again, after excluding the tax and securitization impact. Our results for the quarter reflect higher production volumes for both coal and gas. And higher prices received on the sale of coal and gas. While we still have areas -- [no audio] .

Operator, are we still on?

Yes, you are. Go ahead. We apologize.

All right.

Do you know where I was? When we dropped?

Why don't you start there.

We'll back up ladies and gentlemen. I think we had a technical glitch here.

Production volumes for both coal and gas and higher prices received on the sale of coal and gas. While we still have areas that require, particularly related to cost related to coal production, we believe that the company has made considerable progress toward achieving our targets for the year. Coal segment performance in some ways met our expectations for the quarter. Production was in the target range, although at the low end. This reflects the geologic challenge of seam variability faced by mine 84 and Enlow Fork and Buchanan mines. This impacted both volumes and cost.

Having said that, keep in mind that period-to-period coal production was up one million tons. This reflects, not only the restart of Leverage Mine is March, but also strong performance period to period at the Bailey Mine and improvement at our various operations in eastern Kentucky.

In addition to improved production volumes and the higher sales volumes that followed from that, average realized prices were improved nearly 9% period to period. This reflects the strong coal market that you're all aware of, and also demonstrates that when incremental tons are available for sale, we're able to capture substantially higher prices.

Costs remain a challenge. Period to period, operating costs rose $2.75 per ton. Of that, 46 cents per ton represents the catchup premium to the combined fund that we disclosed in the 4th quarter of last year. We have one more quarter of this catchup premium to pay.

The remainder of the cost increase is attributable to four broad categories of cost. Higher maintenance and supply costs related to adverse geologic conditions. Higher costs for basic materials such as steel, copper and fuel. Higher costs for additional maintenance projects we've elected to do in order to improve the overall infrastructure of our mines that handle anticipated higher production volumes. And higher labor and supply costs related to our decision, to add additional continuous miner shifts to this schedule in order to insure that we have adequate development out in front of our long walls.

When positive development on the cost side was that we recorded the benefit from the new Medicare bill as I had indicated to you last quarter. This reduced nonoperating charges by about 50 cents per ton.

In the income statement, most of the savings is in cost to goods sold. For the year we expect retiree medical expense to be reduced approximately $31 million.

Overall, the cost picture was not all together unforeseen. As we noted in January, we don't expect to see real unit cost improvement until the 4th quarter when we have all of our expansion projects on-line and contributing. If you annualize our 33.4 million tons produced through the first six months, we're still below our expected year-end capacity of 70, 71 million tons, the capacity we will reach once the McElroy and Bailey expansions are completed. Those additional tons will have a very positive effect on unit costs going into 2005.

Through the first six months, total costs are running about 50 to 60 cents above our forecast., but prices are trending about $1.20 per ton higher than what we thought. Gas segments results continue to show period to period improvements and produce sales volumes, price and production costs. Period to period produce sales volumes improved 10%. Prices increased 22%. Operating cost net of production. taxes were improved 13%. And total costs improved 6%. Gas production for the quarter came in about 100 million cubic feet below our target range. This was due primarily to lower gob gas production associated with slower rates of mining in advance at the Buchanan Mine and to a lesser extent, greater than normal power outages, related to heavy storm activity in April and May. Power outages either resulted in wells being temporarily shut in. Or production being vented when compression to the Columbia system was offline. In total the gob and power effects amount to about 300 million cubic feet of lost production versus the forecast we provided at the beginning of the quarter.

Overall the GAAP segment is performing well and has contributed substantially to our results this year. I also want to draw your attention to the progress we have made in strengthening our balance sheet and improving our financial flexibility. As we noted in the release, we completed a new 600 million senior credit facility, the details of which are noted in this morning's news release. A couple of important things occurred when we completed this transaction. First, and maybe the most important, the Trouch B part of the facility was used to pay -- to cover our outstanding letters of credit freeing up 190 million in restricted cash than we had been using to cover these LOC's. We used $130 million of that cash to pay down to zero our short-term borrowing. With the new facility we now have about 375 million of available capacity. We now have the financial capacity not only to run the day-to-day business, but to take advantage of opportunities that may arise.

Before turning the discussion over to Brett, let me mention some things to keep in mind regarding our guidance for the current quarter. We have set our net income target of 5 to 10 cents per share. That compares to a loss of 7 cents per share in the 3rd quarter of 2003.

As many of you know, the 3rd quarter is typically a weak quarter primarily because of the miner's vacation schedule. Depending when the vacation period begins, our mines lose 9 to 14 days during the quarter. In addition the return from vacation is often marked by start-up problems inherent with having the mining equipment sit idle for 2 weeks.

As you will note, production guidance for coal is up somewhat compared with the 2nd quarter actuals. However, it is a fairly broad range. We are trying to reflect any start-up effects from the new long-wall at McElroy, which should begin operations within the next week or two. It also reflects the fact that one of the Bailey long walls is idle for several months while we move out of the older area of mine into the new area. You will recall that we talked about this in our January conference call.

There's some additional downside in coal production related to Mine 84. Mine 84 is struggling with adverse geological conditions. But we have reflected that to some extent in the outlook. The rock problems impacts are difficult to forecast, because we don't know how quickly we can advance through the rock, and what toll that will take on our equipment. We will keep you updated on that situation in our monthly production reports.

The other thing to keep in mind in comparing our current quarter guidance with the last quarter's actual results is that the costs of the coal segment are typically higher in the 3rd quarter because we take advantage of the miner's vacation to do a lot of maintenance work at the mines. As Brett noted in a news release this morning, we expect to hit our targets for the full year.

Brett, with that, I'll turn that over to you for your comments on the quarter. . . . . . Thank you, Bill. appreciate that.

Let me say to everybody on the phone, it is good to be with you again. And what I want to talk about is the short-term issues, talk about the year, talk about the marketplace and how they all come together for 2005.

It's clear we're on track in the short term with our expansion projects in coal, we want to announce today that we will start our second long wall at McElroy by the end of the month. It will be on-line after two and a half years of construction to expand that mine with prep plants, with underground bunkers, with new development for long-wall panels. That will be on-line within the time frame we said it would be, we told our shareholders at the beginning of the year. That will be very valuable to us. It will give us those incremental tons to help handle the cost structure of our company, as well as put us on track to be over 70 million tons of production on an annual rate next year, beginning in the 4th quarter of this year. The other thing that is on track as well is the expansion of the Bailey prep plant, which will give us for next year another 2 million tons of capacity at Bailey Enlow. And then in 2006, another 2 million tons of capacity. Both of those projects are very valuable to us. And are on-line and we are on track to get that done.

In the short term, clearly we would like to see more tons come out of the mine. And as we gave guidance early in the year, we said as these projects came on, we would build up. The 4th quarter looks very strong. As Bill talked about, the 3rd quarter certainly has vacation and other issues in it. But with the opening of the second long wall in McElroy, we're going to see real strength coming in August and -- August and September of the 3rd quarter.

Let's talk about the markets a little bit. We continued to have very strong pricing on the coal side. Metallurgical side as well as the steam side. Not only for the spot market this year, but for our contracts in 2005. We are very pleased about where that is going. And pleased that our expansion and volume and that new pricing is coming together for 2005.

There is strong demand on the gas side clearly. The gas prices hold very well. Our expansion on the gas side this year is on track. And doing well. We're drilling a lot of holes this year in our Virginia properties. And they are on track. We were down there last week. And we were bringing on some pretty strong volumes there. And we'll be on track with our prediction, our guidance for that area, by the end of the year.

Over all, we expect to see the year-end very strong with volume as well as pricing. Demand continues to be strong for coal on the met side. Our capacity will be in place for 2005. Strong pricing is being signed up as we speak. And as we've talked to the shareholders in the past and others, the pricing continues. It is not just a spot pricing scenario. We're seeing a step change in our term business as well for gas and for coal, we are very enthused about that. As we see the volumes run up in the mine, as the projects come on-line and we get over 70 million tons a year, we'll see our cost structure -- even though there is pressure on steel and other products, we will see our cost structure fall into line and to be better cost over more tons, going forward.

The market that we see for CONSOL coal, as we see our customers continue to announce they are going to build scrubbers, we see an expanding market within a market for CONSOL Energy. As the scrubbers are built, especially in our region, these are markets that we've been out of because of our sulfur content of our coal that we will come right back into as the scrubbers are built in '06, '07 and '08. We are very enthused about that as well. I'm pleased about what is being done, we are spending a lot of capital to get ready for next year. The costs are a concern to us. But they will be in line as we finish these projects, as we stated all year long, we are on track and positive about where we want to go and want we want to get done and I'm very enthused about the pricing that we see for '05.

Having said that I would like to turn it back over for questions. Operator if you could give our listeners their instructions for asking questions. . .

[Operator Instructions] The first line we will open is John Bridges with J.P. Morgan.

Morning Brett, everybody.

Hi John.

Congratulations on the results. With respect to the buildup of tonnage Enlow, you say 2 millions tons this year. That's 2 million tons of extra capacity. But how does the sales growth develop over the next couple of years?

Okay. We are capacity constrained at the Bailey Enlow mines, John. And we have found in the last couple of years with 4 long walls feeding that prep plant, by midweek we're starting to fill our bunkers up. And our total capacity of the long walls have not been reached. As we add the capacity in the prep plant, we're going to see more room for those long walls to run at faster paces. And, in terms of marketing, the ability to market that coal in place, especially the Bailey Enlow coal, has not been a problem for us. So we see a natural expansion there. And we're actually out selling coal for that expansion as we speak today with no problems [inaudible].

That's tied into the underground bunkers and all of that sort of thing. So you're going to have a new -- when will you get up the extra 2 million tons a year of annual capacity?

We will have that capacity ready to go by the end of November. And going into 2005, we will pick up another 2 million tons of capacity -- and that coal will be sold for next year.

When do you expect the extra 2 million tons in 2005?

The extra 2 million tons -- We believe once we make the adjustments, it will be in the 4th quarter 2005 going into 2006. Which will give us a total capacity increase on that project of 4 million tons.

Okay. Okay. That's helpful. I see you're making a lot of progress with the sales for next year. Previously there was talk of an $8 increase on prices compared to previous contracts, is that still coming through?

That is all in place. We will see that across every new contract.

John, this is Tom. Just to elaborate on that, that's $8 on those tons open for repricing.

Right. And how far have you got? What percentage of 2005 sales have been made now?

We show on the outlook, 61 million tons committed. Most of that would be priced. There might be some where pricing is yet to be determined. But that would be -- if you assume, say, 71 million tons of production next year, we're 85% committed.

Thanks a lot.

Thank you.

Thank you. The next line that we'll open is the line of Michael Dudas, of Bear Stearns. Please go ahead.

Good morning gentlemen.

Good morning, Mike.

Brett maybe, or Bill, you can address the issue on the costs in the 3rd quarter. How much do you think of start-up at McElroy? Some of the accelerated maintenance getting the long walls and the panels prepared for the capacity you're trying to reach at year-end. Is contributing to the higher costs in the 3rd quarter?

Mike, this is Brett speaking. It is clear that when you put these big construction projects together, your cost rises and you're doing a lot of things to get ready. Especially you're adding capacity to the mines. When you look at what we're trying to do for 2005, not only are we finishing these projects, we're trying to expand in two areas. Most of our capital is being spent in what I call northern [inaudible] seam -- that is on-line. And since the market has changed in the last 18 months, we're also spending expansion dollars on sections in VP 8 more metallurgical coal and some of the central [inaudible]. That gives us a higher cost structure to the south. As we average that higher cost structure into the total, it looks like it is accelerating more than it should. But the preparation really is for higher prices like metallurgical coal and things to be build up in 2005. Now, if you look at the 2nd quarter, our volume wasn't everything we wanted it to be. It was on the shorter end of the range. Midrange or a little higher, we would have seen these drops -- excuse me, the costs be more in line with what we predicted earlier on. So I think it is a function of what we're spending to get ready for '05 and its also a function for the volume we're seeing in the interim right here. As the higher volume prices come on-line, Mike, you're going to see the costs come on line as well. Because, clearly this is a volume business and we can spread our costs over more tons.

Follow-up, Brett, could you discuss a little bit about the tenor of the discussions between you, your sales folks and utilities. Are utilities again starting to recognize the market as being tighter than maybe they would have hoped for? And they are starting to come in and talk longer term contracts with you? How willing are you to do that? And as you look out with the new scrubber projects that are going to come onstream, are you starting to see those companies start to come back and talk to you about term coal from your Pittsburgh eight project.

Yes. Yes on both cases.

In the short term, the utilities I think -- first look was they thought maybe it was just in a cycle. But what we're seeing in the contracts we're signing up, they are recognizing the higher prices. They are recognizing a permanent change of capacity and demand as the economy grows. Some of these utilities typically dealing with us on a one-year basis are now dealing with us on two, three, sometimes even four-year basis. But these higher prices, it isn't a matter of it is just one year and the prices are higher then they want to renegotiate. They are signing up for these higher prices for longer terms. Some cases three or four times higher then they used to, in terms of time and in terms of year. The other side of it is, they really see a capacity shortage, especially in the east. We are willing to talk about term and invest -- even talk about invest -- talk about long-term contracts to invest in new mines. But we have seen a real change in the attitude. Now, that's not every utility. Some utilities are having financial problems. And only can play the spot market. And that's very disturbing to them. But overall we see a change in most of our customers.

One final question, Brett, are you getting term and price on the met side?

Yes, we are. On the met side we are seeing terms. Typically that was a year-to-year business for us across all of our met products. In some cases we have over a million tons signed up for a five-year plus with options. So we have not seen that in years. And there is a clear recognition also on the met side that the capitalization of the coal business, especially on metallurgical coal, is behind where the markets with going. And people looking to lockup long-term volumes, as well as higher prices to go with them.

Thank you, Brett.

Thank you.

Thank you. The next line we'll open is the line of Michael Lucas with Appaloosa. Please go ahead

I wonder if we could touch on in terms of your 2005, 61 million tons. Out of f that, how much is net coal, [inaudible]?

Well, met coal is priced on -- we don't give guidance on '06. But met coal is priced on a year-to-year basis, April to April.

How many tons?

How many tons?

Yes.

Brett, I have that.

Why don't you do that.

On the schedule. Right now, that's about 5.9 million tons.

And before you had touched upon it and said out of 61 million, most of it was priced, but not all of that. Does the met coal form the price or the non-price?

More of the -- fairly high percentage of the met is priced.

As of when? Was that as of --

As of mid-July.

As of mid-July? Is that on like a 1-year contract basis like the rest of the net coal.

Some of it is on a one-year deal. Some of it is on a multi-year deal, like I was saying, we have one contract that is over a million tons on a five-year deal now. I would say most of it is at this point in time.

Okay. Is that another part of the reason why your price -- your cost to get sold has gone up. The metallurgical coal processing?

That's right. We're expanding to the south in [inaudible]. We're adding sections of VP 8 mine because of getting the higher pricing. And that average cost is higher so that average is all in the cost side. Anything in central Aps is a little higher cost structure. So if you expand there and bring it back into our total cost structure, it does tend to skew what is being done in northern Appalachia.

Do you guys think you could squeeze any more metallurgical coal out here?

I'll tell you, we'd sure like to. Those prices are that high because there is no volume out there. How much volume has come back into the market, you see it drop down -- not as low as it used to be, but it would be about 20--$25 a ton higher than it was in 2003. But we're doing everything we get to get more out this year. And preparing ourselves for '05, as much as we can get out.

Have you guys done a bottoms up analysis of the metallurgical coal market. Per that comment you just said, I'm trying to figure out what you mean by if all the [inaudible] come out. Don't we pretty much know of all the projects out there? Isn't there not too many new projects coming on in met coal?

There is very few, there is very few projects coming on, but internally to CONSOLE we have added a couple of sections in the VP 8 Mine and then we've added a couple contractors to [inaudible] to help us there. Otherwise we are running pretty much [inaudible].

Okay, thank you.

You bet.

The next line we'll open is Dave Gagliano with CSFB. Please go ahead.

Thanks, good morning. I just have a few questions. Just to clarify John's question earlier, what are your total sales volume expectations for '04, '05, and if you're willing, '06. First question.

Sales volume itself?

Yep.

We plan to sell for '05 -- this year, Tom, what's the total for this year? What's the final numbers we put out?

For sales volumes?

Yes

I think the guidance was 70 million tons of sales. Production would be less than that. For '05 Dave, we have not provided a final guidance number on sales volumes. We're suggesting that you use 71 million just as a starting point for your modeling, because that will be about what we have in capacity as we go into '05.

Okay.

And we do not provide guidance out to '06.

Does that include your commitments, which was my next question. You have 61 million tons '05, what about '06?

We do not provide guidance for '06.

Okay. Last question, CapEx. Looks like if my numbers are correct, you had about 100 -- roughly you're getting to your full-year total through the first three quarters basically. If I look at your 3rd quarter guidance through the first three quarters, you'll be 320 to 360 million in CapEx. But, I haven't seen a change to your full year CapEx guidance which I think is 340 to 370. Is that right?

What that mainly reflects is a McElroy should be done with the capital, by -- in the 3rd quarter.

So you do expect to spend roughly 30 to 50 million in CapEx in total in the 4th quarter?

We plan to spend, like we said, around $400 million for the year. Our guidance that we projected for the year holds true.

Oh, its 400 million, sorry. I had the wrong number. Perfect. That's it for me. Thanks.

Thank you.

The next line we'll open is Wayne Atwell with Morgan Stanley. Please go ahead.

Hi, Wayne.

Thank you. A couple quick questions. Can you give us how much is booked for '06 yet?

No Wayne. We only do that once a year when we file a 10-K. We don't provide quarterly updates on '06.

This is Brett speaking. We do tell people we run about a third of contract off every year. So as you can see we're going to be open about maybe a third of our volume.

Now, if I'm not mistaken, you have a long wall moving in the 3rd quarter. Can you give us any estimate of cost and volume restriction that might relate to that?

We're moving long walls all of the time. We have 13 long walls in operation. I'm not sure exactly which long wall move you're referring to there.

I forget which mine. I thought it was a long wall that might be a little more detailed --

Brett, this is Tom. Perhaps Wayne is referring to the Bailey long move, which is more protracted because we are moving a new area.

The Bailey Enlow complex has four long walls feeding it all the time, One of the long walls in Bailey is down for major construction. Or rebuilding on that. And we had this planned all year long. Rebuilding on the long wall itself. It will be down for two months. And will be up in late September, early October. And then you'll see full capacity of Bailey come on.

Any kind of thought of how much that unusual rebuild might impact the quarter in costs?

I think -- in fact I'm sure it is in our guidance. And we've talked about that. We've mentioned the 1st quarter that long wall went down to be rebuilt. And it will come back. So it is in our guidance.

That's correct.

What we're hoping for is that other three long walls can run at maximum capacity and fill some of that hold. We'll see that as the quarter develops.

And are you able to look in your inventory of properties and find any met coal that is particularly attractive and maybe ramp that up a little faster or maybe start developing a property that you might not have had in your queue?

Well, we have been working on that all year long. There are some marginal met coals that we have that we bought from steel companies that we typically use as seam coal, we've had marketing looking at some possibilities there, but we haven't seen any dramatic change. Typically our met businesses will capitalize at certain volumes. And even if you look out going forward, VP 8 is going to go down because of reserve depletion at the end of '05. So we're going to be working hard just to stay even.

And lastly, are there any properties that are rising to the top of the queue because of the relatively attractive coal environment that we're seeing here? Anything that you might not have been inclined to crank up that is going to get the nod here the next 1 to 2 years.

Well, we're bringing up Miller creek. That's one that's been on the shelf for quite a while. And that will be in operation in the 4th quarter. About 120,000 a year, isn't it, Tom?

That's correct. 120,000 for this year.

For this year. It will be running at the rate of about 1 million to 1.5 million next year. So I feel good about where that is going. [inaudible] a potential ap project. The ones in northern ap tend to be -- the expansion we're doing right now, that we decided to do in 2001, 2002 are just coming on right now in 2004 and 2005. So in the next couple of years, we'll be working on permitting some new mines. But to bring on a new mine of big capacity is probably going to take six, seven years.

So there are some properties you're toying with now that you may proceed with?

Yes. We are looking although -- but those are going to take time. And we bring those properties back on unless they are firm contracts with volume. We won't speculate on market.

That makes sense. Are utilities willing to step up and sign on the dotted line.

We're starting to see them talk about long-term deals associated with certain mines with new capital. But that's just starting to develop. Still a ways to go.

Thank you.

Which is a good time, though.

Great. Thank you.

Thank you. The next line we'll open is Daniel Rolling with Merrill Lynch. Please go ahead

Hi Dan

Hi, good morning Brett. Thank you. The question I have relates again to contracting and looking forward. Did I hear you correctly earlier when you said that you were having discussions with customers for contracts investing in new mines?

Yes. We're having contracts with customers who are looking for volume going forward. And they are willing to sign some long-term contracts that match the volume with their projects. They can see us undercapitalized and they are looking for some of the higher [inaudible]

And now historically or at least back in the '80s when that happened, those contracts had 15 to 20-year lives. Are we talking about major love term contracts or shorter than that?

Well, it hasn't developed quite that far, yet, Dan. The discussions are just new. But what we are seeing is, they will have to be at least 10 to 15-year contracts. Otherwise the capital -- we're not going to invest that kind of capital, if you don't have the revenues to go with it. The meeting of the mind have to come together. The discussions are there. But it is early. But I haven't seen that in 15 years. So there is a step change in the way some of the utilities are looking at the market.

Now, what type of volume are you looking for before you commit. Clearly if you have a contract, that's for 50% of the offtake of the new mine. Is that enough? Are you looking for something closer to 80% of the offtake.

You know me, I would like to have the 80%. It depends on the price. And what we saw the rest of the market doing. We would do nothing less than 60%.

Dan, this is Bill Lyons. We go through a pretty detailed economic analysis before we make a major capital expenditure or commitment into a mine like that. There are at lot of things that enter into it. And it goes into the formula. We're talking about the price we would receive as well as what we see as the risk encountered in the type of mining we're doing as well as our evaluation of the -- we say the WORTHINESS of the customer. There are many, many variables that go into the equation when we do our risk analysis as to how many tons we would like to have committed before we commit to that capital.

Lastly, along that line, you said six to seven years to get a new property into production.

Yeah.

That takes into account permitting and everything?

Yes, it does.

Thank you.

Yeah.

Next line we'll open is the line of Erik McGidden with York capital.

Hey, guys, nice quarter. I wanted to focus on the balance sheet for a minute, with the new bank facility and the generous liquidity that you mention in the press release. I'm curious for an update, you know, earlier in the year you talked about potential [inaudible] in capital markets potential [inaudible] in OP, maybe some noncore asset sales have been discussed at various times. I'm curious what you're thinking is currently [inaudible] your capital budget liquidity on those type of transactions.

Bill, would you handle that?

Erik, this is Tom. Before Bill goes into the detail, just as a reminder, we did disclose in the last earnings release and conference call that our earlier statement about going to the capital markets to fund our capital needs was no longer what we envisioned.

And that pretty well sums it up. We are in very good shape financially. And, again, it would depend on a particular project, the magnitude of the project and how we would determine how to best finance that project.

So we shouldn't be looking or expecting anything in terms of monetaryizations of noncore assets in the balance sheets or other capital markets transactions what you're saying?

Well, when you say never look for something, I always have trouble dealing with absolutes. I'm going to tell you, we're always evaluating our asset base. And we're always looking to do the best for our shareholders. If an attractive deal came through, we would consider it. And if we felt it was advantageous for the shareholders, we would pursue it. But up until that time comes around, I don't foresee us doing things tomorrow, if that's what you mean.

The next line we'll open is the line of Andrew Shirley with Ivory Capital. Please go ahead.

Hi, I think you guys mentioned about last quarter contract pricing being up $8 a ton roughly over your portfolio. You mention again on this call. According to trade publications I'm looking at, it seems like pricing since last quarter has moved up considerably. And I understand this might not be the best source. But on both spot and contract basis. Is the $8 you're talking about again a bit conservative. Or am I missing something on the price realization dynamic?

This is Brett speaking. Remember, the spot market is certainly very thin in terms of volume up there. You're not going to get big volumes with the spot market. The contract pricing is -- has a tendency to rise over the year if things get tighter and tighter and tighter. What you're seeing, contracts as they are being written through the year for '05, and the volume capacity in the whole coal business is to shrink, you're going to see it move up toward the spot price. Naturally, because there is no new volumes to pick up. We're watching that very close. The $8 is a very solid number. That's the guidance, essentially what I've been telling people on all new pricing on steam coal. At least $8 a ton up. We're experienced in that. We're experienced in some a little better than that. As we get closer to 100%, we're probably going to see it even go higher as the volumes tend to collapse in terms of '05 availability. But I think what you're seeing in these trade publications is a reflection of big volumes are being signed up at much higher pricing, like I was talking about, at least $8 a ton. As it gets tight, you seen them move more towards the spot piece on the smaller volumes.

Okay. And can you guys provide any more color on where you expect us to move into '05. I know you've talked generally about improvement with production ramping, but can you quantify that in any way?

What was the last guidance we gave Tom, on that?

We said for this year, is the only reference point we have out there that we thought costs would be below $27 on average for the year. And that we saw it in the 4th quarter when all of the projects were on-line. The costs for that quarter should be substantially below 27.

Right. And I think that's where it is headed. We're going to see these rising volumes against -- fixed costs over rising volumes, which gives us a lot of leverage in terms of costs. Now, we do have pressure on costs. As you've seen with everybody. I mean, steel prices are up. Copper. All of these things are being pushed towards us. Fortunately we have rising volumes to offset that as we pick up those items. What is key to this, we actually hit the targets that we said we would do. Bring it on leverage. Bringing on the second long wall at McElroy. And bringing on the capacity Bailey Enlow prep plant. It gives us the capacity to spread all of these dollars over more tons. And that's going to help us hold our costs in line. The real question is, am I as confident we can hold our costs today as I was at the first of the year. I think with the pressure we're seeing on some of these commodities, it is going to be tough. We have more leverage than everybody else because we have raising volume and I think that's the point I want to make.

Do you guys still expect to be somewhat below $27 a ton for the full year?

Yes. I think we will be.

Okay. Thank you.

Okay. Thanks.

The next line we'll open is the line of Risa Acathy with Zimer Lucas. Please go ahead.

Good morning, gentlemen. I have a quick question. What tax rate are you assuming for your 5 to 10 cents in Q3 and what can we expect for Q4, because I guess this past quarter taxes were negligible whereas in Q1 it was around $5 million.

The tax rate, when we take into consideration the impact of the Medicare bill is less than 5% for the year. Okay, less than 5% for the year. Is -- but, should we expect divergent taxes like we had in Q1 and Q2 where -- in Q1 we had 5 million in taxes in Q2 we didn't have any taxes. No. We project the tax rate for the year. Do that on a year to date basis. And subtract out what we recorded prior year-to-date. And that's why you get the strange results at times in a particular quarter. The year to date number is our reflection of what the rate should be for the year. And that's the best information we have right now on the tax side.

Thank you.

The next line we'll open is Richard Price with Westminster Securities. Please go ahead.

Good morning, gentlemen. Congratulations on a good quarter Question as you increase production pushing to north of 70 million tons, what constraints do you anticipate if any on the distribution side?

Well, thats going to be a challenge. We can see there is a lot of pressure in the present volume that we are at. The advantage that we have though if you look at the [inaudible] overall. Our central ap properties tend to be in an area where [inaudible] on rail and delivery. If you look to the northern ap, we have duel railroads in most of our major mines. And duel railroads at very high volume tend to be very competitive. And through the 2nd quarter, we didn't have any problems in that area to speak of. About a third of our coal moves on the Ohio river which we have a lot of capacity there in terms of our own barge system and other people's barge systems, so our mix is good for transportation, but now we are going to bring volume on to this market, most of it is going to be in northern ap and we are working with the railroads right now to be sure that we can move the volume as we expanded capacity. We don't anticipate a lot of big problems, but we recognize it is tight out there we also recognize the railroads are working hard to put some more capacity and we're working with them on a daily basis. They know it is coming. We've been planning it with them for over a year. And I think we'll handle it just fine.

A follow-up question on several questions on pricing. It looks as if you're anticipating a little softening in prices in Q3. Is that attributable to a more conservative outlook on spot sales or attributable to other factors?

Actually on the pricing side -- we don't expect the big pricing moves in the market to really hit until the end of the 4th quarter. I think it will be pretty much flat through the year. That's the guidance we've given. What pricing we have seen has been on the spot that we've handled this year. But the big movement we don't see until the end of the year. So I would say we're going to be pretty much on guidance pricing-wise. Tom, is that about where we've been?

Brett, also recall when we bring in McElroy, overall, that is at a somewhat lower price than what you're seeing in some of the other coal prices. Yeah. Because of the type of coal. And where we have it sold.

That's right. That explains it. Thanks, gentlemen. Good quarter.

Next line we'll open is the line of Brett Levy with [inaudible]

Most of my questions has been answered. Quick question on some of the met coal sales contract. Is there any force major that sort of lets anyone out in the event that an iron ore mine is closed due to strike that lifts people out of some of the met coal contracts that you guys potentially have?

In our case, no. In terms of the relationship to iron ore, that was your question, we don't have anything that reflects that?

Any other kind of force major that sort or lets people out of the met coal sales?

I think if it was a drastic problem at a steel mill or something like that. It would be the natural force major type of event. But I don't see anything other than it would have to be a real legitimate force major issue.

Not just running out of iron ore.

I know that's not in our contract.

All right. Thanks very much, guys.

Thank you. The next line we'll open is Larry Peck with Copper Beach Capital. Please go ahead.

If this was asked, I apologize. I jumped on and off. But in the guidance, you've got EBITDA of 87 to 92 million at 5 to 10 cents of EPS. Yet the 2nd quarter was 95 million with 29 cents. I'm trying to figure out obviously it doesn't sort of compute. What is happening kind of below the EBITDA line that has changed to create that EPS.

Bill would you take care of that?

I think it is just a misprint in the guidance. The EBITDA probably should be around -- I'd give a range 82 to 87.

That's some misprint. Okay. That's my question. Thanks a lot.

Thank you. The next line we'll open is Steven Penal with Imperium Capital.

Good morning, gentlemen. There's a line in the press release about lowerer retiree health benefit expense. Is that year-over-year or from the 1st quarter?

Can you repeat the question?

There's an indication in the press release there is lower retiree heath benefit expense. That the result of the recent legislation. And if so, can you give us a little bit of glimpse as to what that was sequentially? First quarter, second quarter? And was there any sort of catchup in the 2nd quarter for the higher expenses in the 1st quarter?

Okay. The answer to your question, yes, that's the Medicare act I think that was pass on December 8 of 2003. The accounting guidance on how to book that was not clear mainly because many of the regulations that need to be put in place to implement this program in 2006, they havn't been done yet. So it is hard to do the accounting for something when you don't know what all of rules are. However, the FASB came out with additional guidance in the 2nd quarter that encouraged the booking in the 2nd quarter and required it in the 3rd quarter based on the existing information. What we did, we're going to save approximately $38 million per year based on our view of this Medicare act right now. And, again, I'll tell you, it is subject to change. But I think the change will be -- I think we booked it conservatively. There was some options we had we booked them as conservative options. The impact on the quarter was about -- a little bit over $9 million. About $9.5 million. And there was a catchup adjustment that reflected the 1st quarter of about $2 million. So there's about $11, $12 million in our year-to-date numbers reflecting the Medicare. And I would expect, as I said, another $19 million for the rest of the year.

I should note, Bill -- this is Tom. If you look on the first page of the news release this morning. We have a footnote to the net income number for the first six months indicating that the 1st quarter net income was restated by $2.2 million to reflect that Medicare adjustment. So if you were adding up the two numbers for net income to get the six month, you'll notice there is a difference there that we've reflected in this release.

Great. Thank you very much.

Thank you.

The next line we'll open is Brandon Eliot with Steve Associates. Please go ahead.

Good morning, gentlemen. The production that you're talking about as we look out into '05 mention in the press release the McElroy and the Bailey prep plant adding about 7 million tons '05 versus '04 That seemingly puts production just on a run-rate basis more in the 75 million tons for '05. What's the delta I'm missing there?

The mix changes from year to year. As you do your planning, you have some mines that have the capacity. So your planning capacity mine by main changes around a little bit. The number we've been telling everybody, conservatively, we believe we're going to be about 71. It could be as high as 75. That planning is all coming together right now. And the board will be approving that plan probably in November we'll be looking at it. So those are the numbers I've given right now. I think if you just add all the positives up and not the negatives, yeah, you do get the 75 or 76. But some mines are in different levels of capacity in '05 versus where they were.

The production you talked about for Q3, you know, really not the midpoint down, a couple percent sequentially. But you're talking down 9 to 14 days as far as vacations. That would seem to be down 10%. How do you get additional production out of that many --

You're starting the McElroy long wall up at the end of the month. You're about 33% off on the McElroy mine itself. It is going to run two months. It didn't pick up the first month. So you're picking up some there. And then you have the round abouts and the other things you're doing. You have the Bailey long wall is being rebuilt. They all come on-line together in the 4th quarter. So you have -- versus the first of the year have two long walls more than you had the first of the year. And that's why your production rate is way up.

And somebody asked this question a little bit earlier. But the average realized price per ton you're looking for in the September quarter down versus Q1. Is it just a mix issue? Is that what is causing the price realization to be down? You're factoring in lest spot -- you know any additional spot sales at these higher prices.

It is probably the mix.

It is the mix Brett. It is the McElroy issue coming on with those tons.

If you look at the mix of everything moving, it is true.

How much spot sales did you guys get in the 1st quarter? Was there any -- I'm sorry the 2nd quarter, how much really helped the 2nd quarter results that you are not expecting in the 3rd quarter.

There is very little spot sales in the 2nd quarter.

I think that most of the spot sales that we had were in the 1st quarter, and if you look at our 1st quarter performance, it reflected that. The 2nd quarter, I don't know of any real spot sales that we had [inaudible] substantial.

And just one last question. The Q3 guidance, when you came out and pre-announced Q2, why not take the opportunity to talk about the fact that Q3 was -- we hadn't factored in the seasonality as much as people should have.

I think we've always talked about that. In some sense, we just assumed everybody had that factored in. As we roll it out this is extraordinary this year. Not only do we have these construction products we're finishing up. We have the vacation on top of it. Plus we have things we're trying to do to expand to get ready for this pricing deck for '05. There is a just a lot going on in this 3rd quarter to prepare us for to do we we need to do in '05.

And Brett, I'm sorry, there was some music on hold there for a little bit during the middle of the call. Did you quantify what that cost impact was that you're expecting in Q3? If you kind of sum that all together what is --

We haven't quantified that.

I don't think we've actually quantified that. But I think it is reflected in our planning cycle, in our guidance thats why [inaudible].

Thanks, guys.

Operator we have time for one more question. I think as I mentioned at the beginning, we want to be mindful that many of you want to go to the Arch call as well.

Thank you. The last line we'll open is the line of Paul Forward at Legg Mason. Please go ahead.

Hi, Paul.

Hi, guys. A quick question on stockpiles. Where do you see -- do you see any regional spread among the utilities in their current stockpile level within regions. Do you look more critical then others as we get into the midpoint of the summer?

Well, I think the stockpiles are lower. My marketing people are telling me that the stockpiles are lower in the east. That they are down in some cases as much as 25 to 30%. In the northern ap area. It depends on what utility you're talking about. But overall, the stockpiles are down, and they are going to be down going into the winter. We're more concerned in our area, our market area. It is pretty tight. It will continue to be tight, it looks like. There is no buildup. The other side of it, there is no coal on the ground in any of the coal companies. Everything that is being mined is moving as fast as it can go.

Except for the companies that have railroads. Maybe out west. having their own problems.

Yeah. That's another market area. I think the capacity to move a billion tons is being constrained. If you look at region by region, especially in our area in the northeast every ton that is being mined is being moved as quickly as it can and the inventories aren't building up. It is going to be tight.

Just very quickly, you had really two very good months of production March and April in northern ap, about 5 million tons per month. And then dropped off May/June to about 4 million tons. Forgetting about the growth at McElroy and Bailey. Second half of the year, do you expect your existing northern appalachia production to be closer to the March/April levels or the May/June level?

I think from August on you'll see that. [inaudible] as these long walls come on we are going to have them running, right now we have the second long wall at Bailey that is not running. And the first month of this quarter you have McElroy not running. So you're going to see those all come on line about the same time. So it will be a very powerful position for us. That's where we want to be.

All right. Thanks very much.

You bet. Thank you operator. And thank you all for joining us this morning.

Ladies and gentlemen, this teleconference will be available for replay beginning today at 1:30 p.m.. And running through August 1. You may access the AT&T executive playback service at any time by dialing 800-475-6701. International participants may dial 320-365-3844. And your access code is 736385. Again, the toll-free number is 800-475-6701. International, 320-365-3844. And your access code ask 736385. That does conclude your teleconference for today. Thank you for your participation and for using the AT&T executive teleconference. You may now disconnect.