International Coal Group, Inc. (ICO)

Q3 2008 Earnings Call

October 30, 2008 11:00 am ET

Executives

Roger L. Nicholson - SVP, Secretary and General Counsel

Bennett K. Hatfield - President & CEO

Bradley W. Harris – SVP, CFO, & Treasurer

Phillip Michael Hardesty - - SVP - Sales & Marketing

O. Eugene Kitts – SVP- Mining Services

Ira Gamm - Vice President - Investor and Public Relations

Analysts

Brent Levy - Jefferies & Company

Jeff Kramer – UBS

Michael Dudas – Jefferies and Company

Shneur Gershuni - UBS

Justine Fisher – Goldman Sachs

[Sinail Sibal – Formaticses]

Luther Lu – FBR Capital Market

Presentation

Operator

Good day, ladies and gentlemen and welcome to the third quarter 2008 International Coal Group earnings conference call. At this time all participants are in listen only mode. We will conduct a question and answer session towards the end of this conference. (Operator Instructions) As a reminder, this conference is being recorded for replay purposes.

I would now like to turn this presentation over to Mr. Roger Nicholson. Please proceed.

Roger Nicholson

Thank you. Welcome to International Coal Group’s third quarter 2008 earnings conference call. I am Roger Nicholson, Senior Vice President, Secretary and General Counsel of International Coal Group. We released our 2008 third quarter earnings report yesterday after the market closed. With me on the call this morning are Ben Hatfield President & CEO of International Coal Group, Brad Harris, Senior Vice President, CFO, and Treasurer, Mike Hardesty, Senior Vice President of Sales & Marketing, Gene Kitts, Senior Vice President of Mining Services and Ira Gamm, Vice President of Public Relations.

Before we get started, please let me remind you that various remarks that we may make on this call concerning future expectations, plans and prospects for the company constitute forward looking statements for the purposes of the Safe Harbor provisions under the Private Securities Litigation Reform Act of 1995. These statements are made on the basis of management’s views and assumptions regarding future events in business performance as of the time the statements were made. Because these forward looking statements are subject to various risks and uncertainties actual results may differ materially from those implied. Factors that could cause actual results to differ materially are contained in our filings from time to time with the Securities and Exchange Commission and are also contained in our press release dated October 29, 2008. Non-GAAP financial measures will also be discussed. You will find a reconciliation of the differences between the non-GAAP financial measure and the most comparable GAAP financial measure at the end of our press release, a copy of which has been posted on our website.

At this time I’d like to turn the call over to Ben Hatfield for his opening remarks.

Bennett K. Hatfield

Thank you for joining us this morning. Despite the difficult and challenging operating environment facing our industry, we are pleased to report significantly improved third quarter operating results as compared to the third quarter of 2007 after excluding net gains on asset sales. Our results this quarter reflect improved margin growth driven primarily by higher coal pricing at our northern and central Appalachian operations. However, we also enjoyed notable operating improvement at several key mining complexes.

In northern Appalachia for example, our Patriot and Vindex operations delivered stronger results through increased production and an aggressive focus on higher margin sales. Patriot identified alternative sourcing for a low quality waste fuel contract and redeployed production units to generate higher value utility coal.

Vindex enhanced their margins by diverting low quality steam coal to a processing plant that boosted quality to meet metallurgical sales opportunities. Although both market optimization efforts raised production costs, the resulted revenue boosts has improved profit margins at both locations.

In Central Appalachia, our eastern complex delivered record level production and profit performance. The Knott County and Hazard operations also performed solidly. Our new Powell Mountain operation became an immediate profit contributor in its first quarter of operation despite inflated production costs driver by low volume start up.

As many of our peers have noted in recent reports, the eastern coal industry faces a number of operating challenges that have driven production costs steadily upward. Underground mines, particularly those in growth modes such as our Sentinel and Beckley operations, are experiencing significant productivity constraints due to scarcity of experienced labor, regulatory delays and heightened enforcement.

Surface mines are seeing similar deterioration from recent productivity levels due to delayed permit approvals and litigation by anti-mining extremists. Over recent months the lower productivity impact has been coupled with high commodity costs and escalating wages resulting in higher production costs across the eastern coal regions.

While many industry observers are anticipating relief going forward on the commodity costs, and perhaps the pace of wage inflation, the productivity issue will likely be an ongoing challenge that could constrain coal supply for some time. The outlook for coal revenues is much more upbeat. Our recent contracting efforts should provide a good foundation for the upcoming years as we have layered in forward sales throughout this period at historically strong prices.

We believe the recent decline in over the counter price indices do not accurately reflect current coal pricing for physical shipments. As an example, during the third quarter, we reached a grievance for the sale of 2 million tons of predominantly steam coal for prices in excess of $115 per ton for delivery over the next three years. Additionally, terms had been settled on two new multi-year contracts for sale of coal from our Illinois Viper mine with average prices in excess of $46 per ton. These multi-year supply contracts are expected to provide the economic base load for our planned expansion of the Viper mines.

We expect coal pricing to be relatively strong in 2009 and 2010 because industry wide supply constraints are projected to largely offset any reduction in demand arising out of an economic slow down. We also believe the export market will continue to provide solid demand for Appalachian region coal; accordingly, we expect our 2009 and 2010 revenues to be substantially improved over 2008 levels.

At this time I’d like to turn the call over to Brad Harris, our Chief Financial Officer to discuss our third quarter results.

Bradley W. Harris

Thanks, Ben. In the third quarter of 2008 ICG reported revenues of $309.2 million including $282.3 million attributable to coal sales of 4.8 million tons. This constitutes a 49% increase over third quarter 2007 revenues of $207.8 million of which $191.1 million was attributable to coal sales of 5.4 million tons. We reported adjusted EBITDA of $45 million for the third quarter of 2008, a 33% increase compared to adjusted EBITDA of $33.7 million for the third quarter of 2007.

For the third quarter of 2008, we reported a net income of $9.7 million or $0.06 per share on a diluted basis compared to a net loss of $1.3 million or a loss of $0.01 per share on a diluted basis for the same period in 2007. Average revenue per ton for the third quarter was $58.87 compared to $42.29 per ton for the same period last year while cost per ton was $50.10 for the third quarter versus $41.69 per ton for the same period of 2007.

Depreciation, depletion and amortization totaled $24.2 million for the third quarter of 2008 compared the $23 million for the third quarter of 2007. Corporate SG&A for the third quarter was $8.4 million compared to the $9 million for the same period last year. In the third quarter we recognized net gains on asset sales totaling $6.4 million. These gains were related primarily to the sale of a used Adcar Highwall Mining System, a real estate exchange, and the disposition of other assets.

At September 30, 2008, total debt was $425.8 million consisting primarily of $175 million of 10.25% senior notes, and $225 million of 9% convertible notes. Our total debt to capitalization ratio was 45% at the end of the third quarter while our debt to market capitalization ratio was 31%. Our 9% convertible senior notes became convertible at the note holders option beginning on July 1, 2008. The conversion period expired on September 30 without any note holders having exercised their conversion rights.

Total assets for the company were $1.4 billion as of September 30 up from $1.3 billion at year end. Capital spending for the third quarter totaled $110.5 million of which 57% related to the development of new mining complexes and 43% related to the support of existing mining operations. Our capital expenditure guidance is unchanged at $179 million for 2008. Our previous 2009 guidance for capital spending of $205 million is being re-evaluated in light of uncertainty regarding the timing of retired development spending, increased equipment costs, and other factors.

We plan to maintain flexibility to maintain our 2009 development capital spending and expansion timing as we continue to assess developments of the economy and on markets. As of the end of the third quarter we had $62.2 million in cash. This balance has increased to nearly $80 million as the close of business yesterday. Fourth quarter requirements include $69 million for capital expenditures that will be satisfied with cash and equipment financing.

At this time I’ll turn the call back over to Ben.

Bennett K. Hatfield

I would now like to provide an update on key developments in the third quarter. On September 25, 2008 the U.S. Army Corp of Engineers provided a section 404 permit to our new Tygart number 1 underground mine project in Taylor County, WV. This permit enables us to begin major site development in advance of shafts and slow construction. This good news was tempered by an adverse decision from the West Virginia Surface Mine Board on October 7, 2008. The Surface Mine Board remanded related surface mining permit previously approved by the West Virginia Department of Environmental Protection requiring that ICG address a technical issue related to projected post mining water falling.

As a result, all site development work will be suspended at Tygart until the required permit modification has been approved. That modification is now being prepared and is expected to be submitted within the next few weeks. We believe the Tygart number 1 mine plan has previously approved, complied with all state mining regulations so we were surprised and disappointed by the Surface Mine Board’s decision. However, we expect the permit issues to be resolved in a timely fashions so that site development on the Tygart site can be resumed by mid 2009.

At the Viper mine in Williamsville, Illinois, we have begun site preparation for construction of a new mine portal that is expected to be completed in 2010. We expect the new portal will enable the Viper mine to improve operating efficiency and increase annual production capacity to approximately 2.9 million tons.

At the Sentinel complex in Barbara County, West Virginia, third quarter production was adversely affected by a non-fatal mining accident. Production was idle for 16 days in August due to the governmental accident investigation and subsequent work force retraining. Additionally, in an effort designed to boost productivity that has suffered due to the scarcity of experienced minors, the Sentinel work force has been realigned to operate more efficiently as fully staffed two section mine rather than as a three section mine. Subject to labor availability, we expect to restart the third production unit during early 2009.

At the new Beckley complex production growth has also been slowed by a regional shortage of skilled minors with further constriction resulting from delays in regulatory approval of mine plan modifications. We have focused additional human resources personnel on hiring issues in order to strengthen staffing efforts and also increase wages to bolster retention and maintain our competitiveness in the regional labor market. We are now expecting the Beckley complex to reach its full production run rate in mid 2009.

Our Hazard complex has begun receiving equipment that will support an expected production increase of 500,000 tons of steam coal annually at its East Mac

& Nellie Surface mine in 2009. This new equipment includes a 44 cubic yard hydraulic shovel and five 240 ton rock trucks. The Hazard complex produced 3.9 million tons in 2007.

Turning now to our committed sales for the next three years, for 2008 the company’s committed and priced sales are approximately 19.6 million tons or about 99% of planned shipments. Currently price volume for 2008 averages $53 per ton excluding freight and handling expenses. For 2009, committed and price sales are approximately 19.3 million tons or about 89% of projected shipments.

Currently price volume for 2009 averages $61 per ton excluding freight and handling expenses. Approximately 38% of the uncommitted 2009 tonnage is planned to be sold as metallurgical coal. In 2010 committed and priced sales are approximately 10.2 million tons or about 48% of expected shipments. Currently price volume for 2010 averages $60 per ton excluding freight and handling expenses. Approximately 35% of the uncommitted 2010 tonnage is planned to be sold as metallurgical coal.

Focusing now on our outlook, we have updated our previous guidance for 2008, 2009 and 2010 to reflect the uncertain economic outlook and recent industry wide challenges. We currently expect our fourth quarter results to be somewhat lower than our third quarter performance. Current projections anticipate adjusted EBITDA in the $25 million to $30 million range. Shipment and production levels will be constrained by fewer work days because of the holiday breaks during November and December. Additionally the fourth quarter will have the higher portion of lower priced shipments than third quarter due to timing of export commitments and our obligations to service older contract sales.

For full year 2008, however, we expect to sell approximately 19.7 million tons of which approximately 1.3 million tons are projected to be sold as metallurgical coal. Coal production for the year is expected to be approximately 18.5 million tons. We project the average selling price for 2008 to be in the range of $53.60 to $54 per ton. This compares to our previous guidance range of $54 to $55 per ton.

The projected average cost per ton for 2008 is expected to be in the range of $46.25 to $46.75 excluding selling general and administrative expenses. This compares to our previous guidance range of $45 to $47 per ton. Our coal exports in 2008 are projected to total of approximately 3 million tons consisting of approximately 1.3 million tons of metallurgical coal and 1.7 million tons of thermal coal.

For 2009 we expect to sell 21 million to 22 million tons of coal of which approximately 2.1 million tons are projected to be sold as metallurgical coal. Coal production is expected to be 20.5 million to 21.5 million tons in 2009. We’re now projecting the prices in 2009 will average between $66 and $73 per ton compared to our previous guidance of $72 to $78 per ton. We have purposefully minimized our exposure to the stock market in the first half of 2009 due to concerns about near term economic conditions. We expect prices and volumes to improve sequentially each quarter with the second half of 2009 projected to be stronger than the first half.

For 2010 we expect to sell 21.5 million to 23 million tons of coal of which approximately 3 million tons are projected to be metallurgical sales. Coal production is expected to be 21 million to 22.5 million tons in 2010. We expect average prices between $79 and $96 dollars per ton. Our outlook is guided by the expectation that demand from international markets will continue to drive coal exports and that Eastern U.S. production will remain constrained.

While the global economic uncertainty is a genuine concern, we believe ICG is well positioned. Our unsold volumes for 2009 represent our most premium quality products which we expect to command appropriate value even in a softer market. We further expect the economic slow down to help reduce cost pressures on commodities such as diesel, ANFO or explosives, steel and tires, and also to reduce the pace of wage escalation. As a result, 2009 margins should be favorable even in a weaker economic climate since most of our coal is committed at substantially higher price levels.

At this time, I’ll open the call to your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Brent Levy - Jefferies & Company.

Brent Levy - Jefferies & Company

In terms of the potential of the funding gap, you guys have moved CapEx around a little bit and a number of the other numbers here. Do you see any potential funding gap as you get into 2009 and when might that occur and I suppose the other thing is how low do you the cash and revolver availability get at their lowest point in 2009 the way you guys are drawing your lines right now?

Bradley W. Harris

The tightest time on the line is going to be in the first and second quarter of 2009. Right now we currently have availability on the line of $28 million that we talked out. Our current cash balance is about $80 million although as we’ve described we have a healthy CapEx program for the balance of the year. I would expect us to be perhaps approaching the line in that first and second quarter timeframe right now.

Current projections would say that we don’t go into the lines and we should continue to have that $28 million of availability at our low point. If we were to touch it that would be the time and we certainly do have considerable flexibility with the timing of our capital expenditures with our expansion plan for 2009 so if we did get constrained a little bit we could move that out, but again, that’s the current expectation.

Brent Levy - Jefferies & Company

I know it is a difficult credit environment; but have you guys investigated the idea of perhaps getting a line that would expand availability beyond $28 million?

Bradley W. Harris

Yes, we have. We’ve had active discussions related to that area so it’s something we are pursuing and we’ve been encouraged by, even in the tight market, by the reception we receive but nothing has been completed at this point.

Brent Levy - Jefferies & Company

That’s something you’re investigating. Is there a possibility of something along the lines of a forward sale or something along that line to raise liquidity as well?

Bennett K. Hatfield

Let me address something for clarity. We don’t envision any constraints on our business plan related to lack of capital. We expect from current forecasts to operate well within the credit facility we have in place as we speak, even assuming that the project goes forward on schedule so the short answer is, there is no constraint in our current business plan at all that technically impacts 2009.

If we were to try to attempt a significant acquisition or something were to change from an operational forecast standpoint we certainly would look at alternative funding mechanisms as we talked about in this call before. We certainly have those options available to us whether it be via lease back or partnership on expansion projects with customers but everything that we see right now in our current forecast indicates that there’s no need to do so; no need to raise additional capital beyond what is already within our reach.

Brent Levy - Jefferies & Company

All right, and then you guys referenced obviously, regulatory and labor related delays at Beckley and Sentinel, can you guys talk about what production was during the third quarter and I know you gave a number for the flow run rate by mid 2009 for Beckley, can you sort of give a sense of what the ramp is going to look like from kind of today’s number to that one four?

Bennett K. Hatfield

Are you talking about Beckley specifically?

Brent Levy - Jefferies & Company

Yes, I guess Beckley and Sentinel, but Beckley first.

Bennett K. Hatfield

Again, Beckley is at full expected to get to the 1.4 million ton pace, we’re probably operating at about 45% to 50% of that currently. The obvious constraint is labor availability first and foremost, and in addition to that, we continue to be constrained with respect to mine plant modifications that limit our productivity in our vernacular, the extended cut plans which are a significant component of any normal mine ramp up that allows you to take more longer cuts as the pace production cycles through from one side to the other.

That is a big issue with respect to productivity growth and the Mine Safety Health Administration has become very tough to review and approve as planned. It used to be perhaps a two month process when you’re starting up a new operation and what we’re seeing over the last year to year and a half is it can take 12 to 18 months to get those fairly routine mine modification changes. That in itself probably represents a 30% to 40% constraint on productivity and that’s just as critical a limitation as the staffing so it’s kind of a two fold issue with Beckley right now that’s limiting us from getting where we need to be but we have made some progress in several fronts with improvements to ventilation plan and roof support.

We’re working close with regulators to meet their requirements and we expect to get to much more normalized productivity levels during late fourth quarter and early first quarter of 2009. Once we’re at those improved productivity levels and operating in what I’d call a more normal fashion, then we’ll have the confidence to add the third unit and that’s likely to come online late in second quarter of 2009.

The ramp up is a continual progression, we’re seeing improvement month over month but the steps are pretty small when you look at it in terms of total production potential because until we get the flexibility we need on the mine plan modifications, the staffing additions don’t gain us as much ground as they normally would.

Brent Levy - Jefferies & Company

And on Sentinel?

Bennett K. Hatfield

At Sentinel, we’re actually performing better now as a two section coal mine then we were in early third quarter as a three section coal mine so we’ve seen some productivity improvements with the realignment. The biggest negative in the third quarter from a Northern Ap standpoint was the 16 day outage at Sentinel mine. That was a huge chunk of production on the order of 130,000 to 150,000 tons that we lost just during that outage so that obviously had a very inflating effect on cost for Northern Appalachian operations during the quarter as well so the third quarter is distorted to the low side on Sentinel production because of that outage. We’re seeing continual progression on productivity week after week now that we’ve realigned the workforce and we’re operating more effectively. We expect to step Sentinel up to its full three section pace probably early in 2009. Again, we’re trying to take very cautious steps to be sure that we hire the right people, get them appropriately trained and that our steps forward are meaningful.

Brent Levy - Jefferies & Company

Last question, then I’ll get back in the queue. Can you guys talk about the outlook for met coal prices right now? Can I get what’s going on in China?

Bennett K. Hatfield

Well, I’ll make a few comments on it then I’ll see if Mike Hardesty wants to add something to it. In short, it’s a big question mark. What we have seen clearly is an ongoing scarcity of a valuable product even though certainly the steel companies are sending signals that their order book is becoming much lighter, that they’re seeing a drop off in demand. That’s clearly going to impact forward demand for metallurgical coal but the supply side isn’t going to change much and the supply side remains very constrained with respect of basic availability of both low vol and premium high vol coals so I think the drop in demand is going to be tempered from a price impact standpoint by continuing supply scarcity.

It’s hard to say exactly where the numbers are going to settle out. I think we would say spot pricing is going to be less now than certainly we talked about last quarter but it’s not yet really measured because we don’t know what the impact is going to look like. I think it’s safe to say the export negotiations, the annual negotiations for 2009 commitments are likely to be delayed whereas we were earlier expecting those would probably happen in late fourth quarter. We think that’s probably pushed out into mid to late first quarter but I’m sure those buyers will be looking over their order book to see what their full demand is going to look like. I think we’re probably a full quarter from knowing much about what the forward picture is going to look like on metallurgical coal pricing.

Mike, do you want to add something to that?

Phillip Michael Hardesty

I’ll just add that I think one think we’ve done is we’ve resisted ourselves pretty well because a lot of our lower quality, low vol products we had pretty well committed with, we don’t have a lot of exposure there. Most of our exposure is on the high vol side which will work equally well in the industrial market so we’re not panicked if we see reduction in demand in the first half of the year. I think we’re pretty well positioned.

Operator

Your next question comes from Jeff Kramer – UBS.

Jeff Kramer – UBS

Just with regards to Tygart, what was the CapEx expected to be originally for 2009?

Bradley W. Harris

We haven’t actually broken out the Tygart components specifically but I’m thinking it’s on the order of magnitude of $80 million to $90 million. It’s in that general neighborhood, but I don’t have a precise number readily available.

Jeff Kramer – UBS

Okay, so I guess it’s safe to say that roughly half of that is getting moved into 2010 or I wasn’t clear what the cadence was for 2009 with regard to the CapEx spent?

Bradley W. Harris

Well there’s two facets to the response. First and foremost we’ve stopped site development work at this point and we’re going to make sure that the pending permit modification meets all of the regulator’s expectations. We thought we’d satisfied that question twice now we’re now taking our third stab at it.

Again, a fairly unique issue with respect to a potential water treatment issues 20 years down that road so it’s not an easy question to answer, but we are going to address it and we’ll get that permit modification hopefully approved in the short term. At this point in 2008, we’re anticipating there will be no forward movement on site development really until we get through the winter months.

We really don’t want to start a big project like that early in the first quarter so we’re stepping back from it and anticipating that more than likely we would begin moving forward in late second quarter. The second aspect to that is during that interim while we’re satisfying the regulatory requirements, it will give us a chance to look over what’s happening in the market place and get a better feel for what the forward looking export demand is going to be and how it’s going to impact the divesting markets and reevaluate the pace in which we want to bring the Tygart project on.

My best guess right now would be that we probably would start full scale development toward the end of second quarter 2009, basically mid year. We still have the flexibility to go longer if we see we can market demand or even accelerate it if the market rebounds quicker. It’s a two component answer. I think if we were just trying to predict when the regulatory issue is going to be resolved, I think that’s going to be a much shorter time frame. Once that regulatory issue is resolved, we’re going to look at what the site construction conditions are in the winter situation and what the market demand is looking like going forward.

Jeff Kramer – UBS

Is there any tonnage Tygart in the 2010 guidance?

Bradley W. Harris

Yes, there is small tonnage in 2010. It’s on the order of perhaps 600,000 tons I believe. It would be pretty marginal contributing tonnage because it would not be long haul cost; it would be pretty high cost continuous matter production in the development mode so it would not be a material financial contributor.

Jeff Kramer – UBS

Just on the recent contracts you signed, the $2 million, was that signed recently; was that earlier in the quarter? Could I kind of have some guidance on where tons are being contracted right now and is that pricing through 2011 or just 2009?

Phillip Michael Hardesty

Those were layered in sequentially throughout the quarter. The last one was agreed to right at the end of the third quarter. All but one of them includes pricing through 2011. We had one small met deal of 50,000 tons that was a two year deal.

Jeff Kramer – UBS

Okay, then the, on the percentages met for 2010 for example, are there tons that are committed but not priced, just kind of banking some of the math on the met coal, I think it was 38%?

Phillip Michael Hardesty

There are no tons that are committed and not priced. We have a small amount of volume in the neighborhood of 200,000 to 300,000 that is committed and priced but not committed and not priced.

Jeff Kramer – UBS

Last question on the cost front, what is your hedge position look like in regards to diesel for 2009? I guess, at what point, and not just diesel, but what’s the timing that you think you’ll see some benefits from the lower commodity prices on costs?

Phillip Michael Hardesty

We’ve been fortunate in that regard because we were cautious about laying forward commitments on diesel as the price was dropping so we began to layer in new contracts for 2009 on diesel fuel after crude oil prices had dropped pretty remarkably, so we already have contracts in place for the first 9 months of 2009 representing about 80% of our total requirements and we expect within the next few weeks to take that on basically through the end of the year. Within the next few weeks we will essentially have 80% to 85% of our diesel requirements tied up at pricing that is significantly favorable to 2008 pricing.

Jeff Kramer – UBS

Okay, so the benefit from other like steel and explosives? When do you expect to see some of that flow through?

Phillip Michael Hardesty

That’s going to impact the entire year because we don’t do any forward commitments on explosives, for instance, the ANFO, that price rises and falls markedly with natural gas pricing as a primary driver as well as ammonia pricing so we will essentially be paying the market, we haven’t made a commitment yet so we’re positioned I think to lock in more favorable pricing on ANFO as well for all of 2009. As far as things like steel and tires, those are also kind of in category commitments that are made as needed not extensive forward purchases, so we believe as prices come down and we believe it will, that will also translate to cost improvements through the course of the year.

Operator

Your next question comes from Michael Dudas - Jefferies & Co.

Michael Dudas - Jefferies & Co.

Ben, maybe you could tell us a little bit about what your experience has been with labor turnover the last three months and maybe what you’re seeing in some of the more important regions that you hire from, and how much of a limit do you think industry wide is it going to be, this lack of labor, just to meet the current productivity totals or even new mine investments that have been made over the last twelve months? Do you think it has a potential of limiting more central operation production growth in 2009 and beyond?

Bennett K. Hatfield

The short answer is yes, but to address your questions in order, labor turnover in recent months has been significantly higher than normal I would say on the order of an 18% to 20% order turnover rate on annualized basis. It’s certainly tougher in some areas than others, as an example, in Illinois, there’s very little turnover of a mature, stable workforce, a much different regional labor market, so their labor turnover and availability is actually quite favorable.

The toughest area by far is southern West Virginia, the Beckley area, and the second toughest area is northern West Virginia. The eastern Kentucky region tends to be somewhat favorable largely because their operations are well established and their work forces have been with us for some time and the operations are stable and even growing so that tends to be a little bit friendlier of a labor environment. The short answer on the turnover is it varies markedly but we are seeing unprecedented turnover particularly during the third quarter.

Having said that, even in recent weeks we’re seeing some moderation of that, certainly with the uncertain economic outlook. We think folks are looking for more long term stability, more of an inclination to go to new operation with a long future in front of them and so we’re seeing a flat uptake in interest in employment applications at some of our newer developing operations and that’s pretty encouraging. I believe we’re well positioned to do as well or better than most of our peers in the tough regions. Looking forward I think labor availability is going to be a significant moderator of production growth.

We have seen it materialize abundantly, certainly with our ramp up at Beckley and Sentinel, but we’re also seeing it in portions of eastern Kentucky where some small independents are trying to add production and we’re seeing and hearing in the labor market that they’re having very little success, so it’s becoming increasingly tough for the small operators to try and jump in the business and participate in the spot market because of that labor constraint.

I don’t see that situation changing markedly. I think you’re going to see a reduction in the pace of turnover but basic labor availability is only going to be remedied in a more forward looking fashion through training programs, the red hat programs that are essentially growing new coal miners in over a 3 to 6 month training period. We’re doing that, our competitors are doing that, so that’s going to increase the field somewhat but by and large I see the labor availability as being one of the largest constraints on production growth and that’s going to extend my view through 2009 and 2010.

Michael Dudas - Jefferies & Co.

And I’m sure Mike is focusing that with his utility customers. Ben, given 2009 production range guidance, is there any slippage of that relative to your potential decision on the flexibility of cap spend in 2009 or is that range just productivity and things that may slip one way or the other from your normal operations?

Bennett K. Hatfield

Most of it’s in the category of productivity risks so to speak. There are some small expansion CapEx that could be postponed if we choose, but the bigger expansion CapEx, as I’m sure you recognize, is the Tygart complex with a big spend in 2009 but no production of a material nature until the latter part of 2010 and more significant production in 2011. The capital adjustments that we would anticipate are primarily focused on projects like Tygart where there is a big capital demand in the near term but not a lot of economic return for the next 1 to 2 years.

Michael Dudas - Jefferies & Co.

How are you looking at staffing Tygart? Is it going to be mostly from current employees or a new pool that you are going to choose from? Is that something you have to work on now or is that something you can kind of play the market and see how things play out in the labor side?

Bennett K. Hatfield

It’s going to be a little bit of both. We are going to use some of our regional operations as essentially ramp up floatations to add Tygart staffing. We can add unit shifts to established operations to units like Sentinel and Beckley in regional operators and then essentially use that as a training ground to start the Tygart workforce. We may be doing some of that, we also believe there are some substantial operations in the neighborhood of Tygart that are fairly mature and indeed somewhat winding down operations because of production reserve depletion. We believe our timing could fit well with what’s essentially a winding down of other regional competitors and perhaps be a big draw for people who are looking for a long term place to work and prosper.

Operator

Your next question comes from Shneur Gershuni - UBS.

Shneur Gershuni - UBS

I guess just a couple of questions. I hate to beat the horse on the permitting issue with Tygart here. Is it fair to say that you’re saying it is potentially delayed into the second quarter more from an operational issue and you feel fairly confident or mostly confident that you’ll be able to resolve the permitting issue at that point in time or should we start thinking that this is similar to the impact of the Judge Chambers decision on permits 404 and it will take a lot longer to resolve?

Bennett K. Hatfield

No, the complexity of this issue is nowhere near the level or the severity of the Judge Chambers kind of issue. This is very much a technical issue. We’ve actually been asked to clarify how we would handle water treatment after the mine has been completely treated if we have discharges when we don’t even expect them to occur. You take a conceptual problem and then they want an extensive discussion on how we would resolve it and we thought we had answered that question twice.

We have clearly satisfied the West Virginia Department of Environmental Protection because they approved the permit twice. We’re kind of into a very much high tech territory on conceptual technical issues that we do not believe are by any means of an industry wide magnitude or signaling any significant change in the viability of the project. It’s more a nature of a short term technical challenge. We feel confident that it is going to be resolved in the very near term. First and foremost it’s not anything like a project ending kind of threat. It is more accurately a stepped up standard for clearly and technically addressing issues within the boundaries of the permit to the satisfaction of the Surface Mine Board.

I don’t think it’s a long term fix, with respect to the timing reference to mid 2009, not because I think it will take us that long to fix the problem by any means, but the permit is kind of our reference point on what would be a logical delay in start up because we really don’t want to start a major project like this in the worst part of winter and we also want to be sure we have thoroughly addressed any technical challenge on part of the West Virginia Surface Mine Board or the West Virginia Department of Environmental Protection. We want to be sure we satisfied all the regulators before we pull the trigger again and that will give us a couple of quarters to also look over the market and see what our view is as what the demand from this quality is going to be and firm up our comfort levels on it.

Shneur Gershuni - UBS

Is there any risk that they make you make some modest change on a technical aspect that would cause you to have to re-file all the permits with every single one of the agencies or would you just be specific just for this type of agency? Is there any kind of risk that you’d have to re-file the 404?

Bennett K. Hatfield

No, again the challenge we’re talking about here has nothing to do with the 404. The Corp of Engineers 404 is in good standing as we speak. It’s the state mining permit that has this challenge which normally is a permit, a permission, if you will, that gets resolved as soon as the West Virginia Department of Environmental Protection has approved it. In this case, it got challenged to the West Virginia Surface Mine Board on a technical issue and we’re trying to resolve that issue. Nothing in this current situation really impacts the approved 404 permit that we referenced.

Shneur Gershuni - UBS

Okay, if I can turn to the operational side, Sentinel, Beckley, there have been some challenges of labor and a host of other issues and everybody in the industry is experiencing rapid increase of MSHA inspections which is killing productivity. Sort of, what is your, when you think about the guidance you have put out there or hinted to with respect to production and so forth; have you basically assumed the worst of these inspections and labor issues and so forth and baked it in at this point, it could only get worse if inspections went up even further or if labor turnover doubled from its elevated levels that we’re at right now? I mean, are we baked in kind of the scenario we are seeing now in terms of turnover and MSHA inspections?

Bennett K. Hatfield

I think our production forecast obviously is arranged because of uncertainty in several aspects of those issues but it reflects essentially our anticipation that we won’t get any regulatory relief; that we’re going to continue to have this level of heightened enforcement; that turnover is going to continue to be a challenge. We believe in that context that essentially anticipates that we continue to have an operating performance that’s reflective of what we have in third quarter, in recent months. Having said that, there are certainly other things that can go wrong, but we also anticipate significant improvements.

We certainly expect relief cost wise on commodities; we expect a productivity improvement at several locations through the new equipment that’s being delivered and through resolving some of the recent challenges. I think the production forecast is a realistic reflection of current performance levels and is not anticipating that we get any kind of significant relief from regulators.

Shneur Gershuni - UBS

Okay, just one final question. Just sort of, your outlook with respect to the met market, not just you but a lot of your peers sort of indicated it’s tight supply and price needs to remain strong, especially for the higher qualities; how do we reconcile that with the comments on the cost side that we expect steel to come down given that coke and coal isn’t input into the seal process? How should we be reconciling those two types of statements?

Bennett K. Hatfield

I think the fact that steel prices may come down and translate into a savings on commodities side doesn’t necessarily translate to a dramatic drop in metallurgical coal prices. Certainly it anticipates some relaxation in the pressure that we’ve seen in recent quarters, particularly at the performance levels we’re anticipating the volumes we have to move, and we’re offering premium quality products that we believe are going to be priced very attractively in the market.

We believe the supply of those premium products is going to be pretty scarce for all the reasons we’ve talked about with respect to regulatory constraints and labor availability and so forth. There aren’t any new low vol mines coming on board of the caliber of Beckley, there aren’t any premium high vol mines that are coming online in material quantity, so I think you’ve got pretty much a supply constraint situation and perhaps some softening in process that I think still leaves a very good outlook with respect to the amount of metallurgical coal that we’re expecting to move in the market.

Shneur Gershuni - UBS

If I can summarize it effectively, it sounds like the lower qualities are going to be the ones that will probably take the brunt of it?

Bennett K. Hatfield

I think you’re right on that point certainly. Generally when you see a softening in the market, it’s the lower quality product that takes the most severe drop in price. Indeed in an extreme situation you might see some weak metallurgical coals get pushed back into the utility market, but the product that we believe we have the availability to move, we feel pretty confident they’re going to be attractively priced.

Operator

Your next question comes from Justine Fisher – Goldman Sachs.

Justine Fisher – Goldman Sachs

The first question I have is on the cost inflation front and I think that if we all look at what’s going on, as far as the data, we can see for commodities not just fuel and diesel cost is certainly going down but then from other producers in the region; just putting labor cost aside, from other producers in the region we’ve heard expectations of continued cost inflation, so barring things like raw materials and regulations I guess, so, would you guys expect on a percentage basis going forward, do you expect net net your costs to continue to increase or decrease based on the fact that we’ve got lower commodity input costs but higher cost for labor and regulations?

Bennett K. Hatfield

That’s a difficult question to answer because you’ve got a mix of different projects and different situations but to try to kind of deal with it more selectively, in our view there’s no question that commodity pricing is going to improve versus experience that we’re seeing here today in 2008. I think everyone agrees diesel is going to improve.

If there is a slack in the steel market, which we’re certainly seeing in the near term, cost of steel products is going to reduce, particularly [inaudible] which is a big cost item to run a ground mine and machinery parts. Machinery parts get cheaper as winter’s reduced demand for growth and production equipment, so those kinds of pieced we can single out and say yes we expect the forward picture on those cost items to be favorable.

The labor piece is a bit more difficult to anticipate but I think it is clear that we’ve seen an incredibly high pace of wage inflation over the last two quarters and if there is a slackening, if you will, in coal demand of whatever nature in the Appalachian region, you’re certainly going to see less pressure on wage escalation, so I think the pace of wages going up is likely to reduce and that is certainly favorable to cost inflation.

The things that I don’t anticipate are going to improve are certainly the points you referenced on the MSHA inspection issues, heightened enforcement, the delay in plan approvals that allow us to increase productivity in underground mines, the constraints negatively impacting our surface operations where we had difficulty getting Valley Fields approved and that forces us to haul rock and dirt a lot further and incur higher cost as we’re disposing of over burden. Those factors are likely to be ongoing at least from what we can see in 2009 and we’re not expecting any cost relief on those issues.

Justine Fisher – Goldman Sachs

And you think it’s too early to say which one might overwhelm the other, because on the one hand, if we think coal prices are going down, it could be okay if costs go down as well. That’s what people are saying for the steel industry, that steel prices would go down but the coal and iron ore prices and scrap prices would go down if coal prices go down, but if labor overwhelms lower input cost then we could see a significant margin squeeze in 2009.

Bennett K. Hatfield

My overall guess and I’ll qualify it as a guess is that you’re likely to see cost go up net net but I think at a much lower rate than you’ve seen say from second quarter to third quarter.

Justine Fisher – Goldman Sachs

If we saw cost inflation in the sort of 5% range previously or in the 1% to 2% range?

Bennett K. Hatfield

I would only say that I think it’s going to be a much lower rate of escalation than we’ve seen.

Justine Fisher – Goldman Sachs

Okay, and then on your $205 million 2009 cut backs estimate, I know that is now under review and I guess earlier you said that about $80 million to $90 million of that is the Tygart complex, can you tell us what the remaining portions are represented by so we can get a feeling for what may be flexible in that number, in other words, what may be able to be cut and what might not?

Bennett K. Hatfield

We’re really not ready to get into that level of detail but I will make clear that the biggest project piece of it by far is Tygart. We don’t have any major expansion projects, we do have some mines being developed at our Powell Mountain operation that will increase volume there in what we believe is a favorable market, that’s relatively small investment levels.

We’re looking at upgrading equipment in several locations so it’s kind of a mixed bag and it’s tough to break out specifically but generally our CapEx is aimed at strengthening our equipment fleet, replacing mines, particularly small scale mines that are depleting and have to be faced up. That occurs at places like Powell Mountain and Knott County is just an ongoing part of our business. It’s pretty difficult to pull out single pieces. They hear something that may move because of the analysis is more complicated than that, quite honestly. In part, it’s going to be tempered by regional market demand and quality of the product.

Justine Fisher – Goldman Sachs

I was just wondering what the maintenance level CapEx was.

Bennett K. Hatfield

What we expect it to be going forward? In order of magnitude, about half of our capital budget is maintenance CapEx so if you get back into the math that’s probably on the order of $5 to $6 a ton order of magnitude, but looking at it from an annual budget standpoint, it’s about half of our spending.

Operator

Your next question comes from [Sinail Sibal – Formaticses].

[Sinail Sibal – Formaticses]

Most of my questions have been answered, I just wanted to call back and make sure that I understand correctly, especially in regard to the new [inaudible] contract signed on which you gave the person who bought [inaudible] and you said that a very little amount of metallurgical was part of that; is that right?

Bennett K. Hatfield

Yes.

[Sinail Sibal – Formaticses]

I guess you mentioned 50,000 tons only and that would be basically high quality metallurgical domestic buyers I guess, is that fair?

Bennett K. Hatfield

I wouldn’t characterize it as high quality but it was a domestic sale.

Operator

Your next question comes from Luther Lu – FBR Capital Market.

Luther Lu – FBR Capital Market

I have a few random questions. The first on is on the 2 million tons contracted for 3 years; were you guys able to get a [contango] contract or flat pricing or [inaudible]?

Bennett K. Hatfield

It’s fixed pricing over that period. It’s basically at a flat rate.

Luther Lu – FBR Capital Market

Okay. You guys were mentioning in the press release that you believe 2009 export will increase out of U.S., can you explain to us how you arrived at that conclusion and what will be your 2009 export level?

Bennett K. Hatfield

That is really a reference to the EIA, they’re still projecting growth in 2009 exports and I think most of our competitors have had the same views. Certainly there’s risk with that, with the economic uncertainty. Next year, currently we are planning much lower levels of export. I think this year we are in the 1.7 million ton range on the thermal side and we probably have booked and planned about 400,000, some of which is the completion of fiscal year type business. From an ICG perspective, we’re going to be lower so we’ll have less exposure to that market next year than we had this year.

Luther Lu – FBR Capital Market

For your Tygart coal, has that been sold forward?

Bennett K. Hatfield

No, not at this point. For clarity, we have the ability to service some of our contracts from several different locations so in part we are able to layer in contracts at adjacent locations like [McAnnon] and Sentinel and kind of used that as a base from which we can grow Tygart contracted business, but we’ve not to this point made any forward contracts on the Tygart production.

Luther Lu – FBR Capital Market

Okay I see and there’s another hypothetical question. Say if [inaudible] coal price goes down to $80 a ton and how much production do you think will be taken offline and would that solve the labor constraint issues for you guys?

Bennett K. Hatfield

I wouldn’t want to venture a guess as to how much but it’s clear that $80 pricing given the current cost pressures that we’ve seen is certainly going to take some production off the market. I think there is little doubt we are seeing some marginal production in the market place probably in the $80 or more cost range. I think there’s little doubt that if that were to be the case, I don’t think it’s certainly not the case yet, then it would result in some production being shut in and even north of $80, I think if prices stay in the $90 range you’re likely to see some postponed development of production because I think some of the enthusiasm, particularly by small independents to bring online new production is going to be dampened by the price outlook.

Luther Lu – FBR Capital Market

And for all of your CapEx projects, in terms of, I wonder if you can give us a ranking of what do you think the highest return project is and which one is the lowest return project?

Bennett K. Hatfield

Again, you have to put into perspective of three of our big development projects, two are up and running and that’s Beckley and Sentinel and the Tygart project is the one that’s just in the early stages of site development. We certainly would anticipate continuing to bring the Beckley and Sentinel projects up to full production output.

Sentinel in normal operating mode is probably in the 80% to 85% of production capacity mode currently and Beckley is probably in the 45% to 50% range of full production output. We’d expect to continue bringing those up to 100% output because that’s clearly going to be the best investment of CapEx. We don’t have to put down any new shafts and slopes, we don’t have to do anything dramatic. We just continue adding onto the infrastructure that’s in place.

The Tygart project is the one that falls into the category of being an opportunity to delay production and expansion if we choose to do so. We would not choose to do so because it’s not a good project, because in my view, one of the best development projects available in the Appalachian region.

We want to be sure that we’re creating production in a marketing environment that is optimized margins and get the best return on capital, so it’s not inconceivable that we may elect to delay the Tygart project for some period of time but there’s little doubt even at current market prices or lower that the Tygart projects provides and exceptionally good rate of return.

Luther Lu – FBR Capital Market

The Viper project, is it the cost [saving] project or is it; you consider it an expansion project?

Bennett K. Hatfield

It’s expansion in the context that we are enabling additional production but it’s also essentially a retooling of a good long term operation. We have a high productive underground mining operation that’s extended its mainline infrastructure for distance for about 5 to 6 miles so we’re consuming a lot of labor time and a lot of maintenance dollars in servicing that extensive main line area.

This project gives us the ability to essentially put down new shafts and slopes and stop using the old infrastructure at significant cost savings and significant improvement to the business so it lets us kind of create a brand new coal mine, if you will using the preparation plant loading facilities, work force, and management team that’s already in place in Illinois and doing an exceptionally good job for us.

It’s essentially kind of retooling an operation both to continue producing for many years to come and also to give us some growth room. It will let us increase output from Illinois from about the 2.1 million tons range that we produced in 2007 up to possibly 2.9 million tons. We’ve seen the favorable market opportunities to accommodate that growth and indeed we’ve already begun selling it as you heard earlier with the contracts that we’ve layered in. The security of revenue and attractive margins that lay ahead certainly gives us a lot of incentive to move forward with that project.

Operator

Your next question is a follow up from Jeff Kramer – UBS.

Jeff Kramer – UBS

Just a quick question, Brad, on the Caterpillar facility. You mentioned $110 million so far in CapEx year to date. The cash flow statement is $93 million, does that mean you’ve spent $17 million or you’ve financed $17 million through the Caterpillar facility and how much is remaining on that?

Bradley W. Harris

I think that’s a fair number. We’ve done some additional financing here in October. Ben talked about the shovel that we did at Hazard, we did the finance that. We’re probably at about $30 million out on that line here at currently; we’re probably at about $20 million yet in capacity.

Operator

There are no further questions in the queue. I would like to turn the call back over to management for closing comments.

Bennett K. Hatfield

Thank you. International Coal Group is looking forward to building on our progress of the third quarter. We truly appreciate your interest and look forward to joining you again next quarter. Have a good day.

Operator

Thank you for your participation in today’s conference. This concludes the presentation. You may now disconnect. Have a good day.

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