Arch Resources, Inc.
Q4 2020 Earnings Call Transcript

Published: 9 Feb 2021

[Operator:]

Good day, and welcome to the Arch Resources, Inc. Fourth Quarter 2020 Earnings Conference Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Deck Slone, Senior Vice President of Strategy. Please go ahead, sir.

[Deck Slone:]

Good morning from St. Louis, and thanks for joining us today. While we are conducting this morning's call from Arch's boardroom, I want to assure you that the team is widely spaced and following CDC guidelines closely. Before we begin, let me remind you that certain statements made during this call, including statements relating to our expected future business and financial performance may be considered forward-looking statements according to the Private Securities Litigation Reform Act.

[Paul Lang:]

Thanks Deck and good morning, everyone. I appreciate you joining us on the call today. Let me begin by expressing my deep gratitude to the entire Arch team for their ongoing dedication during what is quite obviously a complex and challenging time. Even in the face of a significant step up in infection rates over the last several weeks that mirrored the surge nationwide. The Arch workforce remained steadfast in its commitment to taking all the recommended precautions to protect one another and their families from the virus while continue to execute at the highest level as essential service providers. We are fortunate to have a disciplined and professional team and I'm proud to be associated with them. That same commitment to excellence was on display in Arch's list of accomplishments during 2020 as we work to reposition the company for future success. Despite all the requirements associated with navigating the global health crisis, our employees made tremendous progress in achieving a number of strategic objectives. Hitting are just some of the highlights. We've maintained our strong momentum in the development of the world class Leer South growth project and we augmented our liquidity and funded the build out of this transformational project through three successful financing efforts. The teammates maintained our first quartile cost structure in our core coking coal segment despite significant market driven volume reductions. We continued our strategic shift towards steel and metallurgical markets through the contribution of the Viper thermal mine to Knight Hawk coal company. And our employees yet again demonstrated their leadership in the environmental, social and governance arena by capturing many of the industry's top safety and environmental awards, and leading the industry on all of these critical fronts. We've streamlined our organizational structure with a voluntary separation program that reduced corporate staffing levels by 25% and cut our overhead costs by $10 million per year.

[John Drexler:]

Thanks, Paul and good morning, everyone. I'd like to echo Paul sentiments about the great dedication and tremendous contributions of the Arch's workforce in recent months. 2020 has been a year like no other and I'm so proud of how the team has executed despite all of the challenges and distraction. As Paul noted, Arch's single highest strategic objective remains the ongoing and successful build out of our world class coking coal platform. During 2020, we once again demonstrated the already significant capabilities of our existing portfolio, delivering a top tier cost performance despite virus related volume reduction, leveraging our sales and logistics expertise in a difficult market environment, and expanding the breadth and depth of our customer base. At the same time, we drove forward with the Leer South expansion project that should deliver a step change in our portfolios cash generating capabilities. With the startup of that transformational asset in about six months time, we expect to realize improvements in virtually every key metric for long-term success, including volumes, per ton cost, and average quality.

[Matt Giljum:]

Thanks, John and good morning, everyone. Before getting into the financials, I would like to add a little to the discussion around our plans for the thermal operations with a focus on surety bonding. As Paul and John had mentioned, our initial priority is the accelerated reduction of the Asset Retirement obligation and related bonding requirements at Coal Creek. At the same time, John noted the opportunities of Black Thunder for more limited reclamation that will allow for Bond Reduction without any impact on our operational flexibility. The work we plan to perform over the next two years along with the divestiture of Viper should result in a reduction in bonding requirements of approximately $70 million, which represents nearly 15% of the total reclamation bonding for our legacy thermal operations. Clearly, that is a significant first step in reducing those obligations. The logical next step, as Paul alluded to in his prepared remarks is to begin setting aside funds for future reclamation, in line with the cash flows generated from the thermal segment in excess of current reclamation spending. Given the significant amount of reclamation currently underway, along with the typical seasonality in PRB shipping volumes, we would anticipate that funding to begin in the latter part of this year. Turning to the quarterly cash flows and liquidity; fourth quarter operating cash flows of $5 million were weaker than the third quarter, following the trend and operating results and reflecting the semi annual payment of production taxes for our PRB operations. Capital spending for the quarter increased $23 million from the prior quarter, with both project capital and maintenance spending up sequentially. Total CapEx was $80 million, including nearly $57 million of Leer South project costs, and more than $4 million have capitalized interest. Maintenance capital for the quarter was $19 million with substantially all of that related to the metallurgical segment. We finished the year with total liquidity of $315 million and unrestricted cash of $284 million. Availability under our credit facilities was constrained to year end given the divestiture of Viper and the lower than expected volumes in the quarter. If metallurgical prices remain at current levels, we would expect the borrowing base under both facilities to improve meaningfully throughout 2021. In addition, I wanted to note two other sources of liquidity for this year. First, we have approximately $18 million remaining to be received from our 2019 federal land settlement, with substantially all of that expected in the first half of this year. And finally, approximately $6 million of restricted cash from this summer's tax exempt bond offering remains on our balance sheet and will be available to us for qualifying expenditures made of Leer South in 2021. Next, I would like to expand a bit on some of the financial guidance provided in this morning's release. Beginning with SG&A, we're getting to the midpoint of $79 million for total SG&A with cash spending of $62 million. Cash then represents a reduction of nearly 7% from 2020 levels, even as we anticipate an increase in marketing activities as Leer South ramps up and COVID restrictions are eventually relaxed. When compared to our original SG&A guidance for 2020, total expense has been reduced by 15%. And the cash portion is more than 16% lower. With respect to interest, we are guiding to net interest expense on our income statement of $24 million at the midpoint, which represents an increase of more than $13 million from 2020 levels. For modeling purposes the 2021 expense breaks down to cash interest expense of $27 million; non cash interest amortization of $10 million offset by capitalized interest of $13 million. The non cash interest component has increased substantially due to the accounting treatment for the convertible notes. Finally, we are targeting capital spending at $210 million at the midpoint. Of that total approximately $107 million relates Leer South. Roughly $13 million represents capitalized interest. And the remainder is maintenance and land expenditures with more than 90% of that total related to our metallurgical operations. As you recall, the Leer South spending includes $23.5 million associated with the replacement of longwall shields lost in Mountain Laurel, for which we were reimbursed in 2020. From a timing perspective, we expect the vast majority of Leer South spending to occur in the first half of the year while maintenance is slightly weighted towards the back end. Before moving on to Q&A, I wanted to briefly mention one ongoing Financing Initiative. As previously discussed, we expect to have the opportunity to complete the tax exempt financing efforts that we started in 2020. As you will recall, the $53 million that we raised last year was limited by the State of West Virginia's policies surrounding allocation of tax exempt funds. We have worked with the state to obtain additional allocation. And now we'll look to raise another $45 million for the remaining qualifying expenditures. Given the attractiveness of this financing, recall that the original trance carried a 5% interest rate, we plan to pursue this opportunity in the first quarter. With that, we are ready to take questions. Operator, I will turn the call back over to you.

[Operator:]

Our first question is from Lucas Pipes from B. Riley Securities.

[LucasPipes:]

Good morning, everybody and job well done on both the very difficult COVID year and then on the ESG front in particular as well. I wanted to first go into CapEx a little bit more. I think you touched on it in the prepared remarks. But can you provide a breakdown on kind of growth CapEx with Leer versus maintenance sustaining capital in 2021? And then, as we look past 2021, what should we expect? Of course, it's early, but can you give us a sense for where you think longer term capital spending post via COVID checkout? Thank you.

[JohnDrexler:]

Hey, Lucas, this is John Drexler. As we've indicated we're still within the guidance range of $360 million to $390 million at Leer South, We've indicated that we're going to be trending towards the upper end of that range, given some of the challenges of COVID and some of the inefficiencies that we've seen here late in the fourth quarter. In addition, the CapEx includes the insurance recovery of $23.4 million for the longwall shields that we lost in 2019 at Mount Laurel, so at the upper end of the $360 million to $390 million plus the $24 million of that insurance recovery, and that begins to get you the total project for Leer South, then we highlighted the maintenance CapEx of a $13 million, I'm sorry, capitalized did for $13 million. And then the remainder for this year would be maintenance CapEx. As we look forward, we've indicated that prior to Leer South starting up, our maintenance CapEx would generally run somewhere in the 80 to high 90s, there are under $100 million. I think with the startup of Leer South and then ongoing capital needs there that $100 million maintenance capital range or slightly above that is probably from a modeling perspective where we would see maintenance capital going forward. We're excited to get Leer South up and running. We think it's a transformational project. It's been a big commitment for us here as we've worked through the depth and challenges of COVID and the impact on the markets. But we've got great capital into this, as we're coming to the finish line here and bringing this online into a strengthening market and cash generating capabilities as we move forward.

[MattGiljum:]

And look at this deck just to connect the dots really one more time clearly so that we address the so to get to that $390 million, $390 million for Leer South, that's another $84 million or so of spending that we have. We have the $24 million for replacement shields, which effectively is what we got compensated for in 2020 with the insurance recovery. So that gets you to with rounding around $107 million, the capitalized interest at about $13 million. And that gets you to about $120 million and then $90 million or so for maintenance CapEx which gets you to that $210 million at the midpoint.

[LucasPipes:]

Terrific, very helpful.

[PaulLang:]

Lucas, one thing I did want to point out and I think the piece that really modest about this, but if you think about it, it's pretty unusual, this industry to have this bigger project, this complicated project it's effectively being brought in on time and on budget. So just tremendous amount of respect for the team and everything that John and rest of his group has done.

[LucasPipes:]

Thank you. Yes, that's great to hear. My second question is on the 2021 guidance, and there's this kind of thermal bucket. And I wondered kind of, I think in your prepared remarks, you touched on PRB cost thing, similar to recent historical rates, but then I look at thermal guidance, and does cost in their 11.50 to 12. Does that include some of your restaurant operations, for example? Or what you'd say or maybe somewhat even other thermal? Or can you help us place this guidance is this exclusively PRB, or other moving pieces in there as well. And this applies not just to the cost, but also to the price volumes as well.

[MattGiljum:]

Yes, Lucas, I'll start off here and others can jump in as well. As you know, as we continue our transformation to be exclusively focused on metallurgical coal we've had two additional thermal segments, the PRB. And then other thermal, other thermal included our Viper operation in Illinois and West Elk operation or longwall operation in Colorado. With the contribution of Viper into Knight Hawk which kind of continues the path that we have here and focusing on that, that leaves us with the combination of both the PRB and the West Elk operation in Colorado, which we are now putting together into thermal. The guidance that we're representing for thermal the vast majority of that, obviously, is influenced by our PRB operations, and specifically Black Thunder. I think if you look back to last year in the PRB segment for 2020, despite the significant adjustments we needed to make in the in the PRB segment, we delivered costs with around $11.50 a ton for full year 2020. As you look to the guidance in that thermal segment, we're guiding $11.50 to $12; obviously, heavily influenced the vast majority of that influence is performance in the PRB. Our West Elk operation contributes about 2.5 million tons on an annual basis. We've worked to reposition that asset here. There has been some opportunity here; we've not gotten the discussion on the markets, but what we've seen in the Newcastle market to get volumes placed there as well. So we feel good, obviously about the thermal segment. The guidance there is both the combination of the PRB operations and our West Elk operation and that's how we

[DeckSlone:]

Lucas, As John said, we thought it made sense to roll the legacy thermal assets together given how the strategy and how we're proceeding with our strategy. Additionally, West Elk would have been a segment by itself. So we didn't have comfort sharing that kind of specificity on West Elk alone.

[LucasPipes:]

Understood. Appreciate that clarification. Then, last one for me coking coal volume outlook, quite robust. Can you share with us kind of what we should expect in terms of cadence on the volume side, Q1, Q2 maybe full and second half of the year more broadly? And how would you recommend we think about that ramp up over the course of the year? Thank you.

[JohnDrexler:]

So Lucas, as we indicated in our prepared remarks, we're continuing to see the impact of COVID here and we think over time, we'll continue to manage COVID effectively, we're encouraged with the vaccine rollout, but that's going to influence the first quarter shipment levels. We're guiding to we believe rates that would be similar to what we just experienced in the fourth quarter. As you know, we've got the opportunity here to bring the Leer South operation online here in the third quarter is what we're guiding to obviously once the longwall comes up and starts to run, we'll be working out kind of the nuances of starting that up. It typically takes a month or so and continues to work through that. And then over time we'll continue to focus on ramping up and optimizing that asset but with that longwall coming online, you can expect to see an increase in shipments in the back half of the year. So right now from the portfolio we have -- we've indicated flat shipment levels for Q1. I think you could look to some of our historical trends in modestly better quarters historically to kind of build Q2 and then it should continue to ramp up as we step through Q3 into Q4 and ultimately to that we got into now that midpoint 7.8 million ton.

[Operator:]

Our next question from David Gagliano from BMO Capital Markets.

[DavidGagliano:]

Hi. Great. Thanks for taking my questions. On -- just want to ask a little more on the coal side. First of all, on the pricing dynamics, obviously gave us 380% of sold committed on volumes, can you walk us through each of those buckets in terms of how they're actually going to be priced as we go through the year as well.

[JohnDrexler:]

So Lucas, I'll start here, once again, others can jump in. So we feel really good about the book that we've built, as we indicated having 80% committed at this stage of the game, with the vast majority of that commitment being unpriced exposed to market pricing. We feel a very strong position; you know the portfolio of our production prior to Leer South coming online between Leer and Sentinel, the predecessor to Leer South operation. You're running at about 5 million tons of coking coal with that being High-Vol A then you've got Mount Laurel High-Vol B, which is a million ton and you've got Beckley low vol, which is a million tons. So we're real proud of that portfolio. What we've seen, and I'm very proud of the marketing team has a very strong market environment. And we put a lot of over the course of the last quarter. And with all of that at index pricing, pricing in a market that was improving you can kind of take that and spread the market prices across the qualities and an average back to build the rest of the model.

[PaulLang:]

As you look David, obviously, we've got about, if you look at the midpoint of our guidance about 25% can be a fixed price. So that leaves about 75% of our remaining position subject to index pricing. And I think more specifically, as I understood your question, the vast majority of that's priced off East Coast index indices or assessments, although there's a small percentage that has of the Australian POV.

[DeckSlone:]

David, so it's Deck and so most of our Asian business is priced off of that, as Paul said, off of the Australian POV price. And so you will see here in the first quarter a reflection of that fact, the fact that the POV had lagged pretty significantly, you'll see that in our pricing in the first quarter. Having said that with the recovery that'll be short lived. And so that business we've signed into Asia based on Queensland pricing should rebound significantly and reflecting what we've seen in terms of the balance in terms of POV pricing. Additionally, we did note that we sold about 300,000 tons into China, that is CFR business and so that will be priced based on the delivered price of the China, which as you know is quite strong right now, well over $200. And so that's advantageous as we sit here today.

[JohnDrexler:]

So Dave, I mean, even if you look at the averages for High Vol A primary product, USPS codes, for the fourth quarter, those averages were $121 a metric ton delivered to these codes through end of last week that High-Vol A is averaging close to $150. So clearly over a $25 increase in that primary market for us strength across all of the markers, so we feel good about how the book is built and how it will perform as we move forward.

[DavidGagliano:]

Okay, that's helpful. Thanks. So I think I got most of that down. I just want to -- so 75% open, and can you just break that bucket that 75% piece? Can you break that into on a maybe just frame it on percentage basis or ton basis of how much is actually linked to that Atlantic basin price that is significantly higher than the Pacific Rim price, Pacific basin price and how much is actually linked to the Pacific price?

[MattGiljum:]

David it would be more than 75% would be the US East Coast price.

[DavidGagliano:]

Okay, thanks. That's helpful.

[JohnDrexler:]

Of course, the vast majority that being to the High-Vol A, the High-Vol A marker specifically given that's how we're weighted pretty heavily.

[DavidGagliano:]

Okay, perfect. Thank you. And I just wanted to switch gears to the surety bonding reclamation topic. And I apologize I'm not fully up to speed on this subject. But I'm just wondering if you could help us frame the size of this, the potential size of this sinking fund, right

[MattGiljum:]

Yes, Dave, this is Matt. I'll start on that. In terms of the reclamation work that we will ultimately have to do in the PRB, I characterize it in really two distinct things. One is work that we can do on an ongoing fashion while production continues. And the other is work that essentially can't be done until we're done mining and no longer generating revenue. And it's that second piece, kind of the end of the mine life that we think makes sense to build a sinking fund for the remainder and we've worked with our sureties to make sure they understand the work that we're doing, and the focus we're putting on that. The remainder we think as long as we're remaining as current as we can be with there's no need to build funding towards that. So as we look at this year, just to kind of frame up what we're talking about based on the thermal guidance, if you use roughly 50 million tons and an average price of rounded to $13 we're going to generate about $50 million to $60 million in the thermal operations. The CapEx needs are going to be less than $10 million. So there's going to be call it roughly $50 million, $40 million to $50 million available, we're going to spend the majority of that on reclamation work being done today, probably $25 million to $30 million at Coal Creek, and it's going to leave somewhere in the neighborhood of $15 million to $20 million, that would be available to put into a fund that will go for those end of the mine life activity. So that's kind of the way we're thinking about it here. In terms of what that fund builds up to over time. At Black Thunder, there's probably roughly half of their ARO is in that second bucket. So something in the neighborhood of $100 million to $120 million over time that we would have to build to. But that's how we're thinking about it today. And as I mentioned had good discussions with our surety partners about that concept. They're very supportive of the work we're doing today. And the fact that we're meaningfully going to be reducing both the ARO and the bonding and think that's a good path forward.

[PaulLang:]

And Dave, I think Matt laid that out very well, just a couple other items maybe to comment on. We couldn't have two better examples in the portfolio that we're working on Coal Creek and Black Thunder. Coal Creek as we've indicated, at the end of this mine life, we're in a position now where we can make significant advances in final closure of that operation that does two things. It not only reduces the bonding requirement, but it also eliminates the ARO, the reclamation obligation recorded on the balance sheet. At Black Thunder, where we continue to have the opportunity given markets to generate meaningful cash, our focus is on reducing the footprint while simultaneously producing that coal generating cash and using that cash generated to shrink the footprint. And then also as Matt indicated provide for that sinking fund over time for the final mine footprint, as we look to the future. So hopefully, that gives you a little more color and insight on that.

[DeckSlone:]

David, it's Deck. And just one final point on that. Just I know, it's a question that some have had. It's a multifaceted effort and multifaceted engagement with the surety. Certainly we're conveying to them that that strong commitment to conservative balance sheet. And you saw that with the three financings we did during 2020. So making sure that it's clear that we have lots of cash on the balance sheet and a very strong financial position, generally, we've kept them apprised of Leer South coming online, which is going to greatly expand our cash generating capabilities. And we continue to convey as John just described, that we're well committed in the PRB. And we will continue to generate meaningful amounts of cash in the PRB. We have the aggressive reclamation and closure plan that we continue to expand upon, as announced today the closure of Coal Creek as the next step in this really accelerated closure of Coal Creek. Matt laid out the sinking fund mechanism that we are contemplating, we're focusing on both the reducing the bonding as well as the Asset Retirement option. And then we're going to be providing sort of ongoing progress. So we think all those things should provide a lot of comfort to our providers, and feel good about where those discussions are today.

[DavidGagliano:]

Okay, that's very helpful. Thank you. So when you take all of that together, is it expected that the thermal coal business, the cash generated from the remaining thermal coal business will sort of be ring fenced and, or whatever and isolated? And that will be enough for the surety bonding requirements? Or is there and expectation that some of the free cash flow associated with the net business will also end up funding surety bonding requirements?

[MattGiljum:]

Yes, Dave, this is Matt. I think our expectation today is that given the -- certainly the committed business we've got in the near term, but also the plants that we're selling to and our view for the PRB demand over the next handful of years, that there's enough cash that can be generated in the thermal business to pay for the obligations that are there.

[JohnDrexler:]

And Dave that's a reflection, I think of just once again, the tier one nature of the asset that we have out there for years, despite the significant changes we've seen in volume levels, the outstanding team we have out there is continuing to deliver on cost, costs that allow us to generate cash. And as we sit here today, we've got great confidence that we'll be able to continue to do that moving forward.

[DeckSlone:]

And Dave as John mentioned, I mean, if you look back over the last 10 years, as we've systematically reduced production, we've maintained the margin that has been pretty consistent over that timeframe. And so we have the ability to flex as we need to flex still generate cash. And yet, over time, that 50 million tons will become 40 million tons will become 30. But still generating meaningful amounts of cash. We've also talked extensively about the conservatism built into some of our assumptions on the liability. So we feel quite good about the thermal assets being able to continue to sort of pay their own way here, pay final closure costs from those online cash flows.

[PaulLang:]

David without pushing this down the road too far. I think as you stand back, the way I look at this is pretty simple. First, I think what we're doing; we're taking positive control of the situation. We're controlling the things that we can see steer. The other thing is and it's just from my experience, reclamation never gets cheaper or easier. I think if we get it done, and we get it done quickly, we have always tended to get it done cheaper than what we have on liability. So that's kind of the overriding philosophy, what we're trying to do here.

[Operator:]

And it appears we have no further questions. And with that, that does conclude our question-and-answer session. I'd now like to turn the call back over to Paul Lang for any additional or closing remarks.

[Paul Lang:]

I'd like to thank everyone again for your interest in Arch and taking time today to participate in our quarterly call. As you can tell, our optimism and enthusiasm continues to build as a startup Leer South longwall draws closer. While we're trying to guess market timing is always fraught with peril, it appears that we could be very well positioned to take advantage of a post pandemic era, which many countries are looking to stimulate their economies. At the same time that pent-up consumer demand is starting to materialize. However, that timing plays out we intend to be prepared with a significant step up in capabilities that we're going to recognize with our expanding coking coal platform. With that, operator, I will conclude the call and I look forward to reporting to the group in April. Stay safe and healthy, everyone. Thank you.

[Operator:]

And with that, that does conclude today's call. Thank you for your participation. You may now disconnect.