Arch Resources, Inc.
Q2 2015 Earnings Call Transcript

Published: 30 Jul 2015

[Operator:]

Good day, and welcome to the Arch Coal, Inc. Second Quarter 2015 Earnings Release Conference Call Today's conference is being recorded. At this time I would like to turn the conference over to Mr. Charles Dayton, Investor Relations. Please go ahead, sir.

[Charles Dayton:]

Thank you. Good morning from St. Louis and thank you for joining us today. 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. Forward-looking statements by their nature address matters that are, to different degrees, uncertain. These uncertainties, which are described in more detail in the annual and quarterly reports that we file with the SEC, may cause our actual future results to be materially different than those expressed in our forward-looking statements. We do not undertake to update our forward-looking statements whether as a result of new information, future events, or otherwise except as may be required by law. I'd also like to remind you that you can find a reconciliation of the non-GAAP financial measures that we plan to discuss this morning at the end of our press release, a copy of which we have posted in the Investors section of our website at archcoal.com. On the call this morning, we have John Eaves, Arch's Chairman and CEO; Paul Lang, Arch's President and COO; and John Drexler, our Senior Vice President and CFO. John, Paul, and John will begin the call with some brief formal remarks and thereafter, we'll be happy to take your questions. John?

[John W. Eaves:]

Good morning. Today Arch reported an adjusted net loss of $0.73 a share and $45 million in EBITDA. These results reflect persistently weak coal markets driven by an over-supplied global met market, the low cost of competing fuels domestically, and the impact of the MATS implementation. Despite these challenges we remain sharply focused on taking steps to enhance our competitive and our financial position. We continue to believe in the long-term prospects for a well-positioned U.S. coal producer such as ours. Before I get into any further into my prepared remarks I'd like to address our current activity in the capital markets. As you are aware, we are in the marketplace with open private debt exchange offers. If successful, the exchanges will allow us to meaningfully de-lever the balance sheet and reduce volatility (2

[Paul A. Lang:]

Thanks, John. In the second quarter our operations displayed significant flexibility in a rapidly changing market environment. In the Powder River Basin our team did an excellent job managing the operations as the region experienced heavy precipitation during the quarter. While our mines themselves did not sustain any damage, rail service was disrupted to various degrees over a several-week period. Primarily as a result of these rail service issues, we missed about 3 million tons of shipments, which resulted in a 10% decline in sales quarter-over-quarter. Even with these headwinds, the region was basically able to hold cash cost flat as compared to the first quarter and recognized a cash margin of $2.25 per ton and a positive operating margin of $0.58 per ton. For clarity, I would like to note that the cash costs we report are inclusive of all costs except for DD&A. The per ton amounts include the impact of reclamation costs, fuel costs, including the cost of any activity to protect fuel costs, and the impact of brokerage activity incurred in the region. While we believe we'll make up a majority of the shipment shortfall this year, we have reached an agreement with a customer to move approximately 1 million tons back in about 12 months. Given the impact of the shipments during the quarter and a more cautious outlook for the sales the balance of the year, we're lowering the midpoint of our overall thermal volume guidance by 3 million tons. With this we're going to raise the bottom end of our cash cost guidance for the region and are now forecasting a new range of $10.60 to $11.00 per ton for 2015 or an increase of $0.05 per ton over the previous midpoint. In Q2 both of our Bituminous Thermal operations had an outstanding quarter, reducing cash cost by almost 20% as compared to the first quarter and 3% better than 2014 on materially lower volumes compared to the prior-year. With this performance, our cash margins in the region grew to $10.22 per ton, which is almost 34% of net realization. We continue to see success in placing the higher-quality coal produced from West Elk and still believe the operation will ship approximately 5 million tons during the year. Along with this Viper continues to deliver solid operating costs, which have collectively allowed us to lower our expected cash costs for the full year to a range of $23 to $25 per ton. In Appalachia, as expected, we saw an increase in operating costs due to longwall moves at Mountain Laurel and Leer as well as idling for the start of the annual miners vacation. Even with these anticipated events, the region is running a cash cost of $57.71 per ton year-to-date, which is a 10% improvement over 2014. Significantly, during the quarter we continued to see both of our thermal and metallurgical franchises in this region operate on a cash-positive basis. This result highlights the success of the actions we've taken over the last two years to optimize our portfolio of mines and reduce costs. Overall we're comfortable with where the operations are at, and are maintaining our previous cash cost guidance of $56.75 to $59.75 per ton for the full year. Turning to marketing, overall thermal sales remained tempered as generally mild weather and industrial consumption have raised questions about domestic generation levels for 2015. Year-to-date power generation has been slightly down compared to 2014. This reduced generation, along with displacement of coal by natural gas, is collectively adding to customer caution in forward buying. With that background, we took a measured approach to any additional 2015 sales, and in the Powder River Basin placed approximately 1.5 million ton, which was offset in part by working with customers to re-time some shipments and by settling some volumes financially. In addition, we priced a portion of our index commitments and were able to take advantage of a period of low OTC prices and actually purchased some physical volumes that were delivered from other mines in the quarter. For the year we're now showing 107 million tons of committed sales, of which 106 million are priced at $13.32 per ton. With this we're now 96% committed based on our 2014 run rate. For 2016 shipments we sold about 6 million tons and added the volume moved from 2015 as well as priced about 1.2 million tons of indexed volume. With these new sales we now have 66.4 million tons committed, of which 52 million are priced at $13.99 per ton. Based on the run rate of the first half of 2015 we're now over 60% committed for next year. In the Bituminous Thermal region we placed approximately 500,000 tons of sales, the vast majority of which was with domestic customers through West Elk. With our current outlook for production our sales book of 7 million tons puts us at a 97% commitment level. We continue to field inquiries from international customers that desire West Elk's quality of coal for blending. As a result we've been able to complete niche sales well above benchmark prices and have shipped almost a million tons from the operation, roughly 40% of the mine's sales, to international customers so far this year. In Appalachia we completed thermal sales of about 300,000 tons, of which 180,000 were a standard product while the balance was mids (13

[John T. Drexler:]

Thanks, Paul. As John and Paul have described, the challenges in the marketplace continue but our focus remains steadfast. We continue to execute our plan to manage our costs and capital expenditures tightly while ensuring the company is strategically positioned in important markets with large-scale low-cost assets. That plan is designed to help us to manage through these difficult times, but more importantly generate significant value when coal markets turn. Throughout the down cycle, we have been proactive in managing our capital structure in a dynamic and changing environment. Those efforts continue. John mentioned that on July 2 we launched two simultaneous private debt exchange offers. Based on the results to-date from the offers, if the offers were consummated we would issue $631 million of new secured debt with annual cash interest of $44 million and extinguish $1.5 billion of unsecured debt with annual cash interest of $112 million. As a result, we would reduce debt by approximately $870 million and reduce annual cash interest expense by approximately $70 million. We also would incur approximately $60 million of cash costs including payments to holders in fees and expenses. As you saw in our recent release, a group of term loan holders have filed certain assertions with regard to the offers. We believe these assertions are without merit. As you also know, since the exchanges are still active in the market, we are precluded from saying anything further. Next I'd like to address our cash flow and liquidity. As we discussed during the last quarter conference call, we expected the second quarter to have the largest cash outflow for the year due to the timing of interest payments for the majority of our unsecured bonds, along with making the fourth of five annual $60 million LBA payments. However, in addition to those known events, we also saw an increase in collateral requests primarily associated with our surety bonds. We are working very closely with our surety providers and currently expect that our collateral expectations are manageable. We also saw some negative working capital impacts as the growth in our coal inventories that we discussed on our last call did not completely reverse during the quarter and we had other temporary negative adjustments in our receivables and payables. We expect these impacts to reverse over the course of the year. With the LBA payment behind us and as we project out to the end of the year, we expect a significant moderation in cash outflows. In fact, we currently expect our cash to end the year flat or increase modestly from levels at which we ended the quarter. At quarter end we had $812 million in liquidity of which $690 million was in cash. As a reminder, with regard to our capital structure and covenants that apply, we currently have a senior secured leverage ratio covenant that is calculated net of cash of five times on our $250 million revolver. We are in compliance with the covenant at the end of the quarter. In addition, we have a minimum liquidity covenant of $550 million. The leverage ratio and minimum liquidity requirements are tied only to any borrowings under the revolver, and both covenants would cease to apply if the exchange offers were to succeed. And we have no meaningful debt maturities until mid-2018. Our liquidity, focus on cost control and CapEx spend, combined with the potential impact of our ongoing exchange transactions, are designed to help us achieve adequate liquidity as we manage through the ongoing challenging market cycle. In addition to the success we have had managing costs across our operating platform, we have also been active in reducing overhead costs, even though we already had one of the lowest costs in the industry prior to these changes. While painful to implement but necessary as we right-size our company, we reduced our overhead head count during the quarter by 20%, and have reduced our guidance for SG&A from the beginning of the year by $18 million. In fact, between efforts to reduce our SG&A costs and ongoing capital expenditure efforts, we have improved our anticipated cash spend in these two areas alone by nearly $30 million in the past quarter. These efforts will be ongoing, and we believe across the entirety of the company there will be additional opportunities to reduce costs and capital expenditures. Turning now to our updated expectations for 2015, in the PRB, primarily as a result of reduced volume expectations, we have modestly increased the lower end of our cash costs to a range of $10.60 to $11 per ton, an increase of $0.05 over the prior quarter. In Appalachia we continue to expect our costs for the year to be in the range of $56.75 to $59.75 per ton. In the Bituminous Thermal region as a result of solid operational performance to-date and an expectation of maintaining that momentum for the rest of the year, we now expect cash costs in the range of $23 to $25 per ton, a decrease of $0.50 per ton from the prior quarter. In other financial guidance we expect as follows

[Operator:]

Thank you. And our first question comes from Pavan Hoskote with Goldman Sachs.

[Pavan P. Hoskote:]

Question. A matter question to start with, given the stress in the U.S. thermal coal market, how do you think the rebalance process happens? It's probably a different process in the Powder River Basin versus Appalachia, given the different shapes of cost curves and the cost of taking production offline. Would be great to get your perspective on this.

[John W. Eaves:]

Yeah. This is John. We certainly think that the way we position our portfolio with our thermal production, met production and our cost structure positions us very well to be able to respond to market changes. I guess we see a lot of pressure continuing to be applied in Central App. We see a pretty significant step-off in production in Central App this year as well as Northern App, and we think one of the primary beneficiaries in that market, as it starts to improve, will be the Powder River Basin. We think their quality, their economics really position us well to take advantage of the market when it materializes. So as we sit here today we think there's a lot of pressure on higher cost production, particularly in the East; and we think our position in the Powder River Basin places us very well for not only the domestic markets but we see improvements in the international markets with additional access off the West Coast, we do think that we're well placed to take advantage of both of those markets. Paul, you've got anything to add?

[Paul A. Lang:]

Yeah. I think the only other color I'd add, Pavan, is while we think the PRB market in general will remain strong, I think you got to bifurcate that market. As you look at the PRB, the 8,400 mines continue to decline in production, and frankly that's where the pressure is going to be. So the region is not going to escape the downturn or the reduction or the rationalization of production, but I think the higher quality mines like Black Thunder and the other southern mines that ship higher quality coals will do well in this period.

[John W. Eaves:]

I think when you think about Arch, to follow on Paul's point, I mean most of our uncommitted volumes in 2016 are the higher BTU coals. And we think that those will be the most desired in this marketplace. So with our 8,900-plus BTU coal we think we're probably as well or better positioned than most.

[Pavan P. Hoskote:]

Great. And a follow-up to that would be you've talked about production coming offline across the different basins. Is this production coming offline permanently? Or is it just waiting on the sidelines for an improvement in pricing? And is there a different answer say in the Powder River Basin versus the Appalachia?

[Paul A. Lang:]

Pavan, this is Paul. I think it's a little bit of a mixed bag. From what I've seen in Central App, a lot of these mines that are closing, particularly the smaller ones, I think are going for good. And the cost to reopen them, I think, is going to be very difficult when you look at terms (26

[John W. Eaves:]

We were a little taken back when we looked at the MSHA data through the first half of the year. And if you look at the 40 million tons that have come off, the biggest part of that was in second quarter. And we think as we move in the third and fourth quarter that's only going to accelerate. We've got it at about 90 million tons of reduction for the year, but I think that could be conservative. If you think about the marketplace, that's the one thing that could accelerate this correction. I think supply is coming off much quicker than we ever anticipated, particularly in the eastern United States.

[Pavan P. Hoskote:]

Got it. And then one last question on this topic if I may. When you look at industry restructuring and potential bankruptcies that happen over the next year or two, like what role does that have on production? Because in the past we've not really seen a strong correlation between restructuring and production coming offline. Do you think that still will remain the theme of -- or would restructuring accelerate this process of taking production offline?

[John W. Eaves:]

I mean, I guess every situation is kind of unique, but we would think as companies go through restructuring and they emerge from bankruptcy that their supply would be a lot less. I mean what they would try to do is rationalize their portfolio, run just their efficient mines, and close the others. And as Paul said, a lot of the mines, particularly in Central App, might be more permanent closures versus be able to come on when you see a market uptick.

[Pavan P. Hoskote:]

Got it. And then the final question just to follow up to your point right now, you talked about taking some of this production offline. But there are typically reclamation costs and other costs associated with taking production offline, and in the absence of having cash, how do you take care of those costs?

[Paul A. Lang:]

Well, I think in – kind of, it's going to have to be a very general answer because everything is site-specific. But mines or companies that remain in existence will reclaim these mines from cash flow. If the worst case scenario on the other end of the book end is the company is dissolved, the reclamation bonds would ultimately cover the price. I think a lot of what you're seeing is people are making that calculus, have made that, or are making that calculus on some of these mines. But frankly, there is a point where that can't continue and I think you're starting to see that.

[Operator:]

And our next question comes from David Deterding with Wells Fargo.

[David K. Deterding:]

Hey, guys. Thanks for taking my question.

[John W. Eaves:]

Good morning, David.

[David K. Deterding:]

Just wanted to follow up on, you kind of mentioned some later (29

[John T. Drexler:]

Hey, David. This is John Drexler. The self-bonding for Arch Coal, we're self-bonded in the State of Wyoming as disclosed in our 10-K. We've got about $458 million of self-bonding with the State of Wyoming. As we've discussed previously, we continue to comply with the rules that exist for the self-bonding requirements. We do self-bond at a subsidiary level. We've been consistent in how we've applied for that self-bonding and expect to remain self-bonding as we move forward. Those results are under review, but as indicated we would expect to continue to be self-bonded. The overall surety market, as described in my prepared remarks, given what we've seen across the industry, we have been working very closely with our surety providers. One of the things I think that we make sure that we are indicating and that's come across over the course of our remarks here is really focused on the quality of assets, large scale cash flow positive operations. I think as markets look at those, that's something that when they evaluate the opportunity to assure that risk, it's something that's very much a positive for us here at Arch. So something we'll continue to watch closely, we'll continue to manage very actively; but where we stand today we feel good about where things are.

[David K. Deterding:]

Okay. And then just the other one, I've been kind of surprised in the, I guess the liquidated damages that you guys are guiding to in your other operating line. It looks like it's smaller every quarter, so just wondering, two questions; one, is something offsetting that in that line? And two, if not, are you expecting an increase in liquidated damages in the second half of the year?

[John T. Drexler:]

You know, David, I think we'll have to look at the detail of exactly what's flowing through that line, but we have been consistent with our guidance for liquidated damages 2015 being between $50 million and $60 million. That's consistent with where we were last year. And I think we have been essentially accruing that equally over the course of the year. So there may be a little bit of other noise flowing through that line item, but generally that's where we are on liquidated damages for 2015.

[David K. Deterding:]

All right. Great. Thanks, guys.

[Operator:]

There are no further questions in the queue at this time. I would like to turn the conference back to Mr. John Eaves, Chief Executive Officer, for any additional or closing remarks.

[John W. Eaves:]

I want to thank you for your interest in Arch Coal today. We continue in this difficult market to focus on the things that we can control

[Operator:]

That concludes today's conference. Thank you for your participation.