Arch Resources, Inc.
Q3 2012 Earnings Call Transcript

Published: 26 Oct 2012

[Operator:]

Please stand by, we’re about to begin. Good day, everyone, and welcome to this Arch Coal Incorporated Third Quarter 2012 Earnings Release Conference Call. Today’s conference is being recorded. At this time, I’d like to turn the call over to Jennifer Beatty, Vice President of Investor Relations. Please go ahead, ma’am.

[Jennifer Beatty:]

Good morning from St. Louis. Thanks 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 Securities and Exchange Commission, 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 use this morning at the end of our press release, a copy of we have posted in the Investor section of our website, at archcoal.com. On the call this morning we have John Eaves, Arch’s President and CEO; Paul Lang, Arch’s Executive Vice President and COO; and John Drexler, Senior Vice President and CFO. John, Paul and John will begin the call with some brief formal remarks and, thereafter, we will be happy to take your questions. John?

[John Eaves:]

Thanks, Jennifer, and good morning. I’d like to talk briefly about safety. At Arch, we take pride in our company culture that puts safety first. We have consistently led the U.S. coal industry with our strong safety record, and our performance thus far in 2012 has put us on pace to deliver yet another strong year on safety. We’re proud of this record. We also remain sharply focused on continuous improvement, because one injury is too many. On July 31, we were reminded of this fact, when an employee, Greg Byers, was fatally injured at our Beckley mine. Our thoughts and prayers are with his family, friends and co-workers. Turning now to our results. Arch generated $257 million of EBITDA and recorded $0.20 in adjusted earnings per share in the third quarter. These results demonstrate that we’re controlling the variables that we can control in this market. In fact, our success in containing costs has allowed us to reduce our 2012 cash cost guidance in each of our three core operating regions

[Paul Lang:]

Thanks, John. On the operations front, all of our operations turned in a solid performance for the third quarter and achieved good cost control. Overall, cash cost per ton declined 10% versus the second quarter and, more importantly, they declined 7% versus the third quarter of last year when volumes were 6% higher. In the asset – in the PRB, our sales price increased and our cash cost declined from an already solid second quarter performance. Shipments rebounded as we saw a modest improvement in the underlying demand over the last three months. During the third quarter, we redeployed one dragline at Black Thunder, while two draglines remain idled. We also temporary idled one dragline at Coal Creek during the month of September and restarted the machine on October 17. For the full year, we have lowered our 2012 cash cost guidance expectations in the PRB by $0.35 to a range of $11 per ton to $11.30 per ton, based on cost containment efforts and higher shipment levels. At this time, we expect our cost to increase in Q4 relative to Q3, due to the timing of repair and maintenance expense as well as potentially slower trading cycles out of the basin during the fourth quarter. In Appalachia, our third quarter sales price fell modestly due to lower realizations on metallurgical shipments. Overall, volumes in the region declined in line with Arch’s previously announced mine closures. In addition, we took steps to idle lower quality, higher cost metallurgical mines. Our third quarter cash cost per ton was up slightly versus the second quarter, but included the impact of idled operation. If the idle operations were excluded, our cash costs would have been a $1.35 per ton lower. In subsequent quarters, we expect the impact of idle operations to trend down towards a more steady state of $5 million annually. For full-year 2012, we have lowered our cash cost guidance expectations for Appalachia another $0.50 to a range of $68 to $71 per ton. This guidance range includes the impact of the idle thermal and metallurgical mines announced throughout the year. As you know, our goal is to realign our asset portfolio in Appalachia to favor higher margin coking coal assets while maintaining lower cost thermal mines, like Coal-Mac, which can profitably serve either the domestic or export markets. I’m pleased to report that we’re making good progress with the development of the low cost, high quality Leer mine. Continuous miner units are operating well and the preparation plant at the mine is now running. Leer mine also hit a major milestone this week when we loaded our first train, which travelled to DTA, bound for Europe. We anticipate that the Leer longwall will start up in the third quarter of 2013. In Western Bit, our sales price increased and our cost per ton declined, raising our operating margin over 70% versus the second quarter. We had strong contributions from Sufco to West Elk, which helped to offset the loss of production during the planned longwall move at Skyline. The longwall at Skyline is expected to restart operation this weekend. For full year 2012, we’ve lowered our cash cost guidance by $1.25 per ton, with a new range of $23 per ton to $25.50 per ton for the region. In the fourth quarter, we will have two longwall moves, one at Sufco and one at West Elk, which will lower our production and impact our costs in the region. Turning now to our capital plan. As you know, we previously cut $50 million from our 2012 guidance. We also continue to assess the market conditions when evaluating our long-term capital allocation strategy. As always, we take a disciplined approach to spending capital and we will continue to support those projects where the potential returns are the most attractive. In light of our reduced footprint in Appalachia and the ability to redeploy idled equipment in other active operations, we believe we can reduce our 2013 capital spend to around $350 million, which is $70 million below our reduced 2012 levels. Our 2013 capital plan is focused on three main items

[John Drexler:]

Thank you, Paul. Despite the challenges we are currently seeing in the market, we remain focused on preserving and enhancing our liquidity. We have accomplished that task in the third quarter by remaining diligent in managing both operating cost and capital spending throughout the company. In total, we generated more than $260 million of operating cash flow in the third quarter, driven by solid operating earnings and positive working capital trends. Capital spending for the quarter was $102 million, with more than half of that amount related to the development of the Leer mine. We generated free cash flow of $160 million in the quarter and elected to invest some of our excess cash in highly liquid securities to enhance our returns. With cash and investments of $650 million, along with $350 million of additional liquidity under the revolver and other programs, Arch’s total available liquidity increased to over $1 billion at the end of September. Looking ahead, we expect the benefit from working capital to moderate in the fourth quarter. We are currently forecasting that we’ll end the year with approximately $600 million of cash and investments on the balance sheet. As a reminder, we have no meaningful debt maturities until 2016. Turning to our results for the third quarter. I wanted to provide some additional explanation on a few items. First, our third quarter results include an $80 million reversal of a legal contingency, or $54 million when adjusted for taxes and accrued interest expense. In the quarter, we received a ruling on the appeal of the verdict in the Allegheny case. Clearly, we are limited in what we can say, but we have adjusted our accrual to bring it in line with the latest ruling. Second, I wanted to add some clarification on the accounting for our trading and risk management activities. In the third quarter, we reported a pre-tax loss of $6 million for coal derivative and trading activities. Offsetting this loss was cash income primarily related to the exploration of in the money positions, which is reported under other operating income. As you will remember, we had mark to market gains of $32 million during the second quarter, primarily associated with API2 swaps we entered into in late 2011 and early 2012 for a portion of our expected export volumes. As the API2 index dropped in value, the value of the swaps increased. As these derivative positions expire, the cash is received in the accumulated mark to market is reclassified to other operating income. This cash receipt accounts for roughly half of the other operating income in the third quarter. Without material movement in the API2 market, we would expect to have a similar amount of positions expire in the fourth quarter. We view the ongoing activity of our trading organization as an integral part of our business used to optimize earning opportunities, and we would expect ongoing contributions from our trading group moving forward. Lastly, I’d like to review our updated guidance. As you can see, we continue to manage our costs effectively and have reduced our cash cost guidance in all three of our core operating regions. We now expect thermal volumes – thermal sales volumes in the range of 129 million tons to 135 million tons, with met sales of approximately 7.5 million tons, cash costs in the range of $11 per ton to $11.30 per ton in the Powder River basin, cash costs between $23 per ton and $25.50 per ton in the Western Bituminous region, cash costs of $68 per ton to $71 per ton in Appalachia and cash costs of $34 per ton to $36 per ton in the Illinois Basin. DD&A now in the range of $500 million to $525 million, SG&A in the range of $125 million to $135 million, interest expense between $300 million and $310 million and capital expenditures of $410 million to $430 million. Given our current outlook and the impact of percentage depletion, we continue to expect a tax benefit in the range of 40% to 60% during the fourth quarter. In summary, we delivered strong operating cash flow in the third quarter and boosted our liquidity meaningfully. With that, we are ready to take questions. Operator, I will turn the call back over to you.

[Operator:]

Thank you. (Operator Instructions) And our first question will come from Mitesh Thakkar from FBR.

[Mitesh Thakkar:]

Good morning, everybody.

[Good morning.Mitesh Thakkar:]

First of all, congratulations on the quarter and excellent cost control.

[John Eaves:]

Thank you.

[Mitesh Thakkar:]

My first question is just on the PRB markets in general. Obviously, you did a good job on the PRB side this quarter, and also priced some coal for 2013, if my math is correct, at around $12 and 10 million tons. When you look at the strip, you priced at probably at the higher end. Can you give us some color around it and how should we think about this delta?

[John Eaves:]

Yeah, your math is correct, it was about 9.5 million tons at a little over $12. And the marketing team did a great job in being very selective, and we were pleased with the opportunities that we’ve seen during the quarter; we’ve seen little bit more cautious outlook for 2013 as we kind of moved it out of the quarter. We continue to be encouraged by the natural gas price levels that we’re seeing and feel like the PRB coal in particular would do well against natural gas pricing at this level. The concern, at least in near the near term, would be the inventories. I think given the draw down that we saw this summer, typically you have a 20 million ton draw from May to August; we saw closer to a 25 million ton draw. We’re in the – we’ve been in the shoulder season here for few months. If we get a normalized winter, we think we could see those inventories come down pretty quickly and we think PRB would be the first respond. We’re assuming right now inventories by the end of year in that 180 million ton level. Assuming, again, normal winter weather, we would expect to see the PRB market improve.

[Mitesh Thakkar:]

Great. And just on the met side, when you look at various mine idling, how should we think about your total met coal productive capacity? And if you can give some color around the mix, that will be great.

[John Eaves:]

Well, I mean, we guided to a mid-point of 7.5 million this year. We feel good about that guidance. As Paul indicated, we got to 200,000 tons we’ve got to price for the balance of the year. We feel good about that. Most of that would be the high-vol B. We’ve seen the low $80s type price for that product right now. We’re really in the budgeting planning stage right now for 2013. I wouldn’t want to indicate a volume right now until we get through that process, so we would plan to update you in our January call. Our marketing guys are currently in discussions with our domestic customers and really wouldn’t want say much more about that at this time.

[Mitesh Thakkar:]

But is it fair to assume that the 1 million ton capacity which you said idled is something which is not going to be considered next year, or it’s too preliminary?

[John Eaves:]

Well, I think it goes in to our planning process. I mean, we closed three coal mines. We closed the Bismarck, the Carlos and the Imperial. That was higher cost, lower quality met coal that we took out of the mix. As we sit here right today, I wouldn’t see that production coming back, but we do have that flexibility. Again, we’ll update you on that in late January.

[Mitesh Thakkar:]

Great. Thank you very much, gentlemen, and good luck.

[John Eaves:]

Thank you.

[Operator:]

Our next question will come from Shneur Gershuni from UBS.

[Shneur Gershuni:]

Hi. Good morning, guys.

[John Eaves:]

Good morning.

[Paul Lang:]

Good morning, Shneur.

[Shneur Gershuni:]

First question, I was just wondering if we can talk about CapEx as we think about 2013 and 2014. I was wondering if you can sort of, and I realize you may not be completely prepared to discuss it in detail, but I was wondering if you can remind us what the CapEx that’s left for Leer? And then kind of where you believe your maintenance CapEx would be on a normalized run rate?

[Paul Lang:]

I think in 2013 – just broad buckets right now, we’re looking at about $100 million for Leer next year, about $60 million for the LBA payment and the balance in maintenance CapEx.

[Shneur Gershuni:]

And what’s your current run rate for maintenance CapEx as – for this year?

[Paul Lang:]

I guess it’s about $170 million to $180 million.

[Shneur Gershuni:]

Okay, great. Second question is more financial oriented. If I remember correctly, the covenants associated with your facility really don’t apply unless you actually draw on the facility. In the unforeseen circumstance that you are – that you would need to draw, would this legal settlement actually count in the EBITDA as part of the back test against it?

[John Drexler:]

Shneur, this is John Drexler. And the legal settlement, the EBITDA generated from that is included in our calculation and determination for the minimum EBITDA requirement, which is what I think you are referring to. As we sit here today with the cost control that we’ve had in place and the performance during the third quarter, we’ve seen our liquidity grow. We’re currently very comfortable with that. As you indicated, we have no drawings on our revolver, $650 plus million in cash, so we feel good about the liquidity and ability to support the company’s ongoing operations. We’ll carefully look at where markets continue to evolve, but we’re comfortable with the where we sit today.

[Shneur Gershuni:]

But the covenants don’t even apply if you’re not drawing, correct?

[John Drexler:]

If you’re not drawn on the revolver, the financial maintenance covenants only apply to the revolver. If we’re not drawn on the revolver, then there’s no application.

[Shneur Gershuni:]

Okay. Okay, perfect. And just one last question. Paul had mentioned some maintenance CapEx in Q4 and so forth, but you’ve achieved some serious cost improvements in 2Q. You got some volume back, helped you on fixed operating leverage in Q3 here. As we think about next year, do you expect that you’d be able to maintain some of the benefits that you’ve achieved over the last two quarters?

[Paul Lang:]

This is Paul. I think we had the same basic question last quarter, and I think I responded then I felt pretty comfortable about what the guys had achieved on the team. The two unknowns out there always are diesel and explosives. But beyond that, we feel very good with what we’ve achieved.

[Shneur Gershuni:]

Okay, great. Thank you very much.

[Operator:]

And now we’ll go to Michael Dudas from Sterne, Agee.

[Michael Dudas:]

Good morning, gentlemen, Jennifer.

[John Eaves:]

Good morning, Michael.

[Michael Dudas:]

My first question is, John, in your prepared remarks you talked a bit about the global met market and your expectation of an oversupply of 10 million tons to 15 million tons. Could you elaborate, do you think it’s more – is what we’re seeing out of Australia on the cost structure maybe going to allow more cut back there? Or – and on the other side of the hemisphere, on the U.S. side, we’re seeing some announcements, probably expect to see more to come. Do you have a sense of where we are on the pushback on the lower quality coals or even some of the higher quality coals that might be set up for production in 2013 and out of the U.S.?

[John Eaves:]

Well, I mean, Michael, you’ve been reading the same announcements we have about the cut backs. I mean, there has been a number of them here in the U.S. I think you’ll probably see some more of those. We just announced the one with the three coal mines, which was effectively about 1 million tons. I do think the cost pressures in Australia are going to continue to impair some of their production growth over the years. You’ve got a lot of production right now around the globe at $170 benchmark that’s really out of the money from a cost standpoint. So, I think you’ve got to continue to rationalize that. As you’ve heard me say, we’re very proud of our Leer project; we think the cost structure at that complex can be competitive, not only in the U.S., but around the globe. And it’s going to be a unique project. So we’ll have to see where the demand goes certainly the uncertainty we are seeing in Europe right now, the slowdown in China we are seeing, we think over time those steel productions going to continue to grow at a pretty rapid pace. Even with the slowdown in China, you’re growing it on a much higher base. So we are encouraged moving forward. We’re assuming 2013 is going to be somewhat of a challenging year. That’s why we’ve made some of the decisions we have. But when you think about our met portfolio and the cost structure that we have, we can generate pretty positive cash margins even in difficult markets.

[Michael Dudas:]

I appreciate that. My follow up, John or Paul, would be looking on the Powder River Basin, what do you think will turn more on the pricing. We’ve seen volumes pick up and expectations pick up. Do we need to see the inventory levels below what you anticipate with a normal winter? OR is it more $4 gas that’s going to get the utilities who burn that coal more willing to start to lock in for 2014 and beyond at better than the strip prices that we’re seeing?

[John Eaves:]

Michael, this is John again. I mean, we are seeing good natural gas prices. I mean, we feel like we can be very competitive with the current prices at $3.50, the forward strip in 2013 closer to $4. We feel good about that. I think it’s really an inventory issue right now, and I think as we move through the winter with normalized weather you could see a pretty good draw in those inventories and I think you’re going to see PRB volumes and price respond.

[Michael Dudas:]

But across the board, so you think volumes, as we exit 2012 for the basin will be trending higher than, say, what we exited in 2011, is it safe to say we’ll still be below where we exited a year ago? Or is there going to be in your anticipation a ramp up to meet that demand really quickly?

[John Eaves:]

Again, I think it depends on the weather. I mean, right now what we’re seeing is a little bit of caution on our customer’s standpoint. And I think they’re waiting to see what kind of weather they have, they’ve been burned in the past with some of their inventories. And I mean, we are pleased with that we sold during in the third quarter for 2013. We continue to have some activity, but there is some caution out there, and I think a lot of that is driven by the inventory levels that they see right now.

[Michael Dudas:]

Duly noted. Thank you, John.

[John Eaves:]

Thanks, Mike.

[Operator:]

And we’ll now go to Brandon Blossman from Tudor Pickering Holt & Company.

[Brandon Blossman:]

Good morning, guys.

[John Eaves:]

Good morning.

[Brandon Blossman:]

Let’s see, how about Western Bit? Nice uptick quarter-over-quarter, and just on an absolute level, pretty good sales volume. Can you breakout what that looked like as far as domestic demand versus export demand? And then just maybe some color around what you’re thinking about export demand given where seaborne prices are, thermal prices are for 2013 and beyond?

[John Eaves:]

Well, if you notice by the chart, we did sell some coal for 2012 at pretty good prices, most of that was domestic with some of our current customers that we’ve been working with. I think as we look out, we’re going to continue to focus on our domestic customers which we have good relationships and agreements in place, and we hope to build on those. They really see the real growth for Western Bit over time being in the international markets. We’ve set ourselves up pretty good from a port infrastructure standpoint, whether we’re brining coal to the St. Louis area and taking it to the Gulf or railing the coal directly to Houston. The demand that we’ve seen in the international markets has been very encouraging. We don’t like the prices right now, but we think given what we see moving out that will continue to improve and create opportunities for our Utah and our Colorado coals. And if you look at our cost structure out there, we’ve got tremendous costs in that region and think we can complete very well in U.S. and international markets.

[Paul Lang:]

Brandon, to give you a little – this is Paul. To give you a little color, we don’t go down to the regional levels or the granularity you asked, but kind of as a snapshot, about 65% of our exports were met and about 35% were thermal. And if you break that down, about 50% went to Europe, about 30% to the Americas and about 20% to Asia.

[Brandon Blossman:]

And, Paul, are you willing to share directionally what the breakout on the thermal side was, Western Bit versus Central App?

[Paul Lang:]

We’re not going to break it down to that level, Brandon.

[Brandon Blossman:]

Okay. I guess, regardless, it’s a nice upside option there, nice product. Okay, and then just back to get PRB fourth quarter. Looks like total committed tons imply a pretty good fourth quarter run rate for PRB. At least, recent railcar loadings look light on a year-over-year comparison basis. How do you guys reconcile those two data points?

[Paul Lang:]

You know, I guess, Brandon, that’s why in my comments, I was a little cautious on the fourth quarter. We’re off to a little bit of a slow start this month. And I guess in my years out there, I rarely saw us make up volume in November, December that’s why I think we’re a little more cautious about fourth quarter with PRB.

[Brandon Blossman:]

Thanks. That’s helpful, Paul. Thanks, guys.

[John Eaves:]

Thank you

[Operator:]

And we will now go to Jim Rollyson from Raymond James.

[Jim Rollyson:]

Good morning, everyone.

[John Eaves:]

Good morning, Jim.

[Jim Rollyson:]

John, just maybe back on the met subject for a minute. Obviously, a tough market right now. And I guess as you think about negotiations with your domestic steel guys, since you’re dealing with annual calendar contracts, how do you think – and I don’t need absolutes, but how do you think about pricing as far as negotiations with those guys, given that you’re unfortunately kind of doing those negotiations right at the – probably the bottom of the market? Do you think they’re looking to get that bottom of the market pricing or do you think they’re willing to kind of maybe split the middle with you a little bit as you go into next year?

[John Eaves:]

Jim, as we talk to our domestic customers, it kind of goes in two phases. The first phase is kind of volume and the second phase would be price. And I would tell you we’re really kind in the early stages of the price. When we think about the relationships that we’ve created with our domestic customers, they go back a long way, we’ve worked hard on that, and we’ve always looked at our business with our domestic customers as a win-win. We’ll see where this goes. I mean, we’re pleased with our volumes and our pricing this year. When we got those done, the market deteriorated in the international markets, and I assume that as we go through those discussions now, we will see some of that value be expected to get back for 2013. But right now, we’re having meaningful conversations on volume and really haven’t got too heavily into the price yet. So, I’m a little hesitant to talk much more about that. But we do value those domestic relationships that we have and look forward to continuing to build on those.

[Jim Rollyson:]

That’s helpful. We’ll look for an update next quarter when you get a little more intel. And for a follow-up, just broader topic on the export side. You guys have obviously had a pretty good export year and you’re pretty bullish on the longer-term outlook for exports. But curious what you’re thinking high-level for the industry on exports next year relative to the record levels we’re doing this year, just given where prices are internationally for both thermal and met. Any early (inaudible)?

[John Eaves:]

We continue to be bullish on the international markets. We’re forecasting about 125 million tons of exports this year and fairly flat into 2013. Some guys are talking about declines, but we – with the demand that we see in the Atlantic markets, in the Asian markets, our internal forecasts right now are kind of flat year-over-year.

[Jim Rollyson:]

That would certainly be bullish. Thanks, John.

[John Eaves:]

Thank you.

[Operator:]

Our next question will come from David Gagliano from Barclays.

[David Gagliano:]

Hi. Thanks for taking my question. I just want to ask a couple of follow-ups. On the $12 price on the PRB for 2013, just I want to make sure, is that all new business? Is there any deferrals or anything like that in the mix?

[John Eaves:]

That was pretty much new business. Obviously, David, the majority of that was 8,800. But yeah, that was mostly new business.

[David Gagliano:]

Okay, thanks. And then on the – well I have one follow-up. It’s actually a two part follow-up. On the PRB, I was wondering if you could just give us a reminder, what the – what your annual capacity is out there? And then – that’s part A. And then part B, unit costs in the PRB, obviously, optically a good number. I actually would have thought with a 27% sequential increase in volumes that your unit costs would have come down more than 0.8%. I’m wondering is there more room to go on the unit cost side on the downside, or is there something that’s keeping it pretty sticky? Those are my two follow-ups.

[Paul Lang:]

David, on the cost side, I think the – as I said, I think the guys did a pretty good job. Obviously, we’re trying to lay the production and the costs as we go through the year. And, clearly, with the capacity or the idle capacity we have, we have quite a bit of room. I think we have stated in the past, we have about a 140 million tons of stripping capacity and even more of that capable load out capacity. So as the volumes come back to a more normalized level, I still feel pretty good about the cost outlook and think the mine is very competitive with its peers.

[David Gagliano:]

Okay, thanks. That’s helpful. I will turn it over to somebody else. Thanks.

[Operator:]

And we’ll now go to Holly Stewart from Howard Weil.

[Holly Stewart:]

Good morning, gentlemen, Jennifer.

[John Eaves:]

Hello, Holly.

[Holly Stewart:]

John, I guess one for you. You mentioned you signed several deals with power generators in Korea. Can you give us some details? Are these new customers, existing customers, margins kind of compared to U.S.?

[John Eaves:]

Holly, we’re little reluctant to talk about any details, any terms or conditions, other to say they were Korea utility companies that we have sold short-term coal before. We’ve established a long-term relationship with them and we feel privileged to be able to have that opportunity and really a little hesitant to say much more about it than that at this point.

[Holly Stewart:]

Okay. So, existing customers but from the past?

[John Eaves:]

Yes, short-term customers that we’ve never had long-term agreements in place with.

[Holly Stewart:]

And this is for 2013?

[John Eaves:]

Yes.

[Holly Stewart:]

Okay. And then I guess my follow-up would be for Paul. How should we think about cap volumes here going forward, maybe kind of versus 3Q levels would – for 2013 will be using maybe less than a 10 million ton rate be a good starting point?

[Paul Lang:]

You know, I think John talked about this a little bit, Holly, and that we’re still trying to look at our 2013. We’ve cut our volumes and we brought ourselves in line with what we think the market is and we’ll continue to operate that way into the future.

[Holly Stewart:]

Okay, perfect. Thanks, guys.

[John Eaves:]

Thanks, Holly.

[Operator:]

And we’ll now got to Chris Haberlin from Davenport.

[Chris Haberlin:]

Hi, good morning.

[John Eaves:]

Good morning.

[Chris Haberlin:]

I think that you mentioned in your prepared remarks that you lost 300,000 tons of high quality met coal in the quarter. Can you just expand on those comments? And was that domestic or export business and kind of what was the situation there?

[John Eaves:]

Yeah, it was one customer, Chris, that was here in the U.S. that we had 300,000 come back to us. We’re working with that particular customer on preserving that value in future years, and as we stand here today, we feel reasonably confident we’ll be able to do that.

[Chris Haberlin:]

And was that related to price or the customer just didn’t need the coal? Can you expand on the reason why they pushed back on that volume?

[John Eaves:]

It was the inability to take the coal at this time. It really was not price-driven.

[Paul Lang:]

No, it was a issue that they had.

[Chris Haberlin:]

Okay. And then on your outlook for inventories to potentially fall below 180 million tons by the end of the year, can you just give us a little bit more color on how you’re getting there? I guess given strong thermal volumes across the industry in Q3 and guidance suggests that that probably carries over into Q4, I’m just trying to reconcile really how you’re getting kind of that low given that the latest EIA data is in the 185 range and it looks like it’s coming down into the mid-170s at the end of August?

[John Eaves:]

Yeah, I mean, I think it’s driven by a couple of things. One, it was a strong draw this summer. I think that 25 million ton draw we saw from May to August, pretty good draw as we move into the winter season. I think given where gas prices are, you should see utilities pull on their inventories pretty well. And we assumed in our analysis that we would have normal winter weather, and that’s kind of how we’re coming to that 180 million tons.

[Chris Haberlin:]

Okay. And then just last question, can you give us your view on the competitive dynamics in the PRB? You had – one of your competitors had indicated that they were reining in production. And obviously prices have been low, although you all did achieve some decent pricing for next year. Just what are you seeing out there? And to what extent do you see that the market might be oversupplied and that might be keeping a lid on prices today?

[John Eaves:]

Well, I mean, as I said earlier, we’re in the budgeting planning process for 2013. And I think we’ll be able to update you more in our January call, but we’re pleased with what we were able to sell during the third quarter for 2013 and continue to be selective on a case-by-case basis in terms of opportunities. I would say that we cut back earlier in the year, and, as Paul indicated, we brought one of those draglines back, but we still have two idle. So based on what we see with natural gas prices, we think PRB does very well, I think a lot of the driver will be what happens with winter weather as we move into the winter season and what kind of draw we have on those inventories.

[Chris Haberlin:]

Okay. Thanks very much for the color and congratulations on a great quarter.

[John Eaves:]

Thank you.

[Operator:]

And our next question will come from Lucas Pipes from Brean Capital.

[Lucas Pipes:]

Good morning, guys, and congratulations on a good quarter.

[John Eaves:]

Good morning, Lucas.

[Lucas Pipes:]

If met coal demand stays weak, would it make sense for you to sell some of your low-cost crossover met coal back into the thermal coal market? And if it does, do you believe that would trigger additional cuts of high-cost thermal coal production?

[John Eaves:]

We always evaluate our market opportunities on a case-by-case basis. I think, Lucas, as we look at our portfolio in the East, and particularly met as well as steam we’ve got a cost structure that allows us to do pretty well, even in tough markets. So, I just think it depends on the opportunities at that time. And we’ll make the right business decision, but right now I guess as I see 2013, we’re cautious, but at least early discussions indicate that the demand will be there. There might be some price pressures and we’ll just have to make our decisions accordingly.

[Lucas Pipes:]

That’s helpful. And then just on your Appalachian thermal coal business. I know it’s not one of your major profit centers, but could you just give us a high level overview of what you expect for that segment going forward?

[Paul Lang:]

We really have very little exposure, Lucas, on the cap thermal market, and the exposure we do have is generally out of our Coal-Mac operation which is probably one of the lower cost operations in region. So, I feel very good from that perspective about our position on thermal coal in the East.

[Lucas Pipes:]

And in terms of 2013 demand coming back to the market, do you have any sort of idea or ballpark what – how many million tons could come back?

[John Eaves:]

I don’t think we are ready to weigh in on that.

[Lucas Pipes:]

Appreciate your comments. Thank you.

[John Eaves:]

Thank you.

[Operator:]

And we’ll now go to David Olkovetsky from Jefferies.

[David Olkovetsky:]

Hey, guys. Great quarter. Couple of questions here. First, can you describe a little bit in more detail what the legal contingency was? And the second question relates to the other income. We got a little bit of color as it relates to some swaps that you had in the second quarter coming to the third quarter. Just give a bit more detail around what’s in that other income?

[John Drexler:]

David, it’s John Drexler. And related to the legal accrual reduction, as I indicated in my prepared remarks, there was a favorable court ruling related to a case that was originally associated with International Coal Group that we had an accrual established at the time of the acquisition. As a result of that favorable court ruling, we have reduced that accrual, and so that’s what you see coming through in this quarter. That ruling occurred during the quarter. With the – what you see coming through other operating income, is during the second quarter we recognized mark-to-market gains on API2 positions that we had put in place in late 2011, early 2012 in anticipation of our export shipments in international markets. Those positions gained in value as a result in a drop in the API2 price, a lot of that occurring through the second quarter. Those didn’t have hedge accounting treatment. We couldn’t get that from an accounting perspective, but essentially there an economic hedge in anticipation of those shipments. So that P&L came through in the second quarter. As those positions come to fruition and expire, they become cash. And so as they expire, in the accounting that we have, those reverse out of the derivative line item and then they come back down through other operating income. Over half of the – what you see in the other operating income line is associated with the monetization of those positions, we would expect that to continue into the fourth quarter if API2 positions don’t move materially from where they’re at right now as several additional of the API2 positions come to fruition.

[David Olkovetsky:]

So, the second half of the other income was what? And also, back to legal contingency, how much – you said it has been reduced by basically $79.5 million. What is left? And then, if I can, have a couple of other questions relating to the Leer mine, specifically when the growth CapEx stops. And it seems like you’re at about $50 million a quarter. Is that a good run rate to use and, again, when does that – when does that sort of taper off and go towards maintenance?

[John Eaves:]

You know what, David, we lost you completely on that question for a – it was blank for a little bit. If you don’t mind...

[David Olkovetsky:]

Yeah, yeah, no problem. No problem. I wanted to ask a little bit more in-depth about those first two questions. The legal contingency, you said it had been reduced – basically reduced by the $80 million, how much is left? That’s number one. Number two, on other income, you mentioned that half of it was related to this mark-to-market situation. What’s the other half? And then number three, if you could discuss a little bit more about Leer. I understand that that’s doing about $50 million a quarter in terms of growth CapEx, when does that taper off and sort of go towards maintenance?

[John Drexler:]

On a legal contingency, I think the disclosure we have in our Security filings kind of goes through the overall position that we have. So, I can’t really say a whole lot more related to the Allegheny case. In relation to other operating income, another large component flowing through there, about a quarter of it, is our Night Hawk, our equity investment that we have 49% ownership in the entity in Illinois. So that represents about a quarter of it. And the rest is just kind of ongoing miscellaneous items that we’ve seen – see rolling over from quarter-to-quarter through there as well.

[David Olkovetsky:]

Okay. Sure. John?

[John Eaves:]

David, your breaking up real bad. Hello?

[John Drexler:]

David?

[Operator:]

I’m sorry, It looks like his line did leave the queue.

[John Drexler:]

Okay.

[Operator:]

And our next question will come from Richard Garchitorena from Credit Suisse.

[Richard Garchitorena:]

Thanks, good morning.

[John Eaves:]

Good morning.

[Richard Garchitorena:]

So, a couple of quick questions. First, just on the three idled mines in central App. Can you give us some color in terms of how much higher they may have been relative to the other mines in the East? And when you also factor in the ramp up of the Leer mine, how should we think about cash costs in the East next year versus 2012?

[Paul Lang:]

Obviously, Richard, the three mines we idled were on the upper end of our cost spectrum, which is why they were shut down. As far as 2013, I think it’s a little bit premature really to get into those numbers.

[Richard Garchitorena:]

Okay.

[John Eaves:]

But I think we’ve said, Richard, on the Leer project, that we don’t expect any negative impact on our overall Appalachian cost when we bring the Leer mine on, certainly implying that’s going to be a very cost competitive mine as we move forward.

[Richard Garchitorena:]

Okay, great. And my follow-up, I believe in your prepared remarks you stated you had about 75% of thermal price for 2013. I’m just curious, we’re heading into the back half of this year, where would you like to be on a percentage basis, as you look at the portfolio and basically making decisions between leaving the tons in the ground or trying to price them in a market that may be weakening?

[John Eaves:]

I don’t think we have any magic percentage. We feel pretty good about our 75%. Again, as I’ve said a few times, a lot of the opportunities are going to be driven by what we see in terms of the weather this winter, particularly for some of our PRB customers. But we continued to have activity even after the close of the quarter and would expect that to continue and we’ll make a decision on a case-by-case basis whether it makes a good business sense for Arch Coal.

[Richard Garchitorena:]

Okay, thank you.

[John Eaves:]

Thank you.

[Operator:]

(Operator Instructions) And our next question will come from Curt Woodworth from Nomura.

[Curt Woodworth:]

Hi, good morning.

[John Eaves:]

Good morning.

[Curt Woodworth:]

In terms of the ASP this quarter of $105, and I know you talked about booking high-vol B in the low $80s, or I think you said $80 a ton. Given the fallout of some of the higher quality business and maybe just some mix change from the idling or the closing of the three mines, what would you estimate to be your blended spot ASP in met today?

[Paul Lang:]

Curt, I – if I heard your question correct, I think if you look at our shipments this year, we’re about 30% to 35% low-vol or high-vol A and about 65% or 70% high-vol or PCI.

[Curt Woodworth:]

Okay. Where – yes, so where would you peg high-vol A right now for you guys?

[John Eaves:]

I mean, given the fact that we’re in discussions with a lot of our customers here in the U.S., I would be a little bit hesitant to say anything relative to pricing. I think obviously there’s a spread between high-vol A and high-vol B. And as we bring the volume on with the Leer project, we expect to capture that premium in the marketplace. And given our low cost at that operation, we are expecting enhanced margins as we move out over the next couple of years. We’re moving from say a 70% from high-vol B and PCI today, 30% high-vol A low-vol to more of a 45% to 50% range as we get the Leer project up to full production.

[Curt Woodworth:]

Okay. And just quickly, what percent of our met production is export?

[Paul Lang:]

Year-to-date, we’ve done about 60% of our met production has gone export.

[Curt Woodworth:]

Great. Thanks a lot, guys.

[John Eaves:]

Thank you.

[Operator:]

And we will now go to Dave Lipschitz from CLSA.

[David Lipschitz:]

Yes, hi. In terms of with all the blast versus down in Europe, are you having any more inquiries from the Europeans in terms of your met tons and things like that, or is it still pretty slow?

[John Eaves:]

We haven’t really started our discussions very heavily for our international customers in Europe yet, but the marketing guys were just over there a few weeks ago. And actually we’re somewhat cautiously encouraged by at least the demand opportunities they’re seeing over there. We’re quite away from settling anything for next year. But right now we feel okay about at least the demand volumes that we’re seeing.

[David Lipschitz:]

Okay, thanks.

[John Eaves:]

Thank you.

[Operator:]

And we’ll take our next question from Andre Benjamin from Goldman Sachs.

[Andre Benjamin:]

Good morning, team.

[John Eaves:]

Good morning.

[Andre Benjamin:]

You have a lot of cash on the balance sheet and nothing drawn on the revolver, You’re also still guiding to some pretty healthy growth rates in met coal over the next couple of years, I think it’s around 15 million tons by 2015. It doesn’t seem like you’re going to spend that much further on growth next year based on what you laid out. So, I was wondering if you can help give us a little color on how you’re thinking about balancing paying down debt versus growth over the cycle, say, over the next three years, four years? And give us a sense on what you think the appropriate level of leverage is and spending is for the next couple of years?

[John Drexler:]

Hey, Andre. John Drexler here. As we look at kind of what we’re – as we look forward and with some uncertainty in some other markets as we talked here, we think liquidity right now is a place that we want to be very prudent and enhance that liquidity. So, we do have that cash on the balance sheet. We’ll carefully watch the markets as they continue to evolve, as you’ve indicated. Our belief here intermediate long-term as we still feel very good about where the things ultimately are going to go. As we’ve stated previously, as this market does turn, our focus will be on deleveraging the balance sheet. We’re at higher levels of leverage than we would normally like, but we need to be very prudently with what we see right now as we move forward. So, that’s kind of where we stand as we look forward over the next several years.

[Andre Benjamin:]

Is there a target that we should think about what you guys trying to get to over the next couple of years? And I guess, when would you have to maybe start spending on some of the other growth projects to still hit those targets?

[John Drexler:]

Andre, I think we’ve said this before as well, long-term, I think if you look back historically we’ve always been in that mid 40% debt-to-cap, as being a comfortable place for us in the capital structure. We’re clearly above that right now, but long-term over the long market cycle here, multiple years, I think that’s an area where we like to be around in that area longer term.

[John Eaves:]

And we do have a number of growth options. It’s just going to be driven by market opportunities.

[Andre Benjamin:]

Thank you.

[Operator:]

And our next question will come from Wayne Atwell from GHS.

[Wayne Atwell:]

Thank you, and congratulations on a great cost profile.

[John Eaves:]

Thanks, Wayne.

[Wayne Atwell:]

And maybe it’s a little early to talk about this, but I wondered what your thoughts were in terms of how much your export volume could grow over the next few years? And I realize you may have some trouble getting specific, but are we looking at 20 million tons to 30 million tons, or where do you think you could be three, four, five years out?

[John Eaves:]

Well, as you know, we’ve been pretty proactive in going out and getting port infrastructure in place, whether it’s East Coast, Gulf, West Coast. And we think that’s going to serve us well as we see the demand growth in the global markets. As we indicated, we’ve exported about 10 million tons year-to-date and would expected to do about 12 million tons this year. That’s up from 7 million tons last year and really five years ago probably a couple of million tons. So, we have grown that pretty significantly as a company over the last five years and would expect that to continue. I’ve said publicly in some of my speeches that we would hope over the next five years to eight years that we’ll be 30 plus million tons in the international market. Obviously, that’s going to be driven by the opportunities we see in that market versus here in the U.S. But given all the new coal power generation that we see being built around the world, we think that’s a very achievable volume.

[Wayne Atwell:]

Thank you. I would assume India is going to have to bring in a lot of coal to grow their power capacity, so I would imagine that’s a pretty attractive market.

[John Eaves:]

Well, India is going to grow pretty significantly. We still haven’t given up on China. We think that growth is going to be strong. I mean, we think imports this year are going to be in a neighborhood of 220 million to 225 million tons. So, everybody talks about China and how it slowed down, but the imports are still strong. We’ve developed a nice market in Korea, we think there is going to be opportunities in Japan and Taiwan. And then as we’ve kind of watch the coal flow changes over the last couple of years around the world, more South African coal, more Russian coal is going into the Asian market as well as Colombian coals. We think it creates a real opportunity for the U.S. coals in the Atlantic market.

[Wayne Atwell:]

Great, thank you.

[John Eaves:]

Thank you.

[Operator:]

And we’ll now go to Paul Forward with Stifel Nicolaus.

[Paul Forward:]

Thanks. We’ve seen – coal markets have gotten a little less dire here at least the outlook on valuations in the sector with natural gas coming off the lows of where it was six months ago. I was wondering – and, John, I think you talked about deleveraging as a goal. I was wondering if you’ve done any revisiting of the idea of divestiture of some operations that might not be quite considered core to Arch’s future? Or is it still too much of a buyer’s market for Arch to really be considering any divestitures?

[John Eaves:]

Paul, it’s John Eaves. So, I mean, you’ve heard me say before, I mean, we’ve always been buyers and sellers of assets, and we’ll continue to do that. We have an ongoing process within the organization where we’re always looking at our portfolio, seeing what make strategic sense, what doesn’t. I would agree with you, in this environment it might be tough. But we’re not going to fire sale assets. We think what we have has value and we want to get that value. And if somebody is not going to give us that, we’ll retain them. But I would tell you that it’s always something we continue to look at and we’ll make the appropriate business decision.

[Paul Forward:]

Okay, thanks.

[John Eaves:]

Thank you.

[Operator:]

We’ll now go to Justine Fisher from Goldman Sachs.

[Justine Fisher:]

Good morning.

[John Eaves:]

Good morning, Justine.

[Justine Fisher:]

I just have one question about the CapEx budget, and how – what you guys are doing, I guess, on the maintenance side to get it so low. If I look back to Arch’s historical CapEx levels, even in 2009 and 2010, full-year CapEx was, I think, $320 million or something like that. And that was before you bought ICG and that was excluding the $100 million that you’re paying – that you’re expecting for 2013 for the Leer mine. So, I’m just wondering what you guys are doing to get the maintenance numbers so low such that Arch plus ICG plus Leer is the same level that it was in 2009 and 2010?

[Paul Lang:]

Justine, this is Paul. I think if you recall from our last quarter conference call, one of the huge benefits we’ve had from idling a lot of the (inaudible) mines in the East is we freed up a lot of fairly new equipment we acquired from ICG. And we had estimated that that was going to be in roughly the $35 million value range. I think I’ve been very pleasantly surprised where that’s come out. And that’s where you’re seeing a lot of it next year.

[Justine Fisher:]

And then just as a follow-up, do you think that that level is – I mean, it seems to be somewhat of a barebones level as far as the maintenance goes. Do you think that’s sustainable in future years?

[Paul Lang:]

I think over time it normalizes, but for 2013, I feel very comfortable.

[Justine Fisher:]

Great. Thanks very much.

[Operator:]

And we have time for one more question today, and that question will come from Lance Ettus from Tuohy Brothers.

[Lance Ettus:]

Hi, guys. Congratulations on the quarter. Just wanted to know, it seems like you made the right decision by producing a little more PRB because the incremental costs were lower than the price you’re getting. But I still don’t think that’s probably economic long term, given what you’ve paid for the coal leases and given what you’ve gotten for PRB in the past. So, it also seems like you have – you don’t have maturity through 2016, so it seems like you’ve set yourself up that to weather the storm here. I was just wondering if there’s any reason or anything that would stop you from maybe even cutting back on production, kind of taking that hit in the short run, like you did last quarter, for any kind of more extended period of time in the future if you don’t see PRB prices up towards that, let’s say, $13 level?

[John Eaves:]

Yeah, I think we continue to evaluate the market and want to be market-driven. And we’re going to make good business decisions. And as I indicated earlier, we’re in the stages of our planning and budgeting process and should be able to update you much more in January. But we’re pleased with what we were able to sell during the third quarter for 2013, we’ve had further activity. And I think a lot of it will just still depend on what we see in terms of opportunities. We’re certainly pleased with where we see natural gas levels up today as well as 2013 and would expect with normal weather conditions to see those inventories start coming down and creating more opportunities for PRB.

[Operator:]

And at – I’m sorry go ahead.

[Lance Ettus:]

Just wanted to say thank you.

[Operator:]

You’re welcome, thank you. And at this time, that does conclude our question-and-answer session. And I’d like to turn the call back over to John Eaves for any additional or closing remarks.

[John Eaves:]

Yes, first of all, I’d like to thank all the Arch employees for their focus during the third quarter on safety, environmental performance and cost control. We think we’ve positioned the company very well for the future. We are planning for more of a cautious 2013, but we do think with our cost structure and our ability to manage our capital that we are well positioned for the next market upturn. We look forward to updating you on our next call in January. So thank you for your interest in Arch Coal.

[Operator:]

And that does conclude our conference for today. Thank you for your participation. You may now disconnect.