Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

Arch Coal, Inc. (NYSE:ACI)

Q1 2013 Earnings Call

April 23, 2013 10:00 a.m. ET

Executives

Jennifer Beatty - Vice President, Investor Relations

John Eaves - President and Chief Executive Officer

Paul Lang - Executive Vice President and Chief Operating Officer

John Drexler - Senior Vice President and Chief Financial Officer

Analysts

Shneur Gershuni - UBS

Brandon Blossman - Tudor Pickering Holt & Company

Holly Stewart - Howard Weil

Curt Woodworth - Nomura

Brian Yu - Citigroup

Lucas Pipes – Brean Capital

Paul Forward - Stifel Nicolaus

Caleb Dorfman - Simmons & Company

Chris Haberlin - Davenport & Company

Richard Garchitorena - Credit Suisse

Andre Benjamin - Goldman Sachs

Timna Tanners - Bank of America Merrill Lynch.

David Martin - Deutsche Bank

David Gagliano - Barclays

Operator

Good day, everyone, and welcome to this Arch Coal Incorporated First Quarter 2013 Earnings Release Conference Call. Today’s conference is being recorded. At this time I would like to turn the call over to Jennifer Beatty, Vice President of Investor Relations. Please go ahead.

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 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 would 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 President and CEO; Paul Lang, Arch’s Executive Vice 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 will be happy to take your questions. John?

John Eaves

Good morning. During the first quarter, Arch continued to demonstrate strong cost control and capital restraint, which helped offset lighter volumes and realized prices. We generated $84 million of quarterly EBITDA and had negative free cash flow of just $11 million. Our success in controlling cost has allowed us to lower our full year cost guidance expectations in several regions. What's more we began to reduce our capital spending guidance for 2013 to ensure that our cash outflows for the year remain aligned with our view of gradually recovering markets.

While it's no secret that global coal markets have been weak over the last year or so, we are encouraged by the correction that is unfolding. Surprisingly perhaps, that correction appears to be occurring first in the domestic thermal market, with higher natural gas prices and cold spring weather serving as catalysts. How are the U.S. thermal markets fixing themselves, after all just a year ago U.S. thermal market conditions were quite challenging. In the first quarter 2012, power demand was down 4%, coal consumption was down 20% and coal production was more or less flat. That situation led to record coal stockpile builds by May.

Fast forward a year and power demand is up more than 3% through March, even more importantly coal consumption is up over 10% while coal production is down 10%. These trends are helping to correct this significant stockpile overhang at power producers. If the current pace holds, we would expect coal stockpiles to end the year below 145 million tons. That would be lower than the five year average nationally, in a level not seen since December 2007. This correction would set the stage for a much more balanced and dynamic domestic thermal market in 2014.

We are already seeing evidence that stockpiles are correcting. Our customers are no longer calling us to defer turns they did a year ago. We have seen an uptick in spot buying activity and RFPs as natural gas prices have risen. A year ago, natural gas prices were below $2 per million BTU. Now they are 115% higher at $4.25. That bodes well for our PRB and Western Bituminous Coal. Days of burn at PRB served generators are nearing the five year average and we would expect similar weather to help those stockpiles move down even further. But not every coal region is feeling the benefit of higher natural gas prices. In fact those prices would have to move solidly above 450 and stay there to make Central App coal economic on the dispatch curve. That is why thermal production in the region is coming up meaningfully.

We’re projecting total Central App production to fall to 130 million tons in 2013. Of course when generators do reach out again for Central App coal, we believe they’ll find that most of the coal has migrated offshore or been idle. This could make for a very interesting market environment in the future for the lowest cost surviving thermal coal mines in that region. While the U.S thermal markets appear to be on the mend, international thermal markets are in the process of bottoming out. U.S coal export volumes were strong through the first quarter, but we would expect exports to taper off in subsequent quarters unless we see an upward movement in [ARA] [ph] rates.

At Arch, our first quarter export volumes of 2.7 million tons were roughly flat year over year. Our met exports were up versus a year ago and our thermal exports were down. That trend is likely to be consistent with the U.S coal industry overall. Even with anticipated decline in thermal exports, we are projecting exports industry wide to remain above 100 million tons in 2013. This represents a step down from 2012 levels, but still very high by historical standards.

We expect exports to continue their upward trend in the future years as port capacity in this country is built or expanded. What’s driving this bullish forecast? Well, 300 gigawatts of new coal fired generation is coming online around the world over the next five years and those plants will need to secure new, available coal supply from somewhere. With the rising cost in traditional coal export nations and infrastructure challenges in others, we think the U.S can start playing a more prominent role in the seaborne coal trade.

We are confident this shift in dynamic in the seaborne market will have positive implications for Arch. This isn’t going to happen overnight. There will be ebbs and flows. In fact seaborne prices are now at levels where net backs simply did not work for most U.S coals, including Arch. At the same time, we believe global prices are very low today which is prompting some supply curtailments. As global economic growth reasserts itself, we would expect prices to move up accordingly.

Turning now to global met markets, we’re seeing mixed signs. On a positive note, growth in North and South America is evident. Utilization rates at U.S steel mills have remained in the mid to high 70s percentage range. Strength in the auto, energy and construction sectors are driving these trends. Recent forecasts have raised auto sale expectations in the U.S to 15.5 million vehicles, up over a million units from last year. We believe higher U.S steel output could translate into increased buying activity from our met customers in the second half of the year.

In Asia, we’re forecasting a pickup in metallurgical coal demand in the second half of the year. The World Steel Association expects global steel use will rise 3% in 2013 and another 3% in 2014. The BRIC countries, particularly China, we are the main drivers and account for 60% of this projected growth. In Europe however steel markets are weak. Steel use in EU was down 9% in 2012, but may be down only modestly in 2013. Eastern Europe is faring much better. While we’d like to see growth out of Europe, stabilization is a good thing as well. We continue to see buying activity from our European met customers, particularly for the high vol B coals, but prices remain weak.

Lastly I’d like to highlight our ongoing initiatives to expand Arch’s presence in the Asia Pacific market. As you know we’re already a strong and growing exporter in the Atlantic basin, but we’re making real strides to raise our profile in the large consuming regions of Asia. We opened a business office in Singapore in 2011 and will soon be expanding into China, building upon existing customer relationships and developing new ones in key countries such as China, India, Korea and Japan for both our met and thermal coals.

Arch’s metallurgical exports were up nearly 15% in the first quarter of 2013 versus last year and our exports in Asia are growing as well. We’re also working stateside to secure port capacity to facilitate the movement of our coals in the sea-borne trade. Recently Arch has joined port development in a project in Washington State the Millennium Bulk Terminal signed an agreement with local labor to handle construction of the port. This agreement is the first formal agreement with organized labor for any proposed northwest coal terminal project and represents another positive milestone for the project. In summary, Arch is managing what it can control. We can’t predict when prices will improve, but we are seeing signs of markets are correcting and we’re ready to capitalize as the cycle turns.

With that, I will turn the call over to our COO, Paul Lang, for a discussion of Arch's sales and operating performance. Paul?

Paul Lang

Thanks, John. This morning I would like to highlight how we are effectively managing our sales and cost during this market downturn. Despite the challenging market environment, we're controlling what we can across the organization, we are confident that our efforts of positioning Arch to deliver value for shareholders will be the full market cycle. The first quarter of 2013, our consolidated cash costs declined 13% on a total dollar basis and 7% on a per ton basis, versus the fourth quarter of 2012.

The operations managed these cost reductions even as our sales volumes declined 6%. Our solid progress on cost containment in the Powder River Basin and Appalachia has allowed us to lower the cash cost expectations for these two reasons for the full year. In our largest volume region, the Powder River Basin, first quarter cash cost per ton were down 8% even with a 4% quarter-over-quarter drop in sales volumes. We achieved these cost reductions across several major expense categories including lower maintenance and repair costs, reduced contract labor expense and employee overtime, and savings on ports and supplies and the carrying cost that inventory through various initiatives.

Our goal is to run our operations in the most efficient manner, and that includes the combination of strong cost containment efforts and incremental sales where appropriate. As you know, due to weak market conditions, we are operating at a much reduced level in the Powder River Basin. At the same time, we have determined that it's in the long term best interest of our company and shareholders to maintain minimum production level in the region in order to preserve the workable cost structure. As a result, we are always active in the market placing tons to some degree, just as we were in the first quarter.

Going forward, the demand outlook for the Powder River Basin is improving as natural gas prices have moved higher. We believe excess coal stockpiles in the region will be liquidated as we progress through the year. However, at this time we do not plan to redeploy our idled equipment which includes two draglines and 8 truck-shovel spreads, until we see a much stronger and sustained recovery in the domestic coal market. In Appalachia, our first quarter metallurgical volumes were up slightly year-over-year while our thermal volumes declined as a result of our mine closures last year. More than half of the volumes shipped in the quarter from this region were metallurgical coal which is consistent with our strategy to focus on higher margin business. Yet our cash costs were $3 per ton lower than in the fourth quarter.

We achieved these cost reductions by lowering inventory and idle property costs, by reducing other consumable categories. These cost improvements helped offset lower realized pricing on metallurgical sales. During the quarter we shipped 1.7 million tons of coking coal at an average price of $87 per ton. Those volumes were light due to limited shipments to our Canadian customers who cannot accept contracted coal when the great lakes are frozen.

Our first quarter shipments also reflected a higher percentage of PCI in high-vol coal in the sales. In the coming quarters, we expect higher sales volumes and higher pricing as our product mix improves. For the year, we still expect metallurgical sales between 8 million and 9 million tons. That range includes anticipated volumes from the new Leer mine and accounts for the impact of our decision in 2012 to idle some higher cost metallurgical operations. Currently, we have more than 6 million tons of metallurgical coal committed today at an average price of $91 per ton, and we are confident about placing our remaining tons in the market.

We are seeing an uptick in demand for lower quality coking coal and now expect 60% to 65% of our overall product mix PCI in high-vol B in 2013. Overall, our mines in Appalachia ran well in Q1 and we are continuing to aggressively pursue opportunities drive costs out of the system to further enhance our margins. One such opportunity is the Leer longwall mine. We have made considerable progress on the development of the operation in the first quarter. We are nearly fully staffed at the mine and benefitting from the experienced employees transferring from other locations within the company. The main line conveyor belts is in operation and we are in the process of taking final delivery in the longwall system.

Lear’s preparation plan has been running well and we have been loading trains on a regular basis for test shipments throughout the world. Development work by continuous miners is proceeding in the first longwall panel and we’re finding the geologic conditions to be favorable. In a nutshell, we remain on track for the anticipated startup in longwall around the first of October.

In the western bituminous region, our cash cost per ton came in at the low end of our guidance range for 2013. Costs were up versus the region’s exceptional fourth quarter performance, but were consistent with our previous expectations. Realized pricing in the western bituminous region declined quarter over quarter mainly due to the roll off of international hedging. We continue to feel solid interest from the domestic industrial sector and we see real demand for the international market for this type of high BTU low sulfur coal.

Turning briefly to capital spending, we continue to exercise restraint in the trough for this market cycle and spent just $55 million on capital in the first quarter. For full year 2013 we now project total capital expenditures between $300 million and $330 million compared with our previous estimate of $330 to $360 million. We’re tightening our belts while continuing to invest in high margin enhancing projects such as the Leer mine.

Let me close by congratulating our employees for another strong performance in safety and environmental stewardship. Even in the midst of the current market environment, our dedicated operations personnel have remained committed to doing their part to uphold our core values every day.

I’ll now turn the call over to John Drexler, Arch’s CFO to provide an update on our financial results and liquidity positions. John?

John Drexler

Thank you Paul. I’d like to first talk about our balance sheet and strong liquidity position. As a result of the financing transactions completed in 2012, we have over $1.3 billion of available liquidity. The vast majority of that nearly $1 billion is in the form of cash and other short term investments. We have other sources of borrowing capacity as well, namely an accounts receivable securitization program and an undrawn revolving credit facility. Thus we’re very comfortable with the liquidity we have in place and remain well positioned to manage through the challenging market environment.

Let me also recap our financial maintenance covenants. These covenants relate to our revolving credit facility which was amended last November. As previously announced, we have two covenants that apply to the revolver through the end of 2015. These covenants were designed to allow us to meet them during the market downturn. The first covenant is a minimum liquidity requirement of $450 million. As we just discussed, we have strong liquidity totaling $1.3 billion.

The second covenant is a net senior secured leverage ratio. It is calculated as secured debt which is essentially the term loan net of cash divided by the trailing 12 months of EBITDA. Based on our expectations, we are comfortably in compliance with both of these covenants throughout all of 2013 and beyond.

Turning now to the first quarter results, our quarterly EBITDA was impacted by an $11 million charge or $0.03 per share to account for liquidated damages on our export logistics contracts. Absence the charge, EBITDA would have been $95 million. These charges were incurred as the market for international opportunities fell below what is economical to ship. As a result, we have recorded a charge in the first quarter related to those minimum throughput requirements. We believe that it is in Arch’s and the market’s best interest to not shift the tons into an over supplied global market at this time.

While the direction of global demand in pricing trends will dictate whether we meet our minimum obligations in subsequent quarters, we remain quite confident in our export strategy and its ability to drive long term value for our shareholders.

Next I wanted to address our cash flow needs for the year. As we anticipated, we had a modest cash outflow in the first quarter and expect to have negative free cash flow for the full year. Due to timing, we expect to have additional cash outflows in the second quarter, including the second of five annual payments for the South Hilight LBA of $61 million and scheduled semiannual interest payments of roughly $110 million.

As we have outlined, we remain highly focused on cost containment and reduction efforts. We’re also working on minimizing our free cash outflow to the extent possible with ongoing capital discipline efforts and strict working capital management as demonstrated by our first quarter results.

Turning to expectations for full year 2013, we have provided updated guidance in our earnings release. I would like to highlight just a few changes here. Our success in containing costs has allowed us to reduce our cost expectations in two key operating basins. In the Powder River Basin, we expect to have cash costs in the range of $10.65 to $11.15 per ton, representing a reduction of $0.23 per ton from our previous guidance. In Appalachia, we expect cash costs of $66 to $71 per ton, a reduction of $1 per ton at the top end of the previous range. In addition, we now expect DD&A in the range of $500 million to $530 million, in CapEx between $300 million and $330 million representing a reduction of $30 million versus our previous expectation.

Given our current outlook and the impact of percentage depletion, we continue to expect the tax benefits in the range of 30% to 50%. In short, we continue to execute on what we can control from a position of ample liquidity. We are confident that Arch is well positioned to weather this downturn and to create substantial shareholder value as markets improve. With that we are ready to take questions. Operator, now we will turn the call back over to you.

Question-and-Answer Session

Operator

(Operator Instructions) And we will take our first question from Shneur Gershuni with UBS.

Shneur Gershuni - UBS

My first question, I was wondering if we can sort of talk about the market for a second on a pricing perspective. You know, you are moving along with Leer, I am kind of wondering if you have done any test sales. You know how it's been accepted in the market in terms of quality and so forth. As an A, B or low-vol. And maybe if also if you can sort of expand on your comments a little bit on the PRB. You mentioned shrinking inventories and so forth as to when you would expect the utilities to come in and look at 2014 contracting.

John Eaves

Yeah, let me make a few comments and then Paul can jump in. I mean certainly we're seeing a little pressure on the met prices in terms of the quality coals that are out there and we have seen the demand improves for high-vol B, PCI. We think, given our cost structure, we think we are very well positioned to continue to participate in that market and generate attractive cash margins. You know as we build out Leer, we think that project with its cost structure, its quality coal, is going to be a comparable project to the Mount Laurel project.

We think it's well positioned. We would expect to continue to build that out. We think that quality coal is going to see a good market not only in the U.S. markets but in the Atlantic market as well as the Asian market. You know in terms of the PRB inventories, I would tell you that we think we are drawing inventories as we speak. We have got a bonus with the March weather. If you look at natural gas prices, they were about $4.27 this morning. We think at those levels the PRB as well as the Western Bituminous Regions do very, very well on a dispatch basis. We came into the year with 185 million tons of inventory. We think we continue to pull those down. Our internal forecast is to have those inventories falling below 145 million tons by the end of the year. That’s with normalized weather and gas prices actually even a little bit lower than we are seeing today.

And we do think we are in pretty good shape in terms of the regions we participate in and competitiveness with natural gas. I think you could see some buying activity as we get these inventories down towards the back half of the year, but it's certainly a great setup for 2014 in terms of PRB thermal markets. So with that I will let Paul kind of opine on kind of the test results we are seeing for Leer. He just got back from Asia and I think has some pretty up-to-date information. Paul?

Paul Lang

Good morning, Shneur. We have sent large scale test shipments to Europe and Asia as well as (Inaudible) samples to steel mills in South America. I've got to tell you, we are seeing strong interest in the coal in Asia due to its high CSR and volatile content. And what's interesting is we are seeing a lot of interest in China due to its GNY (Inaudible) Chinese classify as fat coal. And I think those familiar with Chinese markets, fat coal is a little bit in short supply and I’m happy to say we’ve also signed a term agreement for the coal in Asia. So we’re seeing pretty good acceptance for the coal and a lot of interest in taking a test. So overall I feel really good where we’re at with Leer.

Shneur Gershuni - UBS

Are you essentially saying that it’s pricing like in A or even a low vol to the Chinese market?

John Eaves

No. It’s definitely a high volume, but they’re finding good interest in this coal as I say they call it a fat coal.

Paul Lang

And I would say that we’re seeing a nice premium in the domestic market for the testing that we have going on for Leer versus the high volume B.

Shneur Gershuni - UBS

Okay, cool. One last clarification question, you had made a comment before in the prepared remarks about the covenants and so forth. If I recall, last year you had recorded a gain on settlements and so forth. If I remember correctly, does that also apply as a positive EBIDTA adjustment when you’re calculating the maintenance covenant test?

John Drexler

This is John Drexler. As the EBITDA is recorded and as we report it, that EBITDA that you’re describing is included in the various covenant calculations that we have for our financial maintenance covenants.

Shneur Gershuni - UBS

So basically it’s operating EBITDA as we all think about it plus that settlement basically?

John Drexler

That’s correct.

Operator

We’ll take our next question from Brandon Blossman with Tudor Pickering Holt & Company.

Brandon Blossman - Tudor Pickering Holt & Company

Paul, a quick question on pricing, like on the Appalachian pricing. Q1 looks a little light on realizations versus the full year hedges, particular for PRB, but also for Western bit. Is there any color you can provide around that?

Paul Lang

I think western bit starting with that obviously got impacted by some of the roll off of the international hedges and I will say we are seeing strong interest in the industrial sector and I think you see that in the contracts that we locked in for 2014. In the Powder River Basin, I think it is interesting the last couple, say the last six to eight weeks we’ve seen a lot of new interest in spot purchases in the back half of the year and I think you’ll see some pricing react as a result of that.

Brandon Blossman - Tudor Pickering Holt & Company

That sounds very positive. To follow up on that, on 2014 it looks like there were some small incremental tons done in the PRB if my math is right around $13. That looks like materially above the forward strip. Are you seeing a disconnect between financial paper trades in what you think the physical market will be for 2014?

Paul Lang

Yeah. I think there is some of that and also as we mentioned last time, we’ve been able to leverage some of our 2013 sales for 2014 (inaudible)

Brandon Blossman - Tudor Pickering Holt & Company

Step up in prices relative?

John Drexler

Yes.

Operator

We’ll take our next question from Holly Stewart with Howard Weil.

Holly Stewart - Howard Weil

First question I think the release points out a significant opportunity to place additional met tons. Can you just provide a little bit of color maybe outside of Leer on what you’re seeing in the market?

John Eaves

Let me jump in here Holly and Paul can add whatever he sees fit. We are encouraged by what we’re seeing in the U.S markets. If you look at capacity factors, they have moved up to the high 70% range. As I said in my opening comments, if you just look at auto production, up over 1 million units versus last year. We’ve got U.S steel production at about 94 million tons. We haven’t seen those levels since 2007. Based on the shipments that we’ve seen year to date we would expect a lot of our customers to come into the market and potentially buy the back half of the year. Clearly we’re seeing some pressure in Europe, but I would tell you that in Eastern Europe we’re seeing our demand with our particular customer base remain strong. We don’t like the pricing, but as you saw we sold about 2.2 million tons during the quarter at about $87 million. We don’t like the pricing, but we do have a cost structure that allows us to generate good cash margins. So we do think globally right now there is a correction going on. If you look at the 172 benchmark we still think there’s a reasonable percentage of suppliers in the world markets that don’t have cost structures that allow them to get a return somewhere between 25% and 35%. So we think there is a correction going on. I mean we hear as well a lot of the spot activity. People out selling coal at $20 below the benchmark. We don’t think there is meaningful volumes tied to those transactions. It could be inventory, it could be transactions that go through the end of the first quarter. We think overtime that there is a true correction going on in the global markets that Arch is going to be ready to be able to take advantage of. But clearly where we sit today at 75% of our coal sold on the met market, we feel pretty confident about moving the balance of that.

Paul Lang

I think the only thing I would add, Holly, is that, we are seeing a slightly to greater demand for the lower quality of coking coal. Now this could be a combination of steel makers adjusting their blend due to cost and it could be just the higher price of natural gas pushing the use PCI coal. But we are seeing definitely a pickup in lower quality metallurgical coal.

Holly Stewart - Howard Weil

Perfect. And then just maybe based on what you have seen to date in your expectations for the second half of the year pickup. Would there be a change in your customer mix?

Paul Lang

Yeah, I think for the back half of the year, what we expect to see is about 35% of our products, low-vol and high-vol A, and the balance of 65% will be high-vol B and PCI.

Operator

And we will take our next question from Curt Woodworth with Nomura.

Curt Woodworth - Nomura

I just had a question and I know that the liquidity position is pretty good where we stand right now. But obviously we are facing a fairly large maturity wall in the out years. And if we don’t get more substantial recovery in met, I am just wondering what are the options you have to look out in the terms of either asset monetization or things you can do to raise some cash. Maybe looked at potential monetization of the 700 million tons of reserves you have in the Illinois Basin because it seems like there would be fair amount of interest in that reserve base right now.

John Drexler

Hey, Curt, I am going to start with a response to your -- this is John Drexler. I think as we sit here today and we look at our liquidity and we look at our expectations for the remainder of the year, we have indicated we expect to see some negative cash outflow over the course of the year. You can look at the components of what we are focused on controlling CapEx, we are continuing to bring that down. We are now at a midpoint of $315 million of interest expense. And that all is cash outflow after EBITDA. So we don’t provide EBITDA guidance but there is a lot of it out there. But as you look at it, we are going to have modest cash outflows.

As we end the year, we continue to believe based on our expectation, we are going to have ample liquidity to continue to weather whatever the market is throwing at us. However, there are other alternatives that we do have that we will continue to look at and evaluate. And I will call over that question over to John to provide some additional commentary.

John Eaves

Yeah, Curt, if we continue to look to the future, I mean if we continue to see soft markets in 2014, I think we will have the Leer project fully capitalized at the end of this year. We won't have any more growth capital associated with that. We do have the LBA payment and maintenance capital, and Paul can speak to the maintenance capital expectations for 2014. But we think there is some things we can pull back if we continue to see pressure in the market.

We do think, as I mentioned earlier, with the quality coal, the cost structure we see at Leer, we want to continue to build out that project. You know we did close three high cost met mines last year that we didn’t think, [worked] in the market about 2 million tons. If we continue to see pressure in the met markets moving forward, we would probably be likely to pull off some higher cost, lower quality coals in terms of met supply. But clearly, the Leer project is going to be a major participant in the U.S. and world markets. So, Paul, you may want to opine on that 2014 capital.

Paul Lang

I think I mentioned last quarter we are looking at a normalized maintenance capital of about $210 million to $220 million and obviously we were very successful in 2013. We have equipment transfers from closed operations that helped keep that down. And on top of that we have the land reserve additions of [three] LBAs that come up to about $80 million. So it puts total CapEx in about to $300 million range is what I talked about last quarter. You know we continue to evaluate this and while we are not ready to provide any further hard numbers, we are clearly looking at decreasing this given the market conditions. Sitting here today, a 5% or 10% reduction of that ballpark estimate is probably not out of the question.

Curt Woodworth - Nomura

Okay. Great. And then just second question on the PRB cost. Obviously, very good performance there. How much do you think of that reduction would be more permanent in nature as opposed to obviously when volumes come back and some of the other variable costs picked back up. Is there any color you can give to think about that?

John Eaves

Our costs were $0.93 below Q4 and as we got in on October we do, we were going to have some higher maintenance expenses at the end of 2012. So in some way we’re starting from a higher place. Even with that, the mine did a great job in the first quarter. We were able to benefit from a number of cost containment efforts and did a really good job on maintenance and repair and lowering parts and supplies. I guess I was comfortable with the success we’ve had that we lowered our cost guidance for the Basin for the full year.

Operator

We’ll take our next question from Brian Yu with Citi.

Brian Yu - Citigroup

First question is a follow up on earlier on about realized pricing. I think you said that realized prices were weaker because they’re committed and price cones market base in export. Would you be able to break out roughly what percentage would fall into those three buckets for the PRB and western bit?

Paul Lang

We don’t break it out to that level of granularity.

Brian Yu - Citigroup

All right. And then my second question is just on the throughput fees where you had to record a charge in Q1. Can you help us understand what the floor level is and what’s built into your guidance at the moment in terms of being able to meet those targets?

Paul Lang

I guess to start with, we exported about 2.7 million tons in Q1 from all of our regions. I think as part of expanding our port capacity over the last several years, we entered into what I would call standard agreements and some of those included minimum volume requirements. We obviously believe the seaborne market will continue to grow and have put in place agreements so we can participate. Even in this downturn as John said, we think exports out of the U.S will be over 100 million tons in 2013. If you look back, had we not locked in this capacity we would not have been able to export about 14 million tons in 2012 and that 14 million tons is accruing to about $1.2 billion of revenue.

In the first quarter we recorded about a $10.5 million charge related to throughput fees under our existing agreements. Simply as we said it wasn’t economical to ship and instead we paid liquidating damages. And as you can imagine, most of these charges were related to thermal sales given the current market. I guess in the end we see these exports grow and understand that potentially there will be ongoing costs associated with the absorption. We continue to review these agreements and see how the market plays out, but there could be additional payments in line with Q1, but I think it’s really too early to speculate.

John Eaves

Let me just make a few comments. Clearly as we look at world markets, we’re bullish long term. We’ve identified a little over 300 gigawatts of new coal fire generation are coming on over the next four or five years. They’re going to need on the order of about 900 million tons of new supply. So you’re talking about replicating the U.S coal industry over the next four or five years and Arch wants to be a major participant in that market. So as Paul indicated earlier, we couldn’t shift the 14 million tons or realize that kind of revenue in 2012 without these types agreements. So as I mentioned in my opening comments, there’s going to be ebbs and flows in this market, but we believe the long term demand growth warrants our involvement and we couldn’t be involved in a meaningful way without these type agreements.

John Drexler

Brian, one last closing comment on that charge. It’s flowing through other. It’s not included as part of our cost guidance that we’ve provided.

Operator

We’ll take our next question from Lucas Pipes with Brean Capital.

Lucas Pipes – Brean Capital

My first question is on the PRB. So it looks like at least we finally turned the corner on the coal market. How do you see this market playing out over the course of the year? it looks like inventories are poised to come down further. When do you expect production to come back? What level of price do you think is necessary to incentify producers to do that?

Paul Lang

Well, we are in great shape right now. If you look at our volume ranges at the midpoint, we are about 95% committed. We have no plans to bring any additional production back on. As Paul indicated earlier, we have got two drag lines idle. A number of truck shovel spreads sitting there. And we are comfortable with where we are until we sustained pricing. Now I think the natural gas prices where they are today, the coal inventory draws we are seeing and would expect to see through the summer, you could see some more buying activity in the third and fourth quarter. I mean, again, we had left ourselves some opportunities with some of our current volume to play in that market, but until we see sustained improvements in the market, we don’t plan to bring anything back on.

As we look to 2014 though, I mean it could be a very exciting market given what we see right now with natural gas prices, inventories coming down, supply prices particularly in the east. We saw about 36 million tons come out of Central App from 2012 to 2013. We would expect another 20 million tons or so to come out this year. So we think the primary beneficiary of that is the PRB coal. So we want to make sure that we are well positioned. Paul and his team did a great job in managing the cost quarter-over-quarter. And that’s really our focus right now, it's managing our cost and maximizing the equipment fleet that we have in place.

Lucas Pipes – Brean Capital

That’s great. And in terms of 2014 contracts which you kind of wait until the second half of the year to look at locking up some additional volumes. So how do you approach that?

Paul Lang

Right now I think we have locked in about 60% of our volume for 2014 based on the 2014 run rate. Because I think we are in pretty good shape and really we are kind of standing back and judging the market and trying to be patient.

Operator

And we will take our next question from Paul Forward with Stifel.

Paul Forward - Stifel Nicolaus

I just want to ask about Black Thunder. Last four quarters or last three quarters you have been about 99 million ton per year rate. You have talked about having two idle draglines and some truck shovel spreads idle. I was just curious, if the market gets back to where you think it ought to be and gets to the point that you can deploy all that equipment, what sort of additional capacity do you think Black Thunder could have in a normalized operating environment.

Paul Lang

You know, Paul, we have the infrastructure at the idled capacity to bring back meaningful production if we wanted. Having said that though, I think there is logical production increments and each of those have different timing and cost associated that make any supply response what I would call non-linear. I guess simply it's not the basin I left eight years ago and production increments could be turned pretty easily. I think the production increments now are a little tougher and a little longer to bring back.

Paul Forward - Stifel Nicolaus

All right. Well, I guess turning over to Central App, Mountain Laurel, it was impacted in the quarter from a longwall move. But over the last few years it has been operating about, from what I could see, about 2.6 million on the underground side. 2.6 million tons per year. And from my understanding that’s below what you think capacity is. I was just curious, are you operating Mountain Laurel at a lower than capacity rate in part due to just the weak market and really it's, call that 3.5 million tons per year operation or do we need think about Mountain Laurel as being something below 3 million tons going forward.

Paul Lang

I guess to begin with Paul, I will say there is still a lot of appetite out there for Mountain Laurel coal. It's a very popular coal not only in the U.S. and Europe, but also in Asia. Having said that though, if you recall, we transitioned from the Alma to the Cedar Grove last year and when we did that we have said there was going to be step change in both production and cost. And really what you are seeing is just simply the change. The mine continues to run well. And it's essentially running at capacity and things are going fairly good there.

Operator

(Operator instructions). We’ll take our next question from Caleb Dorfman with Simmons & Company.

Caleb Dorfman - Simmons & Company

I guess first off obviously you showed some restraint in shipping exports in the thermal side. What do you think you need to have to see some rebound in export thermal pricing?

John Eaves

We continue to monitor those markets and as Paul indicated, a lot of that was thermal coal. You can see where EPI prices are in Europe right now. They’re in the low to mid-80s. Those don’t work for U.S and they certainly don’t work for Arch. We typically benchmark ourselves off the west coast to the Indonesian 5,000 coal. If you look at those products right now they’re pricing in the low 60s. But if you look back over the last 12 to 15 months, the Indonesian prices were $80 to $90. EPI pricing was $120 to $125. Clearly those numbers the pricing works for Arch. So it’s something that we’re always monitoring. Those markets can move pretty hard pretty fast and it’s something that we continually monitor.

Caleb Dorfman - Simmons & Company

Do you think it’s more of a supply response with production coming offline or more of a pickup in demand you need to see those prices appreciate to the point where exports make financial sense for Arch again?

Paul Lang

I think it’s going to be a combination of supply coming offline and demand bouncing back. I don’t think there’s any one answer.

John Eaves

If you look back to 2012, in the U.S there was about 80 million tons that came off. As we look to the global met markets, we’ve seen about 35, 36 million come off. So we think there’s a correction going on. We think as I mentioned earlier there’s a large percentage of suppliers in the met market that don’t have a cost structure that can compete at 172. We also think there’s a reasonable percentage in the Hunter Valley in Australia at the recent settlement price of $95 they can’t make money as well. So we think that this correction is going to be happening over the next couple of quarters and the people that are positioned from a cost standpoint, a quality standpoint where there’s thermal met, transportation options and infrastructure are going to be well positioned to take advantage of what we think is an improving market.

Operator

We’ll take our next question from Chris Haberlin with Davenport & Company.

Chris Haberlin - Davenport & Company

John, you had mentioned 25% to 35% of the seaborne market was underwater at 172. So I guess it’s reasonable to assume that that number was pushing 50% with the current spot price probably $20 below the Q2 benchmark. With that in mind, how do you see a benchmark pricing playing out over the next six weeks when we start moving -- have an agreement for Q3 just given the low prices in the spot market today?

John Eaves

Well, as I mentioned earlier, I think the spot market activity we’re not seeing a whole lot of volume with that. So we hope that’s people that are clearing out inventories that have some agreements maybe that they’re protected buy through the end of the year or the end of the first quarter, I’m sorry. But we don’t think that this is sustainable. So we think this correction has to occur, whether we stay flat or so for a quarter or two. That’s possible, but again it would be hard to envision a meaningful step down from the 172. Clearly at 165 people were struggling even after you had the 172 benchmark, you had at least 1 million tons come off between Canada and the U.S. So people clearly continue to struggle with those price levels and I just think over time that you have to see some kind of improvement in the benchmark pricing.

Chris Haberlin - Davenport & Company

And then just into the PRB, can you just talk about what the impact the late capacity in the PRB might have on the ability of prices to recover? And I think Paul had said that he doesn’t see the supplier response in the PRB as being linear due to a change in timing and cost associated with the ramp versus what it has been in the past. What has changed and how do you see that impacting pricing right now?

Paul Lang

I think it’s some of the basic things that happen to most mines. Ratios are catching up with people. The amount of pre strip that’s out there has now increased. So the ability respond is not as clean as it used to be. And a good example of, when I started in the basin in the late 90s, there was very little pre-strip activity for the drag lines. Now that’s a major part of most of the mines in the basin. So to get drag lines back in operation means firing you truck shovels, so it's a slower response time. And as I said, I think some of this is now kind of a step function in increments to production.

Operator

And we will take our next question from Richard Garchitorena from Credit Suisse.

Richard Garchitorena - Credit Suisse

So first question, back to the met, it looks like you priced 2 million tons during the quarter. Can you tell us what quality that was that you signed during the quarter and what the remaining tons - you have 2-3 million tons, what quality is that coal?

John Eaves

Well, I think we said first quarter, about 70% of our product mix was high-vol B, PCI. We have seen strong demand on the PCI market so we have been able to take some of our higher quality coals from some of our locations and put them in the PCI market. As Paul indicted, as we moved through the year, we think about 65/35, 65 being the high-vol B PCI and the balance being the low-vol, high-vol A. Similarly the higher quality coals didn’t get shipped during the first quarter because it's tied to the lake season and we should see that materialize as we move past the April. So we would expect an uptick in our pricing as we move forward.

Richard Garchitorena - Credit Suisse

Great. It's very helpful. And then the other question, could you talk a little bit about the progress that is being made with the unions of Millennium Bulk Terminal. Can you give us an update in terms of where you are in the process right now and then an updated timeline if possible.

John Eaves

Yeah, I mean they just signed up with a contractor. We are getting ready to start the EIS process. We think that will be a long process. We still continue to be positive on that. If you look at the polling in the State of Washington, it indicates at about 2:1 in favor of coal export facilities in the state. So we think this is something that makes sense for the industry, it makes sense for Arch. We are going to continue this process and we think over the next four to five years, that we could be trans-loading through MBT.

Operator

And we will take our next question from Andre Benjamin with Goldman Sachs.

Andre Benjamin - Goldman Sachs

I was hoping I would ask you a little bit a higher level question and see if you could provide some insight into what your domestic utility customers are saying about the outlook for investing capital to install pollution controls to comply with [MAT]. I know the rules are few years away but decisions are being made today. So any color you can give on, kind of what percentage of your customers [scribe] versus major decisions the [scribers] don’t need to describe and any regional color would be helpful.

John Eaves

Well, let me first say Andre that we do recognize that [MATS] is coming on. We think all the coal fired generation closures are tied to [MATS]. We think that will happen over the next five years. We think there is about 30% of the coal units that will close during that timeframe. But when you look at the capacity factors of those and you just look back to 2012 burn, it's about 6% to 7%. So in terms of capacity it's not as meaningful as you think. It's probably about 58 million to 60 million tons. We think, after talking to our customer base and if you listen to some of our big customers, they have been very clear that they want a balanced portfolio of fuels. They want coal, they want natural gas, they want renewables and they want nukes. And we think that’s prudent.

We think by 2017 that about 80% of the coal fleet will be scrub. We think once those investments have been made that they are not likely to close those units. We think the other 20% are some of the largest, most modern plants that are out there. So we think going forward, the surviving fleets, we have at about 270-275 gigawatts, can run pretty hard. If you look at those particular units, in 2012, they ran at 60% of their capacity factor. We think they can run much higher than that. I mean if you just go back to 2010 and 2011, they were running at about 73% of their capacity factors. If you just assume that, incrementally it's a 100 million plus tons of additional coal demand that is not there today.

So we are cautiously optimistic moving forward that the surviving fleet can run at pretty significant capacity factors and we think in an improving economy that those are going to be pretty economically priced generation units here in the U.S. So we’re assuming that 40, 45 gigs fall off between now and 2018 and that’s driven primarily by mass.

Andre Benjamin - Goldman Sachs

That’s helpful. And then I guess I apologize if I missed this, but if you can give some color on what was priced versus un-priced in terms of your met coal quality, more accurately how much of what un-priced is say your lower quality high vol B quality versus low vol and high vol A?

John Eaves

I think if we look at the balance, as I indicated Andre, first quarter 70% of our mix was high vol B, PCI. We got about call it 2, 2.5 million tons left to put in the market. We will see some of our higher quality coal ship once the lake season opens. We still have got some of the high quality coal to put in the market. But given the demand increase that we’ve seen for lower quality coals, whether it’s high vol B or PCI, we would expect the balance of the year to be about 65, 35 and overall for the year about 65, 35. So that can always change depending on the customer demands, but that’s the way we see it for the balance of the year.

Operator

And we will take our next question from Timna Tanners with Bank of America Merrill Lynch.

Timna Tanners - Bank of America Merrill Lynch.

Just wanted to follow up on the comment on if markets are weaker in metallurgical coal you would consider cutting more. But my concern in the met coal market has been that there really haven’t been the cuts that we would have anticipated given the surprisingly low levels of pricing as you point out with many of the global producers underwater. So can you just tell us a little bit more color on what it would take for you to consolidate a decision to cut further capacity? Thanks.

John Eaves

Certainly we can’t control what our competitors do. We can only control where we are. I think we’re fortunate if you look at our cost structure $67 in the first quarter and that does have our met production in that number. So we think we’re probably better positioned that most, particularly in the United States to make pretty good cash margins even in a tough market. I would tell you that if we saw any material step down from the benchmark prices right now that Paul and I would be having those type conversations about how we move forward with some of our higher cost met coals. But clearly we do think that we’re probably better positioned than a lot of people from a cost standpoint, from a quality standpoint and from an infrastructure standpoint to get those coals into the global markets.

Timna Tanners - Bank of America Merrill Lynch.

Just as a follow up if I could on the rail side. Are you seeing discounting any more? Do you think that that could resurface or what’s the status of rail discounts and facilitation of the exports?

Paul Lang

No question. I think the railroads are -- understanding the issues with the global markets and they’re coming to the table and I think they’re particularly interested on the east coast particularly with the metallurgical sales. So I feel fairly good about what the railroads have done the last couple of months.

Operator

(Operator instructions). We’ll take our next question from David Martin with Deutsche Bank.

David Martin - Deutsche Bank

I had just one quick follow up if I may. Coming back to the port logistics charges. I assume that there’s a few contracts possibly related to this. Are these types of contracts generally annual contracts? If you could give us a sense of what a duration range would be on these contracts?

Paul Lang

Dave, they’re all over the board anywhere from short term to multi year. So it’s a pretty difficult question to answer.

Operator

We’ll take our next question from David Gagliano with Barclays.

David Gagliano - Barclays

Just back to Dave’s question. Is there a way to give us a sense of how much coal you actually have to export on a quarterly basis to avoid the minimum throughput fees and are these mostly just a flat charge or is it on a per ton basis?

John Drexler

That would be difficult to break that out. It's typically is on more of a flat charge. I think it just depends on how we see the markets evolve, but as Paul indicated earlier, it's mostly tied to the thermal markets. Certainly less impactful on our met coal supply.

David Gagliano - Barclays

Okay. And then as a follow up, I was wondering if you could just confirm the forward sales in the quarter of the PRB. Was it 8 million tons for 2013 delivery at about 10.50 per ton?

John Drexler

Yeah, it was about 10.54 a ton. We were about 8 million tons during the quarter for 2013 and then we had linked some smaller sales to 2014 as well.

Operator

And that does conclude today's question-and-answer session. Mr. Eaves, at this time I would like to turn the conference back over to you for any additional or closing remarks.

John Eaves

Thank you very much. This management team is going to continue with laser focus on cost control, capital, sales commitments, liquidity. We think we have positioned the company very well. We are starting to see some positive signs in the market. We certainly appreciate your interest in Arch. We think we do have the company positioned for the next up cycle and look forward to updating you on our next call in July. Thank you very much.

Operator

And this does conclude today's presentation. Thank you for your participation.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Arch Coal's CEO Discusses Q1 2013 Results - Earnings Call Transcript
This Transcript
All Transcripts