Arch Resources Inc (ARCH) 2005 Q4 法說會逐字稿

Good day everyone, and welcome to the Arch Coal, Inc. Fourth Quarter 2005 Earnings Release Conference Call. As a reminder today's call is being recorded. At this time, I'd like to turn the call over to Mr. Deck Slone, Vice President of Investor Relations and Public Affairs. Please go ahead, sir.

Good morning, from St. Louis and thanks for joining us on today's call. Before we begin I need to remind you that the remarks and comments that follow will contain forward-looking statements within the Safe Harbor Provision of the Private Securities and Litigation Reform Act of 1995.

We have based these forward-looking statements on our current expectations and projections about future events, some or all of which may be incorrect. These expectations and assumptions include risks and uncertainties detailed from time to time in the Company's reports filed with the Securities and Exchange Commission.

On the call this morning we have Steve Leer, Arch's President and Chief Executive Officer, and Bob Messey, Senior Vice President and CFO. Steve will begin the call with some brief remarks about recent developments at the Company and Arch's outlook for the future. Bob will follow with detail on the fourth quarter results. After that, Steve and Bob will be glad to take your questions. Steve?

Thank you Deck, and good morning and welcome to the call. We're pleased that you could join us this morning. As you know, Arch reported essentially break-even results for the fourth quarter of 2005. These results reflect a final impact of a near marathon spent in closing -- in the closing months of 2005, bringing to fruition a long list of transactions, projects, and initiatives.

As I noted in the press release, it was perhaps the most eventful quarter in the Company's history and perhaps the most productive as well. I personally believe we will look back at this quarter and rank it as one of the defining moments in Arch Coal's history, ranking up there perhaps with the strategic and defining quarters of when we acquired our Western assets, our merge with Ashland Coal. We believe the progress we made during the quarter has strengthened the Company strategically, operationally, and financially. And the set is staged -- and the stage is set for a continued and sustained value creation in the future.

To recap, the last three months of the year we sharpened our focus in Central Appalachia through the sale of select assets, reducing our legacy liabilities by more than $500 million in the process. We also took a charge of approximately $66 million related to the retention of several below market legacy sales contracts that we no longer have the ability to source through following the Magnum transaction.

We completed a reserve swap and asset sale at our Black Thunder mine that further enhances the competitive position of that world-class operation. We've streamlined our capital structure through an offer that resulted in the conversion of approximately 95% of the Company's preferred stock into common shares. We addressed the combustion related event at our West Elk mine in a safe and efficient manner, putting that mine back on course for what we expect to be a very strong performance in 2006.

And we began work on the restart of our Coal Creek mine in the Powder River Basin in Wyoming. Furthermore, we had strong performance in three areas that represent core values for Arch Coal, safety, environmental stewardship, and creating shareholder value. While I won't take the time to detail all three areas today, I do want to take a moment to talk about safety.

Among our many achievements in 2005 I am perhaps most proud of, and without question, really proud of our safety performance for the year. In 2005 Arch's lost time incident rate declined by 37% compared to the previous year to 0.88 incidents per 200,000 man-hours worked. That's approximately one-fourth the level of the U.S. average -- U.S. coal industry. And it was a record for Arch with an incident rate that really ranked among the very best of all of America's heavy industries.

Perhaps the most significant new development in today's press release was the announcement concerning the restart of the Coal Creek mine. As you may recall, we idled the Coal Creek mine back in mid 2000 due to the challenging market conditions at the time, with the objective of restarting it when the market needed the additional volumes of PRB coal.

We believe that day has arrived. We estimate the demand for PRB coal is increasing between 25 and 35 million tons per year. And we expect that trend to continue well into the future. More specifically, demand and pricing for 8,400 BTU coal has strengthened significantly in recent quarters. With most of the infrastructure and some of the operating equipment already in place, Coal Creek is particularly well positioned to satisfy that demand.

We have signed multi-year contracts in the strengthening price environment for several million tons of Coal Creek coal over the last quarter or so. In addition, we have the flexibility in some of our existing PRB contracts to ship from either Black Thunder or Coal Creek, depending upon market conditions. As a result, we have a good base load of contracts at Coal Creek and, just as importantly, a significant unpriced position that provides good exposure to market condition.

Clearly, rail service has been a challenge in the PRB in recent quarters. However, the principle issue of late has been ongoing maintenance, as well as congestion in the southern most portion of the basin. Coal Creek is located north of that area. And we have posted it on the map in the investor section of our web site a map for those of you who are interested. Another way to think about Coal Creek is, that it adds a third load out for trains destined for Arch's operations.

Both the UP and the BNSF have assured us that the additional volumes of Coal Creek will be a non-issue in terms of overall rail performance. In fact, to be fair, we have seen a significant improvement in service across the entire basin in recent weeks, a trend that we certainly hope will continue. Another significant advantage for the Coal Creek mine is its reserve base, which currently totals approximately 240 million tons. If you are familiar with the PRB, you know that the mines in that region began mining on the eastern edge of the basin, where the coal is closest to the surface and the stripping ratios are the lowest.

Coal Creek is no exception. However, since the operations began at Coal Creek in 1982, the mine has produced only about 50 million tons. As a result, the geology of the mine is extremely favorable relative to the other existing mines in the area, with an initial stripping ratio expected to be less than 2.0 to 1. That should translate into a highly competitive cost structure.

Preparation for Coal Creek's restart is already in full swing. In September we began moving a dragline to the site from our former Southern Wyoming operations. That move is almost complete and we are in the process of refurbishing and re-erecting machines. In total, we plan to invest approximately $50 million to restart the mines. All of the necessary mobile equipment is either onsite or has been ordered with delivery expected throughout the year.

We expect to be operating at the targeted annualized production levels of approximately 15 million tons by the start of 2007 with the flexibility to increase that production by 3 to 5 million tons above that level if and when market conditions warrant. I might also note that we recently secured a permit to increase the air quality and the production at Coal Creek to 25 million tons per year, giving us additional long-term flexibility.

Now let's turn our attention to the strategic restructuring of our Central Appalachian operation. As previously noted, Arch completed the sale of three of its operating subsidiaries in Central Appalachia on December 31, 2005. That transaction has changed the Company in several fundamental ways. First, it sharpens our focus, reflecting the decision to concentrate on a select group of operations in Central Appalachia that we believe can provide a real and sustainable competitive cost and operating advantage over time.

The Mountain Laurel complex, which is currently in development, exemplifies this strategy. We expect that upon the start up in the second half of 2007, Mountain Laurel will become the centerpiece of our operations in the region. Second, the transaction has transformed our balance sheet. Arch's legacy liabilities, which we define as post retirement medical, workers' compensation, and reclamation stood at $285.5 million on December 31, 2005. Of that amount, approximately $177.4 million is reclamation related. We believe these very modest totals differentiate us from every other major U.S. coal company.

Third, the sale of these assets should translate into significantly stronger results for 2006. In 2005, Arch accrued costs of approximately $68.3 million associated with the various legacy liabilities at the divested operations. Furthermore, the operating margins at these operations including post retiree medical costs were a negative $2 to $3 in the fourth quarter of 2005. In 2006, we expect positive operating margins at our retained mines in Central Appalachia to average between $3 and $5 per ton for the full year. Another significant development is the ongoing progress to get the West Elk mine back online. As you will recall, the West Elk mine was idled in late October following the detection of combustion related gases there.

We've made excellent progress at the mine in recent weeks. We recovered the longwall equipment in early January and permanently shield the mined out area where the elevated readings were detected shortly thereafter. The first continuous miner section resumed operation in late January. And the second continuous miner section is expected to start up within the next few days. The longwall mining system is expected to resume operation around March 1. Arch has property and business interruption insurance and has filed an initial claim under those policies for the losses incurred in 2005. We anticipate additional claims will be followed this year as we complete the reopening of the mine.

While the longwall outage will have an impact on our first quarter results, we expect the resumption of operations at West Elk to be a very positive development for the remaining three quarters of 2006. In addition to the many accomplishments of 2005, we expect a continuing roll-off of legacy contracts to drive improved margins, earning and cash flow in 2006. Based on expected production over the next three years, Arch has unpriced volumes estimated at 20 to 25 million tons in 2006, 60 to 70 million tons in 2007, and 90 to 100 million tons in 2008.

Given current market conditions, the expirations of these contracts coupled with the Company's internal growth initiatives, should drive significant increases to Arch's revenues, operating margins, earnings, and cash flow. Arch currently expects to report earnings of between $3.50 to $4.25 per fully diluted share and adjusted EBITDA of between $550 and $610 million for the full year ended December 31, 2006, excluding insurance recoveries associated with recent events at West Elk.

Rail service and prevailing market conditions are expected to be key factors in determining Arch's actual performance within that range. As previously mentioned, the range above assumes a negative impact of $25 million at West Elk during the first quarter as the Company prepares for the March 1 restart of the longwall. Assuming that most of you when you run your models will pull out the impact of the West Elk in the first quarter or conversely count the insurance recovery as ordinary income later, we do believe that has implications for the indicated ranges above.

I will now turn the call over to Bob Messey for a further detailed discussion of our financial results for the fourth quarter and full-year. And then Bob and I would be very happy to take your questions. Bob?

Thanks, Steve.

Let's put some clarification on our forecasts. Earnings per share at 3.50 to 4.25, EBITDA 550 to 610. I want to make sure everybody understands that includes the $25 million first quarter estimated loss at West Elk, and excludes -- excludes any insurance recovery. Since insurance recoveries cannot be timed, we feel it's best to do that. And the exact estimate of the recovery will probably take considerable negotiation with our carriers.

From a CapEx clarification, a range of 525 million to 575. The majority of that is our maintenance CapEx with a midpoint of 250 million. We have the little federal lease payment in there of 125 million and then capacity additions of 185 million. Of that 185 million -- some Mountain Laurel, which includes the surface mine Spruce of 120 for '06. Coal Creek addition, which Steve talked about for 50 and the north lease at 15.

Our forecast for tons for 2006 is 140 to 150 million tons. This includes our organic additions. Unpriced tons, they appear not to have changed very much from our September 30 numbers, especially in the '07 and '08 area. They do reflect that deleting the Magnum operations and adding the Coal Creek unpriced tons. We did have some signings in the fourth quarter in contracts, from contracts in the PRB at market.

Income taxes, our forecast for incomes taxes is that we're currently an AMT payer. And we will be an AMT payer. And we suggest that you use 20% for the expense. Realization, we expect realization in 2006 to be 25 to 30% per ton higher than it was in '05. And that compares if we just take a look at '05 to '04 fourth quarter, 17% in the PRB, 24% in Western Bituminous and 17% in Central Appalachia. So our forward forecast is on average 25 to 30% price increase.

We expect our operating margins to improve greatly as well. '05 to '06 they should be up 130 to 140%. Looking at our PRB costs, our comparison of '05 to our '04 costs, they have risen. It's due to ratios and rails and you must, we should remember that the '04 numbers include a partial year of Triton, which had higher ratios when they were added to us.

Looking forward there, the '06 expected increase in costs is around 6% when we ignore sales sensitive costs for the revenue or realization increase. From a cap Central Appalachia standpoint, our costs will be going up in Central Appalachia with the properties that we have kept, approximately $3 to $4. And our margins are going to be up far better than they were last year to the $3 to $5 range.

If we were looking at apples to apples on those operations, we would assume the forward costs excluding sales sensitive to be somewhere around 3 to 7% on the retained operations. Looking at our balance sheet and always comment a little bit on inventories. Our tons in inventory ended the year at 16.2 million compared to 16.0 in '04. But from the third quarter we were up from 14.6 to 16.2, an increase of 1.6. All of that occurred in our Powder River Basin, Black Thunder mine.

Our ending inventory at Black Thunder was 14.6, compared to the third quarter of 12 million. So we were up 2.6 million. The inventories grew basically because of a lack of rail. Compared to '04, Black Thunder was 13.4, compared to the 14.6. Pit inventories, this is EITF 04-06 accounting per stripping costs et cetera. We anticipate an adjustment to the beginning equity in accordance with the pronouncement of around $42 million in the first quarter.

Legacy liabilities, going forward as a result of the Magnum transaction we now have as Steve said approximately $286 million of liabilities. The majority of those are reclamation, $177 million of it. Retiree health is 44 million. The remainder is traumatic workers' comp and Black Lung, which is 65 million. Probably more significant if we look forward at our expense, last year our retiree health care was $64 million expense. Our forecast is 10 million for the ensuing year of '06.

Last year's healthcare costs were 32 million, they'll be in cash paid out in -- not costs, but in cash compared to our forecast of only 3 million going forward. The discount rate on the 106 retiree health did drop for '06 to 5.8% from 6%. But this will have a minimal effect, and is included in our forward expense forecast of 10 million. The induced conversion of the preferred shares, the special dividend of 9.5 million was less than the net present value of the preferred dividends to call date. We're very pleased about getting that accomplished.

Tax credit for 2005 was basically a result of excess depletion. And why did it occur in the fourth quarter? We had excess depletion created during the year, but produced NOLs, which were reserved on an interim basis until we had these significant events in the fourth quarter. We were unable to recognize that benefit, but after those significant events we were able to receive that benefit in the fourth quarter. As I said before we are an AMT taxpayer of 20%.

We do have evaluation allowance on our deferred taxes. It's approximately the same as it was last year, 163 million compared to 164 million in '04. We do reserve 100% of our NOLs and AMT credits. How can we realize those credits? Well if there's a significant event that allows us to receive the benefit of those NOLs and AMTs that's when we will recognize that evaluation allowance credit. One last item, our contract lost reserve. Again, this was an accrual for retained contracts of which we no longer have the source for. This reserve basically covers our higher priced purchase tons to cover those contracts.

Steve, I believe I've covered everything I'd like. I turn it back to you.

Thank you Bob. Operator, we'd be prepared to take questions when you are ready.

Thank you, Mr. Leer.

[OPERATOR INSTRUCTIONS]

And our first question will come from David Khani with FBR Investment.

Yes, hi guys.

Hey, Dave.

Steve, you've given us sort of the demand picture for PRB, sort of a 20 to 25 million tons a year. Can you give us just sort of the supply side as well? Given that you guys are bringing some supply on it looks like some of your competitors are as well. And clearly '06 will be a catch up year for '05 delivery. So there's obviously pent up demand. But maybe you can give us a sense of what you think the supply side is going to do over the next several years.

Well again, I think everybody, and I can only really speak for Arch. But I'm presuming others might be doing the same. Everybody's working hard to meet the increasing demand. I'll refer to the rail side where they have projected, and this is the railroad talking publicly, where they have projected demand increases of 60 or 65 or 70 million tons in the PRB for 2006 and saying that they will struggle to meet that demand from a shipping perspective.

I think that's out there. We see it. Obviously we have just maybe not finished but we've gone through several months here of winter where it's been very mild. That's given everybody a bit of reprieve in the energy markets. But we are as optimistic or perhaps even more so as we look at stockpile levels, the overall economy, overall energy pricing, and supply demand. You can go through a quarter where the weather helps or hurts, but the fundamental demand picture is very, very high.

Was any of your move here to open up Coal Creek an ability to maybe give you more flexibility from a shipping side and hopefully capture some of the incremental demand before some of your competitors?

Well you always look at yourself vis-à-vis what you think that supply demand balance will be, which we have repeatedly said we will try to meet market demand. One of the things that entered the thinking as well is that we had a lot of customers coming to us. We've been out in the marketplace with Coal Creek for really several years when you get down to it talking to customers about it.

Another part of it is we looked at the congestion in the PRB from the rail maintenance perspective. The lines that were kind of north or, excuse me, the mines that were north of Reno junction ended up getting a lot of the diversions over the last year. And having a third major load out in the PRB to us makes some sense from supply demand balance perspective and from a shipping perspective.

And frankly, some of the middle mines and north of Gillette mines probably got some advantages in the last year as a result of the congestion in the southern lines. And we plan on taking advantage of that as well as they begin the maintenance period this coming year.

Great, one last question. What's the sulfur content of Coal Creek?

It's basically a 0.8 pounds. I mean it tends to be a little bit less actually from time to time. But 0.8 is a good number to use.

Okay, great. Thank you, very much.

And our next question will come from Daniel Roling with Merrill Lynch.

Thank you. Bob, if you could, the reserves that you put out for the tons that you no longer have sourced. Have you locked those tons up under contract or, is this reserve just an estimate of what the difference between the spot price that you anticipate paying and the delivered price?

100% locked contracts.

So these reserves will amortize off as the coal is delivered?

Yes, sir.

Okay. Thank you.

Up next we'll hear from David Gagliano with Credit Suisse.

Thanks. Just a quick question on the, Steve, on the incremental coal volumes out of the Powder River Basin, how much do you think the rails can actually move in 2006? I know you mentioned the 70 million. But what do you think they can actually do?

Oh, man. If I knew that answer, David, I'd be smarter than all of us probably. I think, and I'm going on what the rails have said, is that when you get in that 45, 50 million ton range incrementally they believe they can do that. Above that they get more and more challenged. And I'm really quoting statements or paraphrasing statements from both rails. And I have to go on what they're saying. We saw a slow start in the first week or so of this year. And then things appreciably picked up. And fair enough to the rails in the last 35 to 40 days they're operating very well right now. And we hope that continues.

But I look at it and the maintenance impacts that will begin in the spring and go through the summer of the joint line again will be there. We somewhat again going on what the rails have stated publicly think it'll be more like 50% of the impact of last year, the negative impact of last year. And we'll just have to see. But I think we will continue to see some challenges there to meet demand from a shipping perspective.

Okay, thanks. That's helpful.

And then just on Coal Creek for a second, how much, and I apologize if you already mentioned this. How much of the volumes for Coal Creek have you committed at this point say for '07 and '08?

We haven't said exactly and I'm probably not going to give you a real fine number. Previously we've said we've been looking for base contracts of about 50% of the production. And that continues to be our overall philosophy. But you have to recognize a piece of that is contracts that we can switch back and forth between Black Thunder and Coal Creek. And our view there is whichever product the customer demands the most or whichever gives us the highest netbacks for our shareholders, will be the one that we will ship from. So, we have the ability to really go back and forth. But the 50% number approximately is a way to think about that.

Okay. And then last question is the -- if you could just expand a little bit on what's going in the eastern operations? I know obviously there's a big mix in terms of shift moving forward. But I'm just wondering 22% year-over-year increase in costs in Q4 and 4% sequentially. I guess I'm just wondering if you could take us through a little bit more detail as to what happened there?

Well of course you have just a host of issues over the last year. And you've heard them many, many times before between the labor costs, steel costs, fuel costs, explosives costs, those rolled through the system. Up until really the last month or so of Q4 our Mingo Logan mine really didn't hit its numbers, but it's been running pretty well lately, so we had some issues there.

But it was -- there was no single cost item. I think what we're trying to send the message to as well as the mix changes with the sale of Magnum, really the rapid increase in costs that we saw over the 2004 year, excuse me, 2005 year really has appreciably slowed down. And we think we have our hands around it. And we're feeling pretty good about 2006. And again, a significant cost item, although it was reported separately in the past, has been the 106 charges, which really have been reduced substantial.

So we think that it's very well positioned moving forward and really our message I think is that what we saw in 2004 given the mine that we retained, given the hedging that we have in place, given what we're seeing in some of the other inputs, commodity inputs, that those cost increases have slowed down dramatically.

Okay, thanks very much.

All right, thanks.

Our next question will come from Raymond James' Jim Rollyson.

Good morning, gentlemen.

Hey, good morning.

Steve, just to go back on Coal Creek for a second. You presumably since this is a fairly new project, I mean you've been looking at it for a while but kind of ramped this up a little bit sooner. I'm guessing that what you do have locked in has been fairly recently signed. Which, I guess what I'm trying to get to is presumably the pricing is closer to what we've seen here in the last few months versus it's not something that you went out 6 or 9 or 12 months ago and contracted. So I'm guessing the pricing realization is just even from start up through '06 and '07 and '08 should be pretty strong for Coal Creek?

I think looking forward we'd certainly agree with that. Looking back there are some older contracts. They're not real old but some older contracts from Black Thunder that were signed as the market was ramping up that we have the ability to transfer in. And their net results is we may do that; we may not. It's whatever gives us the most margin. So there will be some of the, I'll call it the middle contracts probably assigned to Coal Creek. But we'll just have to see how the market conditions warrant.

Right. And just there's been a lot of volatility in the last four or five months in PRB prices. What's your take for the outlook on PRB pricing?

Well, it's still the most competitive BTU in the world whether it's at today's spot prices or spot prices of a month ago or two months ago. If you go back to the fourth quarter, we were having the some of the same discussion. We saw a little softness in the spot pricing indices in the fourth quarter in the PRB. It backed down. And then it went back up. Clearly the winter weather has lessened some demand, immediate demand here.

But as we look forward and if you do a bit of the macro analysis and you can put gas in at $8 or at $7, oil at $60, and the economy continuing to kind of clip along at somewhere around 3%. The coal demand continues to increase as we see as that 25 to 35 million tons a year of overall PRB demand.

And as the trains are getting better service our ability to obtain new customers in the East has I'll call it resurfaced. It becomes a possibility again. Where for a while the railroads were reluctant to take on new customers in the East the latter half of 2005 because of -- they needed to really get coal to their existing customers. So our view really hasn't changed. We have a patient view. Maybe we'll go through the remainder of the winter and hopefully get a little bit of cold weather here.

But as we move into the summer months, I think there's a lot of things that the market hasn't been able to build in yet as you take, again, the macro view of the serious safety initiatives that we're seeing in the deep mines in the East. I think hopefully we'll come out with some better safety practices. Historically when we've seen regulations dramatically change in the Eastern mines you've seen productivity get impacted. You've seen the overall production get impacted. That remains to be seen how this all works out. But that's probably a likely outcome.

So I mean, we're -- our view is today the Company is more competitively positioned with net, net, net, a lower aggressive cost structure moving forward and a supply demand position probably improved as we move through the summer more than our view a year ago. And there's some serious supply issues, East and West that remain out there.

Yes, I agree. Thanks.

Thank you.

Our next question will come from John Hill with Citigroup.

Thank you, very much. And good morning, everyone.

Good morning.

Just curious on the West Elk $33 million charge, is that just your out of pocket expense? Or is there some opportunity loss for sales and production that was not sold?

It's a combination. The fourth quarter charge was a combination of the firefighting, the expense of fighting, and all of that, which was in round numbers, was two-thirds of it. And the rest was lost sale opportunity.

And that would apply for the guidance in the first quarter there as well, same type of treatment?

Really more of that would move towards the opportunity. There are some costs in there as well. But we substantially, well we did get the fire combustion event in place in January. And a lot of those kind of expenses were eliminated by the end of January. And so really the February numbers would be more lost opportunity.

Understood. Great answer. Looking at Mountain Laurel where you've talked about costs coming in the low $30 range previously. Is that still a good number to use or should we be tacking on $2 or $3 there as we've seen elsewhere?

Again, we still think that's a good number. I would only caution there we would like to see the ultimate outcome of any additional regulations that the Eastern mines might have to handle. But in the scheme of Mountain Laurel at 5 million tons per year we don't think it'll be a big material number, whatever comes out. But that would be the only caveat I would add to that.

Very good. And then, if we could just revisit the subject that was asked previously about essentially Central Appalachian operating margins coming in from 246 to $0.24 in the quarter and then the guidance going ahead for $3 to $5 next year, understanding that excludes the service costs on the liability, et cetera. Can you just walk us through how we get from the $0.24 to the $3 to $5?

Yes. I'm not going to get into all the details. But a simple way to think about it is, we had a fair amount of contracts that were being serviced from those mines that were divested that were not only below market, but many of them were below cost. And as a result of the transaction we have been able to reserve, if you will, we bought Coal and reserved the losses there of $66 million. So that's a chunk of it. The 106 is a chunk of it. And our remaining mines for the most part are a higher quality coal.

We do see a bit higher cost of some of those mines but they're higher quality coal. So that coal both moves into the high quality steam market and to the bent market. So it's really all 30 pieces. But the contract piece is a significant piece of it. I always look at it when you have a contract under your costs it's kind of like getting hit twice. The market is wherever the market is and then you're absorbing the costs on top of it.

And there were some costs that were, excuse me, some contracts that were signed back in the late 90s that were in the mid to low 20s that were pretty disastrous. And it's great to have those behind us.

Great. Thanks for the perspective.

Thank you.

[OPERATOR INSTRUCTIONS]

And from Morgan Stanley we'll hear from Wayne Atwell.

Thank you.

Could you tell us when the next auction is of reserves in the PRB range? And are you contemplating going into Wyoming not Wyoming, Montana at all? Is that an area where you might spend some money or develop a property?

The last part first, Wayne. And is that we always kind of look. And we've looked before in Montana.

It's my view that you will see the Southern Wyoming, which are the mines both north and south of Gillette get fully loaded and developed before you see the real significant competitive developments in Montana. But eventually that will curve. And I would anticipate that we will be very serious whether we see that going on. But I still think that's some years out.

The next reserve auction, I'm not sure when it is off the top of my head. They're kind of a [constant train]. And they're handing me a note here. From an Arch perspective there's probably nothing, well again, I'm not sure there's anything for the next year or two for anybody out there that's coming up that I'm aware of.

Let me play devils' advocate, why wouldn't you look at Montana pretty hard right now? My understanding is reserves are very cheap. The economics should be very attractive. The BTU content's very high. The issue, which you'll probably bring up and I certainly agree with, is rail access. Is rail access a big enough hurdle that this really should go on the back burner? Or, is this something that should move to the front burner?

I think there's -- rail access is a huge hurdle. And it's a very long-term answer. I may disagree with your characterization on reserves are cheap up there. We have had discussions with various reserve holdings, private holders, and we haven't come to that conclusion that they're cheap. You also have to look at the sodium content of Montana, which is for the most part much higher than Powder River Basin, which limits some of the market.

And we have studied it very, very hard since the late 90s. Have periodically had discussions with private landowners up there. And then the federal government obviously would do it through their leasing. I'm not saying we won't be there at all and that we don't look at it as a long-term future development, because we do believe it will be developed. But I do believe it's long-term. And the rail is an issue.

Thank you.

Thank you.

Our next question will come from Pearce Hammond with Simmons and Company International.

Good morning.

Good morning, Pearce.

Just a few questions here. As far as the realizations in the Western Bit and the drop Q4 over Q3, what can explain that?

Colorado was the higher realization. And Utah is lower realization. And it's basically the majority of the coal in the fourth quarter was Utah.

Okay. And as we look out in '06, what's going to be your steam in coke and coal mix in Central App?

Again, on Central App traditionally we've sold I'll call it 2 to 4 million tons of metallurgical coal. We can take that number a bit higher if, and even higher once Mountain Laurel starts up. And just really what we look at is overall margin. I would think we would still stay in that 2 to 4 million-ton range for 2006. Although if the market would allow us to have a greater margin for the ultimate coal we can take that up a million or 2 tons if the market allows it.

And then on Coal Creek, and you had mentioned this before regarding sort of the optionality in these contracts at Black Thunder and the ability to shift some of this contracted volume over to Coal Creek. If Coal Creek initially is supposed to come fully say 15 million tons, what amount of tons have that flexibility on the contract? And can you just give a little more color on this optionality?

Again, it's probably half that number as -- you could view as optionality and maybe even a bit more if we so chose. And it really will be driven by market demands for the 2 BTU contents and which customers want which. And we will always look at what's best for our shareholders as a result. I would guess that we'll some switching but not 100%.

So is Coal Creek coming on in '06 because of new contracts with utilities or because of its optionality? Which one's driving it more for bringing it on this year?

Really it's a new contract; new demand out there that's driving it. Our overall PRB demand might be the best way to view it as driving it. And the fact that we have signed some contracts for Coal Creek that can begin delivery in late 2006, '07 timeframe really wasn't the driver. It's the overall demand for the coal.

And then what we looked at is it's an opportunity to free up Black Thunder coal, which does have a better sulfur performance, does have obviously a higher BTU. And I don't want to diminish that third loadout, because we see that as important.

Sure. And just one last question, a large truck tire situation, is '06 going to be the worst year of it or is it '07?

As we look at '06 we think we're in pretty good shape. We've got on it early; really back in '05 even late '04. And we don't see it as an issue for Arch in '06. As we move into '07 we think we're okay. It will be tighter in '07. And we really think '07 could be the tightest year for the industry. But it depends how quickly some of the announced expansions or additions at the tire manufacturers get up and running. But right now I characterize tires as an issue to watch, but they're not a problem for us.

Thank you.

[OPERATOR INSTRUCTIONS]

And our next question will come from Justine Fisher with Goldman Sachs.

Hi. The first question I have is just to clarify what the outlook is for Central Appalachia next year. I was wondering if first of all you could give us just a round about estimate of what the tonnage is going to look like for '06?

And then second of all, my understanding, and please correct me if I'm wrong, but my understanding when you guys first announced the mines that you'd be getting rid of in the Magnum transaction were that they were sort of the lower revenue producing and higher cost mines. But then I think you said that you expect Central App costs per ton to be up next year. So could you sort of walk us through that as well please?

Sure. Again, round numbers we're kind of in that 16 to 18 million tons of total production in east our Central Appalachia on our retained operations. The operations that we sold last year produced approximately 12 million tons. As we begin to ramp up the development of Mountain Laurel you'll start seeing some of those tons show up late in the year and the longwall start to fit in the latter half of 2007. And that adds about 5 million tons.

But you have Mingo Logan backing off in 2007 as well. So the net increase there might be 2.5 or 3 million tons between those two operations. In terms of cost, I guess and revenues they both are right in terms of the divested operation. They were servicing many of our lowest priced contracts. We have written those contracts off and the nerve begins some.

And so in that regard, not again, not only were they below market substantially but really a substantial portion of them were below actual costs. The mines that we sold really their cost performance, I mean they were large surface mines. They were reasonably good cost performance mines on a relative basis for Central Appalachia. So they weren't our highest cost mines. But they produced a lower quality coal and they were servicing our lowest priced contracts. So it's kind of half right on both of them.

So the margin benefit will basically be from the higher revenues per ton not necessarily on the lower operating cost per ton?

Yes. We expect the cost increases to moderate substantially as we look at 2006. And the real issue as the margins expand dramatically due to higher quality coal and being done with the low priced contracts.

Okay. And then the other question I had was just to confirm or to I guess dig a bit deeper into what the impact of West Elk will be in the first quarter? If it was on a total dollar basis, 33 million in the fourth and you said 25 million in the first. You said in the fourth on a per ton basis it was $5, which accounts for the over $20 operating cost per ton. Is it going to be I guess $4 per ton in the first quarter?

I haven't thought of it about that way. But it's basically linear. So I'd think you'd have to think through that $25 million would have a similar impact. So it'd be 25 over 33 times 5.

Okay. And so, I guess if you just add times 5, then I'm assuming that the production level is going to go up from the 4.2 million tons that it was in the fourth quarter.

That's all of West.

Oh, from the West. Yes, we would anticipate, we'll be producing coal. We are producing coal right now, which from the October 28 event we didn't produce any coal really. So we're producing coal with our continuous miners right now. One's operating and one should start hopefully in the next 48, the second one should start in the next 48 hours.

And then the longwall we would expect a few days of ramp up issues, which always occur when you start a longwall. But within the first week we really did expect to be in full production. So the mine would be back at its annualized rate of approximately 7 million tons a year.

Okay. And then the last question I have is just as far as free cash flow is concerned and the flexibility of the CapEx number. It's obviously increased since the last time you gave CapEx guidance, and I know you know a lot of it goes to Coal Creek and Middle Thunder.

But how flexible is that CapEx number? And if you see that the rails are not being able to ship as much coal as you would expect out of the PRB, is there flexibility to ramp down that CapEx if you don't think you'd be able to move the coal? Or, are there other flexible parts of it?

Well a piece of it's always flexible because it is spent over a period of the whole year. But as we see it, a substantial piece of it's going to the Little Thunder lease, which obviously isn't flexible unless we wanted to abandon the lease, which I would not recommend.

Then you have the Mountain Laurel project again, which really argue is we'd rather speed it up than slow it down. And then you do have the 50 million of Coal Creek expansion, which I guess in the latter second quarter we can slow down. But we see no reasons to do that. There's always some flexibility in there. And as the year develops we will redirect some. And historically we've tended to be a little bit under whatever our projections are on capital. But the marketplace is pretty robust.

And the maintenance capital of kind of 200 to [2.25] again, our view of that is when we describe maintenance capital it really means that we're replacing equipment on our current replacement cycles. And we're replacing it with the latest and best model. If there were a downturn or an issue that would occur, which let me emphasize we don't expect one, you always have the opportunity to stretch some lives to maybe buy refurbished equipment.

And that's not how Arch typically does business. But those opportunities always exist. And if necessary we would do so. I think from a competitive standpoint some of the other steps we took in the fourth quarter on lowering the liability costs, the actual expenses. If the business cycle returns in two or three years it puts in a great position, vis-à-vis many of our competitors.

We'll now take our next question from Stifel Nicolaus' Paul Forward.

Thanks.

Guys, we've seen a pretty strong negative move here just weather related or whatever it is in the SO2 allowance pricing just over the past month or so. I was just wondering, how sensitive are your PRB average price realizations in 2006 to let's say a $100 move one way or the other in SO2 allowance pricing?

Paul, we're generally not going to give that detailed. But let me say this. In the guidance that we gave, if you look at pricing of coal, uncommitted coal pricing, the SO2 allowances in the cost structure. We're basically kind of within the range of the current spot market. And so we think we've taken a reasoned look at it. And you're right; it has pulled off here recently for SO2.

I think if we look back at a year ago it was below where we are today. We certainly have folks out there forecasting it'll go much higher. Some are saying that it's kind of in the range we are today. We try to be, the lawyers don't like me to use the word conservative, but we try to be realistic as we look at those prices.

Okay. I guess also just following up on something you said earlier. I think it was you talked about plus 25 to 30% price realizations in '06. Is that a fairly consistent number across the regions?

Across, you mean all our mines?

Well if you look at Central App, PRB, Western Bituminous. Within those regions do you see a plus 25 to 30% number in each of those regions in '06 versus '05?

I think you're basically going to see a greater, Paul, increase in the PRB and Western Bit than you're going to see in Central Appalachia, because the Central Appalachia prices have gone up previously.

Right.

So we're not going to give you the detail of each region. But that's how it was set up.

All right. That's about as expected.

Paul and I'll add a little bit to that on more of a cost side. As Bob was going through his costs, I mean one of the things we've seen in the West particularly obviously West Elk impacted costs this last quarter and will the first quarter.

But for the most part, particularly in the PRB but in the West as a whole, the costs have been pretty stable if you back out the sales related costs, which are 28 to 30% of the price. And then we did have volume metric increase that we haven't -- impacts that we haven't talked about where we didn't ship 2 to 3 million tons out of the PRB and obviously the West Elk impact. If you back those out, we're real impressed with our, the guys' abilities at the mine of they've handled costs in the West.

All right. And I guess lastly we've seen some pretty strong coal production numbers both east and west. I know about the PRB, but can you maybe comment on Eastern volumes year to date being up 5%? Is that just weather or is there, can you comment on why the shipments have been up pretty well so far?

I think it's weather and the railroads have been running pretty well in the East as well. And there are -- to my knowledge there are a couple of mines that have had some production problems. Obviously you have where the two disasters, those mines are shut down. But I think it's more of a perhaps some easy comparison from a year ago. And the weather, good weather does help particularly surface mines.

Right. Okay, thanks.

Thanks.

Our next question will come from JP Morgan, John Bridges.

Hi, Steve, John Bridges.

Hey, John.

I'd like to congratulate you first on the structural changes you've been making. I think those are great for the longer term.

Well, thank you.

And then I wonder if you -- a bit of bookkeeping really. If you could point us to where you put some of these charges that you list on the front page. Perhaps Bob could --?

Yes, Bob might help you. We had so many things going on this last quarter it was a marathon.

It was a bit confusing, yes.

Do you have a specific question on the charges?

The 33 million --.

That's in cost of coal sales, John.

The charge of the legal settlement, 16 million.

That's in other expenses.

$5 million associated with establishment of a new charitable foundation?

SG&A.

4.5 related to stock raised incentive, oh that's G&A I presume.

Yes, yes.

And then for the, just wondered with Spruce, how are you getting along with that one?

It's going along very, very, very well. Actually we have John Eaves, our COO sitting in here listening to the call. And he was just at the mines, so I might let him comment on them.

Yes, I mean the process is going very well. We hopefully will have a permit in hand later this year. And hope we can get started on the development. But we're excited about it.

We do hear that the permitting prices is becoming more manageable in Central App. I wonder if you could sort of detail that a little bit.

It is. I mean I think historically we've looked at three to five years from start to finish in getting a permit. And I think that's gone down significantly where you're probably -- a couple of years now. So, we feel real good about where we are in this process on the Spruce permit. And really all our other properties we're in very good shape on the permitting process. So, we don't really expect any negative impacts on permitting this year in the East.

Okay, great. Okay good luck, guys. Thanks for that.

Thank you.

Our next question will come from Bear Stearns, that's Michael Dudas.

Good morning, gentlemen.

Well it's afternoon your time, right?

Exactly. Thank you. Two quick questions, first Steve can you remind us back in mid 2000 when you decided to shut down Coal Creek what the capacity production levels were? What was the price of that type of coal back then? And how much in the last seven years will have the cross structure increased at that mine, obviously being more offset by the market price?

Boy, I'm speculating a bit here. But I think the pricing was back $3, $4. I mean it was maybe the high 3s was probably; it was pretty ugly. As far as a cost structure, there's certainly been some general inflationary issues. It's a little hard to compare because we had a contract miner back then and we’re really opening it as our own employees today.

So there was a higher cost structure back then that maybe we would have had, had we had all our own employees in there. And that's a debatable issue. But we would expect it to be up $1 or 2 on cash costs. Obviously sales sensitive costs with the spot market would indicate it's much, much higher than let's call it $3.89 for 2000.

Mike, the volume then was between 10 and 12 million tons. But it had been at that level only a very short period of time. Really for most of its history prior to that, there was a minimal amount of tonnage being produced, 2 to 3 million tons typically just to keep the (indiscernible) on.

Very good. My second follow up is, Steve you mentioned in some of your remarks on some of the questions this morning about some of the issues in Central App and safety. And you seemed to suggest that there could be regulation or things put forth in the mining industry that could cause costs to increase. And I just want to say, is that significant? Is that across the board? Do you think it'll be for underground and surface?

And what are some of the things that really can be done to significantly increase the safety that would make the regulators and politicians comfortable with some of those efforts? And how costly could it actually be?

One, it's very hard to get your arms around that. Let me state that we're supportive of improving safety. And Arch has always taken a very serious value that we promote and our numbers. If you'll look up a 0.88 on 200,000 man-hours for lost time injuries, you'll find that in American industry that's among the best. It doesn't matter what industry you want to look at.

Having said all that, one is there has already been legislation proposed. There's been legislation signed in West Virginia. Most of the other coal producing states, particularly in the East, are proposing similar legislation. We think it would be better if it's done at the federal level only in the sense that you don't get conflicting issues or varying regulations at the state level.

What's being proposed, some of those things I think are positive, things like lifelines, additional caches of SCRs make sense to me. We have been using the PED devices in our Western mines, which are communication devices. We have found at least on our preliminary evaluations a year or older where in the lower seam mines in the East the radio signals don't work as well. And we hope technology comes out of that.

I think you will see some millions of dollars at each major mine being spent on those kind of devices, those kind of additional SCRs. Where we go from there and the regulations it's hard to get your arms around until we really define the regulations.

We went back and did a study on some of the major legislation that has passed over the years on the mines. And you try to evaluate what it did to productivity, what it did to costs. And it's hard to get a real rule of thumb other than traditionally it seems that it took some years for the mines to adjust and productivity went down but safety went up so it's a good thing.

I mean Mine Safety and Health Act in 1969 clearly works. And we would expect that to develop over the coming year. But first the regulations have to be passed. And see what they are. And we hope they're just good sound thinking. And frankly, we hope some really good technology comes out of it. We are 100% behind that.

And we'll now take our final question from Ian Synnott with Natexis.

Yes, hi. Thanks. One quick question on the post retirement medical expense in the fourth quarter that 16.9 million. Is that mostly in Central Appalachia or what's it kind of spread across the regions?

Well, it's mainly in Central Appalachia.

Great. Great. And then another question, just thinking kind of follow up on the Coal Creek. You have some flexibility there that you've spoken about. Now those tons because this is your 0.8 pound product you're going to pick up a little less SO2 premium, right, then you would have on the Black Thunder mine. Is that the correct way to be thinking about it?

That's the correct way to be thinking about it. And if you think true, various customers, some customers value sulfur, lower sulfur higher, or at a greater value, than some other customers. So hopefully, we can appropriately meet the customers' requirement and wants with the right product.

Right. Certainly and deliverability is going to be almost more important, right?

Right. And that's, as I said, is a critical piece of our thinking and having a third load out is good.

Great. Great. Now, thank you very much.

Thank you.

And that does conclude our question and answer session. I would now like to turn the call back over to Mr. Steve Leer for any closing remarks.

Thank you. Let me just close by reiterating one or two points. The first is that from a safety perspective, Arch is committed to maintaining record performance. We take it very seriously, as I know does the rest of the industry.

Secondly, we look at the fourth quarter and I personally looked at the fourth quarter as a strategically defining quarter that really positions the Company moving forward to aggressively compete for really any and all business. It lowers our cost structure. There's no one that has a balance sheet that looks like ours, if you look at the total liability side of the equation. And it really is again a strategically defining position.

As we move forward we think that 2006 is in the first month is shaping up to be very positive. The rails are performing at levels that they said they would. And they publicly stated and that's great. So I think, to go back to my Valvoline days, we have the car trimmed out to go very, very fast. And that's what we did in the fourth quarter. Thank you.

That does conclude our teleconference for today. We'd like to thank everyone for your participation. And have a wonderful day.