Arch Resources Inc (ARCH) 2006 Q3 法說會逐字稿

Good day, everyone. and welcome to this Arch Coal Incorporated third quarter 2006 earnings release conference call. 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 Chairman and Chief Executive Officer, John Eaves, Arch's President and Chief Operating Officer, and Bob Messey, our Senior Vice President and CFO. Steve, John and Bob will begin with formal remarks and thereafter, we'll be happy to take your questions.

Steve?

Thank you, Deck. Good morning and welcome to the call. I will spend the next few moments addressing highlights from the recent quarter and the first nine months of the year, and provide some commentary on current market conditions and Arch's outlook for coal markets going forward. John Eaves will then discuss Arch's operating performance, and Bob Messey will conclude by commenting on our recent financial performance and expectations for the full-year 2006.

Earlier this morning, Arch Coal reported solid financial results for its third quarter ended September 30. Fully-diluted earnings per share increased by 169% to $0.35 from $0.13 for the prior year period. Net income rose to $51 million compared to $19 million in the third quarter of last year. And Arch more than doubled its operating income during the quarter just ended.

For the first fine months of the year, Arch reported fully-diluted earnings per share of $1.25 compared to $0.19 in the prior-years period. Net income rose to $181 million and operating income increased more than three-fold for the first nine months of 2006.

In short, it was a solid operating performance, despite a weaker market environment. Looking ahead, Arch remains focused on achieving continued margin expansion from the roll off of lower-price legacy sales contract, on taking a strategic view of the market and on optimizing operational execution. We are committed to managing the principal drivers of our business in such a way as to create shareholder value during the long-term.

During the quarter, Arch made several strategic investments that we believe will benefit the Company in years to come. In August, Arch announced that it acquired 33% equity interest in Nighthawk Coal, a growing coal producer in the Illinois basin, in exchange for $15 million in cash and approximately 30 million tons of coal reserves. This investment supplements Arch's current 230 million ton reserve position in Illinois.

As a result of this transaction, Arch recognized a $10.3 million gain in income from operations due to the unrealized value of the coal reserves transferred. Given the outlook for the future coal demand, we expect the Illinois basin coal to play an increasingly important role in domestic energy markets, particularly as we move into the end of this decade. We view the Nighthawk transaction as the first step for Arch to re-enter this region in an active way. We expect the transaction to be accretive to earnings and to create meaningful value for our shareholders.

During the quarter, Arch also announced that it acquired a 25% equity interest in DKRW Advanced Fuels, a developer of coal-to-liquid facilities. In exchange for this interest, Arch agreed to extend an existing option agreement with DKRW Advanced Fuels on our Carbon Basin reserves in Wyoming and to contribute $25 million in cash and to cooperate with the company to identify coal reserves for two additional CTL facilities outside of the Carbon Basin.

The current Medicine Bowl CTL project with DKRW Advanced Fuels is being planned as a mine mouth facility that will use coal from Arch's Carbon Basin reserves as seed stock. The project already has licenses in place from the leading technology providers, as well as a site with a nearby access to a liquid pipeline network that supplies a large refined products market.

In addition, DKRW Advanced Fuels has signed a letter of intent with a regional oil and gas producer that plans to use the carbon dioxide generated by the facility for enhanced oil recovery. We believe our partnership with DKRW Advanced Fuels will allow Arch to play a formative role in the emerging CTL industry as a coal supplier and, as well, as an equity participant.

Arch announced in September that the board of directors had authorized a share buyback program of up to 14 million shares of its common stock. Arch began repurchasing its stock at the end of the third quarter and Bob will provide additional details on this program later in the call.

On the marketing front, Arch continues to take a patient approach to its sales contractoring -- contracting layering in near-term sales while maintaining a significant unpriced position in the future. During the quarter, we signed selective commitments in each of our operating region for prices that are significantly higher than current real-life prices. In the PRB, we committed approximately 4.7 million tons of coal for delivery, principally in 2007, at prices more than 25% higher than our price realizations for this region in the third quarter just ended.

In the Western Bituminous region, we signed commitments for approximately 1.6 million tons of coal for delivery through 2010 at prices more than 50% higher than our average realized price in that region for the third quarter of 2006. In Central Appalachia, we signed commitments for approximately 4.9 million tons of coal for delivery over the next two years at prices close to 10% above the region's average real-life price in the quarter just ended.

Paced on our recently-signed commitments and the revisions to our production targets that I will discuss shortly, Arch has an unpriced volumes for 2007 of approximately 35 to 45 million tons and 80 to 90 million tons in 2008. It is also important to point out that some of the coal we shipped during the third quarter was priced when coal markets were less attractive than they are today.

As a result of ongoing legacy contract explorations, we should have a positive impact on our bottom line in the future, despite today's near-term market condition. Arch believes strongly in the near term -- Arch believes strongly in the long-term fundamentals of the U.S. coal market. As we look back, the last year has been a bit of an anomaly. Despite a growing U.S. economy which typically benefits electric power demand, Arch estimates that compared to last year, coal consumption for power generation was down approximately 1% through September, due to milder weather, increased nuclear utilization, and increased precipitation in the hydro region.

These same factors have contributed to a record high natural gas storage level, reduced natural gas prices despite another year of lower production in North America. Arch estimates that the natural gas overhang led to some coal pile stock conservation efforts at power generators earlier this year and further contributed to the lackluster demand for coal.

Currently, power generators have an estimated 42 day supply of coal inventory on hand, which is generally in line with the five-year average. Coal production was up an estimated 2.7% year to date through September based on revised MSHA and EIA estimates, after three consecutive years in which consumption has outpaced supply. Arch believes that a reversal of one or more of these near-term pressures could change the current outlook for coal over the next few quarters. A normal to cold winter, the commencement of the recycling -- excuse me, the refuel cycles of the nuclear plants, and a more normal year-over-year hydroperformance could all contribute to increased electric generation demand for coal in 2007.

It is worth noting that this morning, the nuclear regulatory commission reported that, as of this morning, October 20th, the nuclear plants were at their lowest points in capacity utilization in the last four years, at approximately 71.8% as they are going through their refueling cycles. Furthermore, the serious cost pressures on Central Appalachian production, as evidenced by the recent announcements regarding the elimination of high cost production, could clearly impact ongoing production moving forward.

In contrast, Arch sees a number of positive influences that could support a continued long-term growth cycle for coal. Demand growth for new coal fired fuel -- new coal fueled plants represents a major driver in the favorable long-term outlook for coal.

Announcements have reached more than 90 gigawatts today, equating to more than 300 million tons of annual new demand and representing close to 30% of coal's current installed generation base. We expect at least 15 gigawatts translating into nearly 60 million tons of coal demand to come on-line by 2010.

Another 15 gigawatts of capacity is believed to be in the earlier stages of development that is currently slated to come on-line by 2010, as well. This is on top of the steady increases in capacity utilization at existing coal generators. Additionally, the strengthening outlook for the advancement of BTU conversion technologies, such as coal to gas and coal to liquids, remains a favorable long-term development for the industry.

While the intermediate and long-term outlook is very favorable, Arch is taking steps to better match our current production with current demand in the near term. Arch has invested significant time and energy in recent years to increase the flexibility of our mining operations. As such, when the market demand dictates it, we believe we can operate our mines very productively and profitably at reduced production levels, despite the relatively high fixed cost nature of the mining business.

Consequently, we are lowering our production targets for the fourth quarter of 2006 by three million tons and for the full year of 2007 by approximately ten million tons. In summary, given our size, diverse asset portfolio, skilled work force and low-cost operations, Arch expects to benefit from the demand growth stemming from the existing coal plant, new coal fuel capacity and BTU conversion technology. Furthermore, Arch is committed to making the right business decisions in the near term, given current market condition,s in order to obtain the upside potential for the long term.

With that, I will now turn the call over to our President and COO, John Eaves, for further discussion of our operational performance during the quarter. John?

Thanks, Steve. Our mining operations delivered a solid performance during the third quarter. Consolidated operating margin increased to $2.60 per ton versus $1.40 per ton in the third quarter of last year. Our average price realization for each operating region increased meaningfully on a year-over-year basis, benefiting from the roll-off of lower price sales contracts.

We managed our cost-effectively in both the PRB and Central APP operating regions, and as expected, costs in the Western BIT were impacted by the longwall moves during the quarter. We have added key personnel to our skilled work force to strengthen our competitive position within the industry.

We continue to make progress on initiatives that should boost our productivity and control costs at our operations. And we have won awards in key areas, such as safety, corporate citizenship and innovation. In short, Arch continued to build upon its strong performance in the first half of 2006.

First, I would like to highlight the major awards our operations have won this quarter. Arch's Skyline Mine in Utah was recognized by MSHA as the nation's safest underground coal mine in 2005. Skyline employees worked more than 28 months and 500,000 employee hours without a single report of a lost time injury.

In addition, our operations have been recognized for excellent safety performances six times at the national or state level during the third quarter. This recognition demonstrates Arch's commitment to the industry's safest coal mines. Safety is one of our core values at Arch, one that we constantly strive to improve.

Additionally, Arch Coal's Black Thunder mine in Wyoming earned the U.S. Department of Interiors national good neighbor award for its strong community involvement, including its quick response to the destruction caused by the tornado and its aftermath in nearby Wright, Wyoming, last year. This award demonstrates the value that Arch places on being a good corporate citizen.

Lastly, Arch earned a spot on the 2006 Information Week 500 list for its leadership in eCommerce process improvements and key strategic efforts. This ranking further reinforces Arch's smart application of information technology, not only among our peers but across all enterprises.

Arch is also proud of its accomplishments in the process improvement area, as we continue to focus on initiatives designed to optimize our operational execution. Second, I would like to mention several key additions that Arch has made to our talented work force.

Jennifer Johnson has been named president of Arch Energy Resources and will be responsible for developing and implementing a corporate strategy for revenue risk management optimization of Arch's annual coal supply. We're pleased to have Jennifer on board as Arch looks for ways to optimize its revenue and margin streams, develop strategies to minimize overall risk and leverage market information obtained through the trading to benefit our operations.

Additionally, Larry Metzroth has been named Vice President of analysis and strategy and will be responsible for providing Arch with a global economic and energy market intelligence. Larry has more than two decades of experience in strategic analysis for the energy industry and will allow us to further ratchet up our performance in this area and achieve a new level of expertise in analyzing our business as well as a competitiveness in both the domestic and international market places. Larry and his team will be key contributors in developing and influencing Arch's marketing, trading and business development strategies, going forward.

Moving to our operational performance during the quarter, consolidated results were impacted by the divestiture of some of our Central APP operations at the end of 2005. Comparing our results to the second quarter of 2006, we did experience some erosion in our consolidated average price realization. Our consolidated average price for all tons during the third quarter declined to $16.31 per ton, compared to $16.78 per ton during the second quarter.

That decrease is primarily attributable to lower PRB pricing obtained on market index price tons, which reset at generally weaker market pricing. Also, operating cost increase from $13.11 per ton during the second quarter to $13.71 per ton during the third quarter. Major drivers of increased operating cost included three scheduled longwall moves, one of which was extended, as well as mixed western rail service. Consequently, operating margins across all of our tons declined relative to the strong levels we achieved in the second quarter of 2006.

Looking at our operating performance by basin, Arch experienced meaningful expansion in pricing realization and operating margins across all its operating regions when compared with the same time last year. That being said, I do want to spend a moment discussing the trends in the regional results when comparing our third quarter performance to the second quarter of 2006.

Price realizations at our PRB operations declined $0.94 per ton compared to the second quarter 2006, driven by lower realizations on tons indexed to market prices, as well as lower realization attained on our Coal Creek tons, which represented a greater percentage of our mix this quarter. Operating cost in the PRB have remained quite steady, a testament to our ability to manage our controllable costs and offset any cost pressures with process improvement initiatives.

This cost management was particularly impressive, given the rail service issues experienced during the quarter, as well as the start-up cost at Coal Creek in anticipation of the drag line coming on-line shortly. While cost had been favorable at Coal Creek based on its current status as a mobile equipment operator, we expect further improvement when the drag line comes on-line. Furthermore, the addition of the third track and supporting infrastructure to the section of the joint line south of Reno Junction is beneficial for our Black Thunder mine going forward, as it should help to achieve an even greater level of operational efficiency. That project is slated for completion by the end of October.

In our Western Bituminous regions, volumes declined the third quarter 2006 due to the scheduled longwall moves, while average price realizations rose substantially, up $2.14 per ton versus the second quarter of 2006. As in the first and second quarters of 2006, our regional cost performance benefited from a $10 million insurance recovery associated with the outage of West Elk longwall in late 2005 and early 2006.

However, operating costs were up still yet in the third quarter 2006 compared with the second, largely driven by the scheduled longwall moves, including the extended move at our Dugout Canyon mine in Utah. In total, the Dugout move took more than 30 days, whereas a more typical move in western bit operations would be 10 to 14 days.

While the goal of any longwall mine is to keep the development process ahead of the longwall's advance, there are times when that cushion is reduced. And in this instance, there were two factors that eroded that cushion. First, we had achieved very rapid rates of longwall advancement in the previous panel, which benefited production but still led to the erosion of the cushion.

Second, we had encountered a slower going in the development work as a result of some tougher geology. Going forward, we expect and are currently achieving solid productivity levels for the longwall in the current panel. We're also achieving a return to normal productivity levels for the continuous miner units. As a result, we expect the next panel to be developed and ready well in advance of the longwall move at Dugout, which should occur in the second quarter of 2007.

In our Central APP region, we achieved solid operating performance, as our average price realizations rose to more than $50 per ton in the third quarter 2006 compared to $48.55 in the second quarter. This is thanks to the roll-off of lower price contracts and favorable contract mix. Operating cost increased slightly, reflecting higher sales sensitive costs and higher operating costs in our Mingo Logan operation.

As Mingo Logan nears the end of its life, we look forward to our Mountain Laurel operation replacing that production from the depleted Mingo Logan operation. We expect this transition to result in a lower operating cost at our Central APP operations. Additionally, operating margins was $4.15 in the third quarter, well in line with our overall guidance of $3 to $5 per ton for the expected average Central APP operating margin in 2006. We believe these results validate the rationale for strategic restructuring of our Central APP operations at the end of 2005.

Looking ahead, we continue to remain focussed on achieving further gains in operational execution going forward. We have extremely talented and dedicated work force at all of our mines and they're truly embracing the concept of continuous improvement, safe production and environmental compliance.

With that, I will now turn the call over to our CFO, Bob Messey, who will provide additional color on financial results, as well as some insight on our expectations for the full year. Bob?

Thanks, John. Good morning, everyone. I'd like to recap a few of the highlights that Steve and John have already touched upon, and then discuss key initiatives completed during the most recent quarter. We're pleased to report ongoing positive financial results.

We had increased income levels and earnings per share for both the third quarter and for the first nine months of 2006. Income from operations, more than doubled in the third quarter of 2006, reaching $82 million compared to $34 million in the prior year period.

For the first nine months of 2006, we had more than a three-fold increase in income from operations, from $82 million to $276 million. We recorded net income of $51 million or $0.35 per fully diluted share for the quarter, just ended, compared to the $19 million and $0.13 per fully diluted share in '05. For the first nine months of 2006, Arch earned $181 million of earned income, or a $1.25 per fully diluted share, compared to $29 million or $0.19 per fully diluted share in 2005.

Our adjusted EBITDA grew to $136 million during the third quarter of '06, representing close to 50% improvement over the third quarter of '05. For the first nine months of 2006, adjusted EBITDA rose more than 75% to reach $427 million.

Additionally, our consolidated revenue dollars declined nearly 7% in the third quarter of 2006 compared to the third quarter of 2005, due to the sale of select mining operations in Central Appalachia at the end of 2005. Despite the decline in overall revenues, our per ton price realization increased substantially on a year-over-year basis climbing 26% in the PRB, 15% in the Western Bituminous region and 17% in Central Appalachia. These increases reflect the benefit of the ongoing roll-off of coal sales contracts that were priced when coal markets were less attractive than they are today.

Operating margin per ton expanded considerably on a year-over-year basis, doubling in the PRB and rising from just $0.20 per ton in Central Appalachia in the third quarter of '05 to $4.15 per ton in the most recent quarter. Our Western Bituminous operations experienced an operating margin per ton reduction of 3% due to the two scheduled longwall moves in the region, impacting the most recent quarter results.

Insurance receivable. During the third quarter, we received our third partial insurance recovery of $10 million associated with the West Elk spontaneous combustion claim. Although the claim is not yet final, we do believe we have received the majority of the claim to date and are hopeful we'll have the claim settled by the end of this year. We ended the third quarter with total debt of $1.122 billion. Total debt-to-cap ratio was 46%. Our debt-to-cap ratio is approximately where we have been all year and well within our comfort zone of our overall capital position.

During the third quarter, we borrowed $51 million on our revolver. The borrowings were precipitated by the timing of CapEx, cash to fund the acquisitions, Nighthawk and DKRW, which, as previously discussed, totaled $40 million, along with the expenditures for our share repurchase program. In summary, we're pleased with our most recent quarter performance and believe our large, diverse portfolio of mines enables Arch to overcome operational or market place challenges than any single region or any single quarter.

As previously announced, we are authorized to repurchase up to 14 million shares of Arch's common stock. As of September 30th, we had purchased 850,000 shares at an average price of $28.10 per share. To date, we have funded these stock repurchases primarily through operating cash flows and revolver borrowings.

We continue to evaluate the attractiveness of our stock as one of the vehicles for creating value for our shareholders. Additionally, we will continue to value the returns offered from organic growth projects, acquisitions and dividends, as we make capital allocation decisions, going forward.

Now, let me turn to our outlook for the full-year 2006. Given current weak near-term market conditions, we are lowering our production targets for the fourth quarter of 2006 and now expect the following. Earnings per share between $1.60 to $1.70 per share. Adjusted EBITDA in the range of $540 million to $560 million. Total sales volume of between 125 million to 130 million tons, excluding pass-through tons of approximately eight million associated with the legacy Magnum contracts that we are currently servicing.

Our CapEx guidance remains $420 million or $550 million, including reserve additions. This figure excludes -- and I repeat -- excludes both the Nighthawk and DKRW transactions. DD&A is expected to be roughly $210 million. As our tax rate -- as for our tax rate, we have previously indicated our expected tax rate for the full year to be around 10%. We are revising that number and now expect a rate of around 15%.

As we have discussed in the past, Arch has a significant valuation allowance on its deferred tax asset, which totaled $163 million at the beginning of the year. Over the next several years, depending upon a number of factors, including profitability, volume, and the related mine percentage depletion calculations, the valuation allowance could be reduced, having a positive impact on our effective tax rate. As a result of those potential reductions, it is not always possible to project our effective tax rate with a great deal of precision.

Naturally, we'll do our best to keep you apprised of our tax rate estimates, going forward. Additionally, Arch is lowering its preliminary 2007 production target by ten million tons and expects 2007 production to reach around 140 million tons, excluding pass-through tons associated with the legacy Magnum contracts that we are currently servicing. In summary, despite the recent softening of the coal markets, we remain bullish on the long-term fundamentals of the coal industry, and will continue to focus on ways to strengthen our position and increase shareholder value.

With that, we're ready to take questions. Operator, I'll turn the call back to you, please.

[OPERATOR INSTRUCTIONS] We will take our first question from Jim Rollyson with Raymond James. Please go ahead.

Good morning, everyone.

Morning, Jim.

Steve, you talked about the reduction in the outlook on the tons, for fourth quarter three million tons, next year, ten versus what you were thinking before. Can you kind of share with us what regions you think that supply will come out of?

You know, we're hesitant to do that for some obvious reasons. But, you know, it would be most likely you'd have to look at where we produced the most coal and we'd have -- but it is going to be spread across the entire Company.

Just assume kind of a similar mix to what your production profile is?

I think for modeling purposes, that would be appropriate.

Okay. As my follow-up, if you look at your costs, obviously in both Central APP, you're trending up, and Western Bituminous, I guess, was more tied to the longwall moves. Looking at Central APP, if you look out over the next year, I guess we should assume that that continues to trend up just with the way things are going in the Central APP, at least until you get the new mine up and running, second half of next year?

Yes, Jim. I think we'll do a recently good job in managing our costs. We have the same pressures everyone else does. Don't forget this third quarter, we did have a longwall move at Mingo Logan, which distorted those costs a little bit. But, yes, we're running three CMU units at Mt. Laurel right now.

We won't bring the longwall on at Mt. Laurel the second half of 2007 when you should see our cost average down overall, probably toward the latter part of 2007, probably toward the latter part of 2007. I think -- you know, we'll do a reasonable job in managing our cost, but we are under some pressure and you could see some slight increases between now and when that longwall comes up at Mt. Laurel.

Got you. And with the Western BIT market, region, your costs were up quite a bit, which I presume is mostly tied to the longwall moves. Where do you think that trends back to on average if you had to guess?

You know, Jim, yes, we had two longwall moves during the quarter. We had one that was particularly difficult. You know, we think -- once we get steady state -- and we're actually in a longwall move right now at West Elk -- so, you know, when you net all that together, we think in the higher teen range is probably where we're going to shake out on a cost basis going forward. So, you know, if about you look at our contract roll-off and what we're repricing, we're still creating pretty attractive margins in that region.

Great. Thank you.

And we will now take our next question from David Lipschitz with Merrill Lynch. Please go ahead.

In terms of the east, when does -- so when the longwall comes up at Mt. Laurel, does that mean the longwall will come down in Mingo Logan?

Yes, our plan is to move that longwall crew from Mingo Logan over to Mt. Laurel, so we're trying to time when we decline at Mingo Logan with when we start up at Mt. Laurel.

And what will Mingo Logan's tonnage be after the longwall moves down?

Well, our plan is right now to run about to or three CMs, so it's going to be about a million to 1.2 million per year on production and then whatever we can bring in in terms of purchase coal.

Is there any other coal in the east -- I know you don't have that many operations left -- that you could bring down if pricing doesn't rebound in Central APP?

We're always looking at our cost structure. We're pretty happy with where we are right now. The restructuring we did in late 2005 has really kind of set us up to be very competitive from a cost standpoint in Central APP. So, we think we're going to be pretty competitive with any kind of production in the east right now with what we've got.

Okay And one just follow-up. In the rail situation out in the PRB, how do you look for it next year? Do you think it's proving? Same? Weakening?

Well, I guess in the PRB, certainly we saw some improvement in the early part of the quarter and then they got progressively worse in August and September. I think they continue to work on their maintenance. We're very excited to get the third line completed south of Reno Junction. That should take place in late October, early November. So, you know, we're expecting that to really have a real positive impact on Black Thunder moving forward, but will it be without problems? No.

Dave, this is Steve. I think -- you know, several times we've said that we think there will be continued challenges for a number of years, just given the overall demand growth for the PRB likely to occur, and the rails are certainly extending capitals to catch up and coming back to Central APP, I kind of look at it as, you know, I think we may be one of the few, if not the only one, that once Mt. Laurel starts up, that if it starts up like we expect, to see Central APP costs coming down from all of the producers in Central APP, which is going to be a great position to be in.

Thank you.

we'll now go to Michael Dudas with Bear Stearns. Please go ahead.

Gentlemen?

Hey, Mike.

Yes. First, I want to commend you on not gloating from last night's game. As a big met fan [LAUGHTER] We really appreciate it. We've had enough pain over the last --

I was nervous in the bottom of the ninth.

Yes, you and me, both. All right. Two questions. First, Steve, your decision to take ten million tons of growth off the market next year, go through like -- I don't want to get too specific -- but is it driven by your rate of return, the cost, the margin that you'd expect from those marginal tons or is it the fact that you're trying and you see that market price or what you could get for that -- or the margin from those tons isn't quite what you would like it to be or think it should be for shareholders? And is that also reflective of the large open position that you have for 2008 that you do feel that the market will start to -- to factor in more positive notes and inventory levels get drawn down to get better pricing for the coal?

We really think that, you know, longer term, the propensity for higher energy pricing across the entire energy sector is much greater moving out 12, 24, 36 months than currently reflected by the stock market. And you know, clearly, with the mild weather, the market place has been telling us that we don't need all of the production in the industry, so we sit there and said fine.

We've always advertised that we're willing to meet market requirements, whatever those requirements are, and that will continue. So, really, we see longer term value in the reserves being a greater value to be held in place for awhile than moving them into a weak energy market, principally due to mild weather.

You know, as -- the other kind of adjunct to your question is historically, if you look at Arch, there's been times where we've been higher lever -- had much higher leverage ratio. Our fixed costs were much higher, as a result, and also a lot of the efforts that John alluded to in focusing on being able to operate our mines in a more responsive pattern to the market place, i.e., that we can be profitable at lower levels of production and higher levels of production.

And we really focused on that, and not having that leveraged allows us to be willing to try to preserve the upside for our shareholders and not be risking a great deal if that doesn't occur. And we firmly believe it is going to occur as we look out at the current environment.

My follow-up's regarding your plans next year for capital. Your budgets are probably not 100% in yet, but remind us what is left on your growth projects, i.e., Mt. Laurel or anything else through 2007. What you anticipate your maintenance capital spending level and a dollar term might be? And again, with your decision to pull tons off the market, how's that affect your decision for capital allocation relative to some of the growth and acquisition targets that you might look at?

Yes, Michael, this is John. You know, we're certainly in the middle of our budgeting process for '07, so we don't really want to comment on our capital expenditures for next year. But if you'll remember, we said that our replacement capital is about $165 million. With some of the volume reductions that could come off a little bit.

We have our next payment of $122 million on our LBA, and then we've got about $100 million to finish up Mt. Laurel. And don't forget, some of that $100 million will be for the eventual development of Spruce, in terms of shops, offices, et cetera. So, you know, with those three big items, I mean those are going to occur next year, so we're going to have a reasonably healthy capital budget for those items. Beyond that, I think we're reviewing that right now.

We're making some tough decisions on capital and we'll do everything we can to minimize that. But you know, we certainly want to get the Mt. Laurel operation up and running like we know it can. As Steve said, we expect it to be the lowest-cost, low-sulphur operation in the east.

Just a quick follow-up on that. On the timing. So when we get to 2008, you think that the longwall will be running at a full rate and it'll be more of a clean view from a standpoint of what is it, five million tons that you plan to get out of those operations?

That's correct. We expect to have a full run rate in 2008 of the longwall and the continuous miner section, so that's a good way to look at it.

Terrific. Thanks, gentlemen.

Thank you.

And next up is Brian Gamble with Simmons and Company. Please go ahead.

Good morning, guys..

Morning.

Wanted to get a couple of points of clarification on prior questions, if I may? I know you have talked extensively about not wanting to put tonnage into a weak market, but entering '07, what level of unpriced tonnage do you feel comfortable carrying into the market, knowing that, if prices don't improve, you might end up having to sell some of that tonnage at a shorter term, possibly unfavorable pricing environment?

We're comfortable with what we have in the press release right now.

Ok. That's good to hear. And secondly, wanted to ask a little bit about the Illinois Basin strategy. There's a little bit of talk yesterday on someone else's call about potential scrubber delays that they're seeing in the market and how that might impact some of that tonnage out of the east and out of the Midwest. Have you heard anything about scrubbers being possibly delayed or utilities, and if so, what would that do to the Nighthawk/Illinois Basin strategy going forward?

Yes. We have heard delays and, you know, Arch has expected delays in scrubber builds over the last couple of years. We looked out at the announcements and we looked at the availability of pipe fitters, electrician, welders, the whole gamut that we see in the coal mines and you see in the oil business, you see on the rigs, you see at the power plants that it was just inevitable that you would see some delays. Then on top of that, as many of us have seen in heavy capital-intensive businesses, the cost of these various new activities, if you will, or new projects have jumped, from everything from steel to wages, et cetera. I think the utilities are seeing that.

The other interesting thing that we've seen is, with the reduction from the highs earlier this year of SO2 credits, been told by several, you know, utility customers that their estimation of the marginal cost of scrubbing today is somewhere around $800 per ton. And in a perfect world or in an efficient market, that would imply that SO2 credits should be at about $800. Obviously they're not. They're down in the $550 to $600 range lately and more than one customer has told me that they're buying credits and they see the potential to delay some of their scrubber units. Putting all of that together, we would expect some delays to occur. Some have been announced.

You see some cost increases by various utilities get announced. And with Nighthawk, the great thing about Nighthawk is it is a relatively small produce,r and they have a very sound current production base and customer base that they're serving. And we see it, as we've said, an entry into Illinois Basin. And those who've followed some of my comments, I've often said that we'd see it in the second decade of this century, not the first decade, and really, it appears to us that the [inaudible] market and the scrubber markets are developing to that view.

Thank you very much.

Thank you.

Our next question comes from Leslie Rich with Columbia Management.

My question's been answered. Thank you.

thank you. We'll move on to David Gagliano with Credit Suisse.

Hi, thanks. I wanted to just focus in on the prices or the commitment that you made in the third quarter, for a second. The 4.7 million tons of PRB coal you committed in Q3, what was the mix in quality of that coal? When during the quarter was that committed and roughly what is the dollar amount of the sulfur credit behind that implied $13 per ton price? That's my first three-part question.

You know, David --

there's a tricky question. [LAUGHTER]

I'll Try to cover all of those. You know, the sales were really made throughout the quarter, and it was a combination of both products. You know, we've been very patient. We've missed a lot of business. We put a lot of bids out there, but we feel pretty good about what we've obtained. And you know, it was basically throughout the quarter. And there was a third question.

-- SO2, something like that.

The SO2 was -- I don't remember what it averaged during the quarter but it was -- you know --

John, that was just calculated on recent SO2 prices.

Okay, yes.

So, does that add -- is there a dollar amount associated with that? Like, they add on top of it? On the $13 implied profit.

Those prices included that.

They include it and

Those prices had that embedded in it, David.

Okay.. And then as a follow-up, in the east, did the -- I think it was a $56 implied price for 4.9 million tons sold over the next two years Did that include any met coal and if so, how much?

You know, David, it probably had a very small percentage for the most part it was steam.. We feel like there again, we've put some bids out. We've missed. We've been successful.

We think particularly in the east, that you know, you would've have been rewarded for a [live goal] that we provided to our customers, and feel pretty good about the prices we obtained. We've been clear about our met position. It's 300,000 to 400,000 tons per quarter, and we expect that to continue for the next few quarters.

David, this is Steve. You know, we've talked before. There are different market places. The trading market, as I call it, or that spot market that we see out there in the indices. But the contract market is much different.

It takes into -- as John mentioned, obviously, the price and qualities, but the other terms and conditions of the contract, the reliability, the supplier, the -- you know, the underlying quality itself of the coal. So, you know, we've been patient on it and, you know, very meticulous, but at the same time, we're encouraged by what we think are some good buyers.

That's good news. I happen to agree.I think it does highlight the disconnect out there between contacting and spot. Just on the follow-up on the eastern side, was that also priced throughout the [inaudible]

Yes.

Okay...

Pretty evenly, yes.

Thanks.

We'll now go to Ann Kohler with Caris and Company .

Great, thank you. Just two questions. One, I would assume that the lower SG&A was a result of less bonus accrual? Is that correct?

Actually, we had less -- this is Bob Messey. We had less legal and severance costs in '06 than we had in '05 for about half of it, and the rest was the market-to-market adjustments on comp and benefits.

Ok, great. Could you just detail the purchase volumes during the quarter, where they were?

Purchase volumes on coal?

On coal.

We're going to look --

Ann, we'll get back to you on that. It may be after the call, but we'll circle back to you.

Okay, thank you.

Next is Brett Levy with Jefferies and Company.

Hey, guys, I know it's tough to size this up, but you guys have got to be looking over your shoulder a little bit. Can you make a guesstimate from beginning to year to end of year how much capacity has come out in Central APP in terms of percent of total? And then, as you guys look at what you think actually does come on in the way of full-fired new capacity on the utility side, what do you think the growth rate is over the next couple of years in terms of demand?

On the reductions, you know, we're just reading the newspaper ads yourself. It looks like it is somewhere seven, ten million tons. There have been more perhaps announcements, and I think in this market environment, we may see some additional reductions out there. It has been our view, and from a lot of study and a lot of detailed study, that the reserve dictates or the reserve base and the current cost structure of Central APP dictates that, by 2010, we drop from kind of 232, 33 million tons of annual production to under 200 million tons of annual production. And we see that right now, we're on the course for that happening in the industry and it's just a matter of the reserves themselves after the industry has operated there for over 100 years.

In terms of the growth in new power plants coming on-line, you would have to think that in kind of eyeballing the various announcements and assuming that there's some delays in the construction schedules, somewhere around 15 to 20 million tons of incremental demand on new plants maybe in 2008, 35 million by say 2009, and upwards beyond 70 million by 2010.

So, over the next three years, you will be over 100 million tons, assuming all of the plants have announced or have really advanced to the later stages of development come on-line. When you look at them, most of them, not all of them but most are new units at existing power plants, so they're -- they are very likely, we think, to be built because of they're brownfield developments.

And then the follow-up is question obviously there's been rail car shortages, tire shortages, labor shortages, et cetera. Has the recent shuttering activity produced any relief on any of those fronts? And is labor just now more available?

In the east, I think it is interesting to view. I mean my view is that, one, Arch is a great place to work. So, you look at a complex like Mt. Laurel, it has a natural competitive advantage to recruiting labor. The other side of closures is when the mines close, the ability to reopen that mine because the labor disperses -- it comes to us and other folks -- is much, much more difficult because you know, there is an inability to go out and hire folks off the street, if you will.

So, we see some marginal perhaps relief but it hasn't been a great deal. I think it's continued challenge moving forward and, frankly, in this tight labor environment, we think that Arch stands out as an attractive place, and we actually have a competitive advantage. John, do you have anything to add to that?

Yes, I mean, I think Steve's right. We think Arch is a good place to work. If you look at our turnover rates, they're between 8% and 10%, which is pretty attractive. In terms of your other question about pressure from vendors, tires. We still see those pressures. There's still a shortage of tires in the industry. We've managed that very well this year. We think we've got it well managed in the first half of 2007, but it will continue to be a challenge. But on the labor front, we think we're in pretty good shape east and west.

Thanks much, guys.

Thank you.

the next question will come from Paul Forward with Stifel Nicolaus. Please go ahead.

Thanks. Good morning.

Good morning, Paul.

Do you -- maybe you could tell me what your level of interest would be in growing through substantial acquisition in Central Appalachia, or is it your strategy to continue to move away from the region?

You know, when we closed the Magnum transaction, we made the statement that, you know, we are in Central Appalachia and we think that, in our current configuration of very focused mines in Central Appalachia, that it's a great place to be, and we continue to have that view. You know, I really can't comment on longer term strategy of one area or another.

We do envision that the industry's going to consolidate. The likelihood of those things occurring and how Arch participates, we'll just have to see. My view is that, under the right circumstances, we'll look at, you know, various acquisitions and at different circumstances, we'll let somebody else spend their money.

All right. And I guess, given the rash of production cuts we've seen, first in the Appalachians, now in the PRB, have you discussed these cuts with your customers and have you detected any nervousness about 2007 from your customers?

You know, I think that the customer base is still -- from conversations, still focused on their growth. It's interesting to note that many of our customers are very focused on some recent reliability council numbers and the reserve margins for generation dropping below 15% starting next year.

At the same time, you know, they have been able to -- in the last year, for the most part, replenish their stockpiles, although some have told us they want to take them higher. But you know, it's one of these things. It's a market dynamic that is out there. There's a give to and fro so, generally, I don't think it is surprising news that some of the customers would have seen this coming and then others may be surprised. I don't know.

Ok. Thanks a lot.

We'll now go to Mark Liinamaa with Morgan Stanley. Please go ahead, sir.

Regarding the pass-through tons in Mt. Laurel, can you remind me what volume that is and what, if any, the bottom line impact may be next year?

It was 1.8 million tons for the most recent quarter, Mark. For next year, it's going to be less than that, and substantially less than the eight million we've seen this year. We haven't given a number for it.

Ok. So there's no guess on what that might affect the bottom line?

It won't have any effect on the bottom line, of course, as a pure pass-through.

Ok, good. And regarding again, the PRB shipments, was that done based on an assessment of what the rails can handle? Is that how you arrived at roughly the number that you came to?

It was a combination. the coal mines have -- I call them certain levels of production of where they're efficient and where the equipment matches up with the level of production. That was the first driver. Obviously we continue to look at rail performance, as a second part of that decision, within the PRB. Now, as I want to emphasize, part of that was at other basins, as well.

Good. Thank you very much.

our next question is from Justine Fisher with Goldman Sachs. Please go ahead.

Hi. I just have a quick question, first of all, on the CapEx levels. Correct me if I'm wrong, because I know that you broke out previously what sort of maintenance CapEx is and what the spend may be, and it seems that most of it is for build-outs in Central Appalachia and the lease payments,and then maintenance Cap Ex. And so is that the reason why CapEx is not going down. even though tonnage is being reduced by ten million? The lease payment kind of doesn't -- you're still going to have to make the payment even if tonnage goes down.

You still have to make the lease payment. Way the LBAs, what they call a lease by application work, so that you can put 20% down upon obtaining the lease and then for the next four years, on basically the anniversary day, you pay the remaining 20% each time. So, that continues.

We're in the middle of the CapEx, as John mentioned, or middle of our budgeting process. But we would see some marginal perhaps savings out there in CapEx. But it's the maintenance capital, a little bit, perhaps. The lease payments are what they are, and then we do have the $100 million John referenced to really complete Mt. Laurel and that will occur.

And is there a reason it is not going down this year? I guess we're pretty close to the end of the year anyway so there's not much wiggle room.

Yes. Our guys -- you know, we -- when we do our capital budgeting, it's been all placed and put in, and a lot of it's already built in to the entire process. And, frankly, three million tons and 125 to 30 million tons of annual production, you know, you're not going to see that in the CapEx line.

Right. Okay. And then the second question that I had was just about a clarification on Central APP in Western Bituminous tonnage for the quarter.

Is it right there were longwall moves in Western BIT and they did increase the cost, but there actually wasn't a decline in tonnage, despite the fact that you had a month outage on the one and a couple-week an outage on the other longwalls. Why didn't tonnage go down?

There was a small decline in Western BIT, I think, of about 300,000, 400,000 tons.

And then on Central APP, is the additional tonnage that you're bringing on right now, or at least through the end of '06 and most of '07, is that replacement tonnage and then we'll start to see tonnage growth from current levels or even say '05 levels starting in '07 and '08?

Most of the new tonnage associated with the Mt. Laurel project is replacement tonnage for the Mingo Logan operation.

So, we shouldn't expect to see notable, even on a quarterly basis, increases on Central APP tonnage until late '07, early '08.

Late '07, early '08. I mean, you will have the continuous miner production at Mingo Logan at a million, which is say a million, a million two, and then you'll have between four and five million tons out of on an annualized basis our or Mt. Laurel.

Okay.. And then the last question I wanted to ask was just a clarification on a previous one that was asked about why exactly -- how does the view on prices correlate with the production cuts, because it seems as though, if prices were going to be high, maybe you wouldn't want to cut production as much because you'd want to take advantage of that. I'm trying to come to a conclusion as to how those fit with each other. Is it that you don't think the price will go up unless you take the tonnage out?

Well, you know, we're not going to comment on specific prices, but I think John alluded to it earlier. We bid an enormous amount of tonnages over the time with our views of what the future might look like in terms of pricing and contract terms. We did not land very much of it. You know, customers went elsewhere, as far as we know.

So, you know, what the customers were telling us is we don't need to buy right now or whatever. And so we made our adjustments accordingly. So, it is our view that, given kind of the current market place as evidenced by the indices, has a greater propensity for energy to be higher than the coming 12, 24, 36 months than being lower. And for our shareholders, we're willing to be patient.

We'll now go to John Hill with Citigroup.

Very good. Thank you, everyone. I was wondering if we could get some clarification on the PRB indexed pricing tons, how those work and how much more of that is in store for us?

Not a lot , but a certain percentage of our agreements out of the PRB are priced on the index and they're priced by the previous quarter. So, whatever that price is in that quarter, I think some of them are different, but on a weighted average basis, that prices the next quarter.

So, that's based on the spot market price in the trailing quarter?

Pretty much the indexes that you can see when you go into the trade rags. You know, some are weighted averages. They're done differently, but it's usually the previous quarter average price will set the next quarter.

Sounds good. Do you include those in let's say the tonnage sold or price numbers that you give us? For example, when we've got 35 to 45 million open next year, does that include some of these floating price tons or are these all considered priced and sold the way you tell us?

John, those tons are included in the unpriced tons. We do not break out the index tons. We simply give you total unpriced tons, which would be uncommitted, as well as committed and unpriced. So, the 35 to 45 would include some tons that are committed but unpriced.

Thank you. Excellent. And then just a follow-up on some of the nonoperating items. There was 10 million or so for the reserve sale. That in other income in the income statement and what's the after tax number?

It is in the other operating income net and it probably -- it pulled a 20% tax rate.

Ok. And then also, just to -- finally, on the insurance recoveries, how much of that is on the income statement this quarter and then how much of that would be cash?

There was $10 million on the income statement this quarter. The cash was all rec -- $5 million was received before September 30th and the rest has been received subsequent.

Ok. Very good. That's also in the other income line?

That's in the cost of coal sales.

Ok. So, it is basically a credit against the cost of coal sales?

Yes. That's where the loss went.

In the Western BIT, yes. The insurance recovery will not match the law, unfortunately.

Very good. Thank you for the detail.

Our next question comes from John Burgess with JPMorgan. Please go ahead.

Good morning, Steve, Bob.

John.

Just -- I seem to remember from previous presentations that there is a fair chunk of repricing of the old canyon fuel contracts coming through next year. I wonder if you could give us a bit of detail on that, because, presumably, that would give you a bit of a boost and would protect you somewhat from a lower price from the PRB.

Well, you know, the Western BIT -- I mean I don't remember those presentations, but it is an ongoing. I mean we're talking to the customers out there all the time. We have Skyline running.

You know, I think what John said is that the Western BIT margins are very attractive in the current world and we continue to see that being a very positive impact to the bottom line to move forward. I won't get into much detail here.

I just wondered. But you still rolling off those old contracts, which were around $16 or something?

We're still rolling off old contracts across the entire Company, and even some of these indices price contracts are old legacy contracts, as we would classify them. For the next couple of years, as we've said, through 2008, we have contract roll-offs pretty much.

Does a big chunk of them come off next year?

You know, I don't know it off the top of my head, but it's --

It is pretty systematic, John. It is not a bigger chunk this year than the year after, but over the next two to three years, obviously, we're resetting a significant amount of the business.

Yes.

Okay. Mt. Laurel, metallurgical/good grade thermal, which way are you going to direct that call?

I think it'll depend on the market. We're fortunate to have a cost structure that's going to allow us to be in and out of the steam market or the met market, it just depends on where the opportunities are.

Ok. And presumably, as a longwall operation, that is going to be sort of high 20s cost, something like that?

Well, you know, we haven't given any of those numbers out, and we won't. I think for Central APPS, to say you're going to be in the 20s would be an aggressive assumption.

Ok. Thank you very much.

Thank you.

we'll take the next question from [Sam Mertini] with Cobalt Capital.

Hi, guys. I just had two questions. First, could you just update me in light of the production cuts. I don't know if you've addressed this.

The 15 million tons of growth walk from '06 to '07, can you give an estimate of which regions will be expected to grow by which amount to get to that 15? And then secondly, just on PRB, can you give me whatever detail you could on how many tons you think in the quarter were sold at spot, and your assumptions for, as Coal Creek ramps up, what the cost improvement potential we could see there over the coming quarter or two would be? Thanks.

Again, we're not going to be specific on our regions. I think you have to look for modeling purposes, using a pro rata as reasonable model assumption on, you know, our overall production. Within Coal Creek, we would expect it to come down as it grows to it's full production levels.

How bloated do you think the cost structure today is relative to where it will be in a quarter or two?

Again, it is probably a couple dollars, but we're not going to be specific. And we're not even -- for competitive reasons, we're not going to break out Coal Creek and Black Thunder.

I personally never liked the fact that we've -- the SEC required us to report Black Thunder by itself, and we will report at the Powder River Basin from now on, and that's just purely a competitive issue. But you know, the driver will always be Black Thunder and Coal Creek's will be an add-on. And from either a production perspective, a cost perspective or a price perspective, I think that's the right way to think about that.

Okay. And what about spot sales this quarter?

We're being patient on our spot sales. If they're opportunities that make sense, we'll look at them, but we're in reasonably good shape.

Just to clarify on the 15 growth, if this quarter production was sort of 75, 15 and 15 -- 75, 15 and 10, you would [inaudible] across the 15, across your regions to get to the growth for '07.

I think that's an appropriate way to think about it.

Okay, thanks, guys.

And our final question today will come from David Conney with FBR.

Hi, guys.

Hey, Dave.

We need a little help here, if you could. If you could give us a sense of how much or roughly how much of the 35 to 45 and the 80 to 90 is actually contracted and not priced, just to give us a sense of if the market was weak out there, how much coal would maybe not be sold?

Dave, it is a meaningful percentage, but we really aren't comfortable disclosing that. We've discussed that here and have elected not to disclose that.

Ok. Ok. And I guess the pace in which it gets repriced, is it all January 1? Does it get scattered throughout the year?

It is a variety, Dave.

It is scattered.

Ok. Ok. And John, you know, some of the things you sort of touched upon was some of the cost initiatives. What do you think as far as as an overall Company [cost creep] that's a fair number to think about for next year and the outer years, with all of the programs that you're doing?

You know, Dave, we've worked real hard on trying to manage our costs and we've got a lot of good programs. I've touched on some of them from extending tire life to predictive and preventive maintenance.

We've been real pleased with our results, but in saying that, we've got cost pressures. And just like everybody else, you know, I would think somewhere in the 4% to 6% range would be a general rule on cost increases from '06 to '07.

Ok. Great. Thank you.

And that will conclude our question-and-answer session. I would like to turn the call back to Steve Leer for any additional or closing remarks.

We thank you for joining us today. I think, or at least I hope that we conveyed and answered many of the questions and conveyed our views tha,t you know, the intermediate long-term view of the coal business is as strong and perhaps stronger than it has ever been.

The mild winter weather, the mild summer weather has certainly weakened some of the softer near-term markets, but Arch is focused on shareholder value. Arch is very focused on creating shareholder value, and we will continue to work hard on your behalf. So, thank you for your time. Thank you for your interest.

And thank you very much. That does conclude our conference for today.