Arch Resources Inc (ARCH) 2006 Q4 法說會逐字稿

Good day everyone and welcome to this Arch Coal incorporated fourth quarter 2006 earnings release conference call. Today's call is being recorded. At this time I would like to turn the call over to Mr. Deck Slone, Vice President of Investor Relations and Public Affairs. Please go ahead sir.

Good morning, thanks for joining us on today's call. Before we begin I want to remind you that certain statements made during the call including statements relating to our expected future business and financial performance may be considered forward-looking statements pursuant to the Private Securities Litigation Reform act. Forward-looking statements by their nature address matters that are to different degrees uncertain. These uncertainties, which are described in more detail in the annual and quarterly reports that we file with the Securities and Exchange Commission, may cause our actual future results to be materially different than those expressed in our forward-looking statements. We do not undertake to update our forward-looking statements whether as a result of new information, future events or otherwise, except as may be required by law. 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 the call with brief formal remarks and thereafter we will be happy to take your questions. Steve?

Thank you, Deck, and good morning. Welcome to Arch's fourth quarter earnings conference call. Arch received record earnings last year as measured by any key financial metrics, EPS, net income, operating income and EBITDA. Arch reported fully diluted earnings per share of $1.80 in 2006 compared with $0.17 in 2005. These per share figures are on a split adjusted basis reflecting ACI's two for one stock split last May. Our profitability increased significantly in 2006 with a more than 300% increase in income from operations and close to a 600% increase in net income. The roll off of legacy sales contracts increased focus on cost containment and the strategic divestiture of select Central Appalachian operations at the end of 2005 all contributed meaningfully to Arch's record results.

In 2006 Arch made several strategic investments that we believe will benefit the company in future periods. We acquired a one third equity interest in Night Hawk Coal to expand our presence in the Illinois basin which we expect will become an increasingly important coal producing region in the next five to ten years. This investment supplements Arch's 220 million ton reserve position in Illinois and represents an initial step towards reengaging in a region where Arch has a long operating history and deep institutional knowledge. Arch also acquired a 25% equity interest in DKRW Advanced Fuels, a developer of coal to liquid facilities. This investment allows Arch to participate fully in the emerging coal to liquids industry both as a coal supplier as well as an equity owner.

It was a rewarding year for arch despite the downturn in the U.S. coal market. While we strongly believe in the positive long-term if fundamentals of the U.S. coal industry we are taking proactive steps to address current weakness. On the supply side coal production was up an estimated 26 million tons based on [AMSHA] and EIA estimates after three consecutive years in which consumption outpaced supply. In a typical year 26 million tons of increased production would have been easily absorbed by the market, particularly since stockpiles were very low at the outset of last year. Unfortunately 2006 was anything but typical on the demand side. We estimate that U.S. coal consumption declined by approximately 10 million tons last year. As a result generator stock piles increasedly approximately 35 million tons during the course of 2006. Representing an approximate 47 day supply. While this level is above historical five year averages it may reflect the decision by generators to maintain a higher level going forward given that critically low stock piles at the end of 2005 were in part due to significant rail challenges that year.

The the good news is electric generation appears to be up strongly in January of 2007 when compared with January of 2006 and coal production so far this year is down approximately one half of a percentage point. Of course it is very early and these are preliminary numbers and it is likely take some time for the coal markets to return to a healthier balance. However weather patterns do average out over time and there are certainly some meaningful indications that production rationalization is occurring, particularly in Central Appalachia where severe cost pressures continue to exist. In contrast Arch sees several positive factors that should support continued long-term growth cycles for coal. Demand growth from new coal fueled plants represents a meaningful driver in the long-term fundamental story on coal. Announcements have reached 96 gigawatts to date representing more than 300 million tons of new annual coal demand. Nearly 60 million tons of incremental coal demand should be on line by 2010. And another 60 million tons of incremental coal demand is well on the drawing board and progressing forward. All of this is on top of the steady increases in capacity utilization that are expected to occur at the existing coal generators. Clearly increased coal production will be needed to meet the future demand growth and Arch's position to meet these new market needs. Furthermore, the strengthening outlook for the advancement of coal conversion technologies such as coal to gas and coal to liquids remains a favorable long-term development for the coal industry.

While the intermediate and long-term outlook is very favorable, Arch is taking additional steps to rationalize production targets in the near term. To meet current demand we have decided not to force additional tons into an oversupplied market. By following this market driven strategy we believe we are creating greater value for our shareholders in the years ahead. Consequently we are lowering production targets for the full year 2007 and now expect to produce between 130 and 135 million tons. We're also will ratcheting down our capital spending in 2007 given the current soft market environment. Current coal prices simply are not strong enough to provide an adequate return on new discretionary investments. We expect the markets to strengthen over time and so we have elected to leave more of our valuable low cost reserves in place for future development.

During the fourth quarter Arch did sign collective sales commitments in each of our operating regions. Approximately 15 million tons for 2007 delivery and approximately 5 million tons for 2008 delivery at prices above and in many cases significantly above current realized prices. Based on our recently signed commitments and the revisions to our production targets already discussed Arch has an unpriced volume of approximately 11 to 16 million tons in 2007, 75 to 85 million tons in 2008, and 110 to 120 million tons in 2009. In summary, Arch has committed to making the right business decisions in the near term in order to retain the upside potential for the the intermediate and long-term. Furthermore we believe the size, diversity, and low cost nature of our asset portfolio positions Arch to take advantage of any potential opportunities that may arise in the current market conditions. With that I will now turn the call over to our President and COO John Eaves for further discussion of our operational performance. John?

Thanks, Steve. Our mining operations delivered a solid performance during the fourth quarter 2006 despite a weak macro environment for coal. Overall our average price realization for each operating region increased meaningful on a year over year basis, benefiting from the rolloff of lower price sales contracts. We managed our costs quite effectively in all regions during the fourth quarter, a testament to our ability to manage our controllable costs by offsetting any cost pressures with process improvement initiatives. As a result operating margins per ton expanded significantly on a year over year basis in each region.

Compared with the third quarter of 2006, however, we saw some erosion in the PRB and Western bid operating margins, primarily to the due to the contract mix and soft market conditions. In Central App our operating margin per ton continued to expand during the fourth quarter, partially benefiting from the higher met sales which commanded premium price in the market. In 2007 we are targeting an increase in the percentage of met and industrial coal in our sales mix and we are off to a very good start in that effort.

In 2006 two of our three major capital projects were completed. Arch successfully reopened Coal Creek surface mine in the PRB during the second quarter of 2006 with the dragline coming on line in the fourth quarter. Additionally we added the Skyline underground mine to our operations in the western bit region. While market conditions have weakened since we began these organic growth efforts, we expect these assets to earn a meaningful return on our investment in the coming years given the positive long term outlook for coal demand.

In addition Arch received several national distinctions in 2006 that I would like to acknowledge. First, our Skyline mine in Utah was honored by the U.S. Department of Labor as the safest underground coal mine. Safety is our number one priority at Arch and we remain sharply focused on achieving improvement in this front in 2007. We're enthusiastic about the implementation of a behavior based safety approach that we are rolling out to all our operations during 2007. We will keep you informed of major milestones we achieve with them. Second, we were honored in the Green Lands award in West Virginia for excellence in land reclamation for the 5th time in the past six years. The U.S. Department of the Interior awarded Black Thunder the national Good Neighbor award. I'm very proud of these accomplishments, and want to personally thank all our employees for their dedication and hard work.

Looking ahead to 2007, we're taking steps that will help us navigate through the current challenging market environment. Arch has invested a significant amount of time and energy in recent years to increase the flexibility of our operations. In response to the weak market demand we are reorienting our mines to run at reduced production levels while still maintaining our profitability targets. This operation is designed to help maintain unit costs despite the high fixed cost nature of mining. We're also focused on cost containment and productivity improvements. Arch is managing cost pressures through traditional hedging, trading activities as well as implementation of the predictive maintenance initiative. In some cases we're foregoing the high end contractors to contain labor costs. Our predictive maintenance schedules are also us to lengthen current maintenance cycles. And we are scheduling major repair work now to prepare our mines for when the market does return.

As Steve mentioned we are also committed to lowering our capital cost in 2007, including eliminating any discretionary capital spending in the current soft market. In 2007 we will continue with the development of Mount Laurel underground mine. We expect this asset to be the cornerstone of Arch's operations in Central App and contribute to the reduction of operating cost in that region over time. We also plan to begin work on the new load out at Black Thunder to replace the south load out that was sold in December of 2005. In addition, Arch will continue to maintain the appropriate level of maintenance capital that is necessary to run the business. The continuous process improvements mentioned above, along with the reduced capital spending should help Arch manage its business in the current weak market. Additionally the flexibility in production, the lean cost structure that we put in place will benefit the company in many years to come. With that I will now turn the call over to CFO Bob Messey who will provide some additional color on our financial results as well as offer some insight on our expectations for the full year. Bob?

Thank you, John. And good morning everyone. Rather than repeat the numbers contained in the press release I thought I would take just a few minutes to expand upon some of the major financial developments for Arch during 2006 and provide you with a picture of our strong financial position entering 2007. We ended the year with total debt of $1.2 billion and a debt to total capital ratio of 46%. That ratio has been steady all year, and is well within our internal targets given our current structure. Our debt did increase modestly during the fourth quarter as we borrowed an additional $52 million. These borrowings reflect the timing of capital expenditures as well as the timing of expenditures related to our share repurchase program. As mentioned in the earnings release, we are authorized to repurchase up to 14 million shares of Arch common stock. During the fourth quarter we purchased an additional 712,000 shares at an average price of $28.06 per share, bringing total repurchases under the current program to 1.6 million shares at an average price of $28.08 per share. We will continue to evaluate opportunities under this program to purchase shares, and will do so when we feel that our purchases create the most value for our shareholders. Additionally, we will continue to evaluate the returns offered from organic growth projects, acquisitions and dividends as we make capital allocation decisions going forward.

Now let me turn to the outlook for full year 2007. We expect the following. Earnings per share between $1.25 and $2. Adjusted EBITDA in the range of $530 to $650 million. Sales volume of 130 it to 135 million tons, excluding pass through tons of approximately 2 million associated with legacy Magnum contracts that we are currently servicing. As discussed, our ultimate production level will be dictated largely by market conditions and will have an impact on where we are likely to fall within our EPS guidance range. Cap Ex of between $240 and $280 million excluding reserve additions. Included in this total is approximately $110 million related to the completion of the Mount Laurel underground mine in Central App, which is expected to start up in the fourth quarter of 2007.

In addition we plan to spend approximately $25 million as we commence construction of new loadout at Black Thunder. You will recall that we pre-financed this loadout by the sale of existing south loadout among other assets for $85 million at the end of 2005. We have an exclusive lease on the the use of the south loadout through October, 2008, by which time we expect to have the new loadout completed. The new loadout will be a very modern facility located to our future reserve base at Black Thunder. That leaves the remainder which we consider to be maintenance Cap Ex. During 2007 we will be very judicious in our approach to capital spending and we will look for opportunities to reduce spending if this current weak market continues.

DD&A expected to be between $250 and $260 million. On the tax front we currently expect our annual tax rate will be between 10% and 13%. Which includes the realization of excess tax depletion, NOL tax benefits and AMT tax credits. The tax rates for the earlier quarters will range 15% to 20% depending solely on excess depletion and levels of mine profitability. Arch has a significant deferred tax asset evaluation allowance of $114 million to the end of 2006. Depending upon future levels of profitability, thus utilizing NOL carry forwards and AMT tax credits, the deferred tax asset evaluation allowance could be reduced. Similar to the fourth quarter of 2006 we expect a reduction in our tax rate to occur in the fourth quarter of 2007, thus lowering the annual tax rate to 10% to 13%. Naturally we will do our best to keep you apprised of our best estimates on the tax range going forward.

In summary, we were pleased with our strong operating and financial performance during 2006. And we're very confident that the steps we took during the year position the Company for future growth and value creation. We believe we have the strong financial footing that will allow us to weather any short-term market weaknesses, and to take advantage of opportunities that may arise. We will continue to focus on ways to strengthen our position and increase our shareholder value in the year ahead. With that we're ready to take your questions. Operator, I will turn the call back over to you.

Thank you. [OPERATOR INSTRUCTIONS] And we will take our first question from Pearce Hammond with Simmons and Company, please go ahead.

Good morning. You mentioned on the call that you think the Illinois basin is an attractive area and Arch historically has been a low sulfur story. How do you increase your positioning in the high sulfur coals, how do you go about it in the most economical way.

Good morning Pearce. We do and we have said for really a number of years here, certainly in the last couple, that we expect resurgence in the Illinois basin as the world develops and eventually the scrubbers get built. We continue to believe it's five to ten years away. You know, 220 million tons of reserves excluding really what we own in our Night Hawk acquisition of one third of the company. It's significant position, we continue to look at additional reserves, but really the concentration will be more the timing of the development of what we own already. Which will carry us for a long, long time. And, you know, as we look forward, you know, from an economic perspective those reserves can be brought on line at the appropriate time once the scrubbers are eventually built in the east. If PRB is still going to be a very competitive position, obviously we produce coal in the PRB and have access to Night Hawk cost structure in Illinois basin. The world is going to need both of them as we see, so we're very comfortable with it, but it's not any time soon that we see major developments there. And if anything the timing may be stretching out as you see some of the scrubbers get delayed moving forward.

Great. And then on the PRB I applaud your decision on leaving those tons in the ground. On joint line rail capacity this year where do you see that capacity, at what level, and does your decision that you have made to leave some coal in the ground, does that actually potentially create some excess capacity on the rail line or do you think it will be fully filled as far as what the rails can it actually move out of the PR B this year.

Well you know that's a question of where the ultimate market, coal market demand ends up. But the rails continue to invest significantly in PRB. They have completed what we would call the triple tracking of the joint line. Which did impact Arch certainly in 2005 in the first half to two thirds of 2006. As they move on further north into what we call the tier two 8400 mines triple tracking that will add capacity. And they're starting the 4th line at Logan Hill as well, which will add capacity. We think and it depends on market demand, that the rails will continue to be pressed on capacity. Given normal demand growth and, you know, the mines out there are going to be continue to be pressed on loading capacity. But that's ultimate question of kind of will they will be perfectly matched, I doubt if ever perfectly matched. What we see is when you're running 70 or 80 trains in and out of the basin, well 160, or 140 to 160 at any given 24 hour period, half full, half empty, that it's just a lot of congestion even when things are somewhat fluid and it takes one mishap to ball up the system. That mishap can occur in Nebraska or Kansas or Texas or at one of the mine sites or we can lose a belt or and it's when it works it's a wonderful machine, but it is a very complicated machine out there and very congested. So we don't think we're being driven by rail capacity, it certainly improved in the last quarter, in the last half of the last quarter, though January was a rough start with the storms. But I think it's all we're really pressed on capacity growth out there.

Great, thanks so much Steve.

Thank you.

And we will take our next question from David Conney with Friedman Billings Ramsey.

Yes, hello, can you hear me?

Yes, Dave. How are you doing.

Good. Could you give us help, how much met coal did you sell in the fourth quarter of 2006 as well.

Dave, this is John. We sold about 600,000 tons in the fourth quarter which put us at about 2 million tons for 2006.

Okay. And then what do you think maybe give us a range what you think you will sell for met for '07

We have about a 1.5 million tons sold right now in the met market.. And we can sell as high as 3 million tons. As we move out in '08 and '09 obviously that number can increase significantly. We have also had a concerted effort to put more coal in the industrial market, pull it away from the steam market. Quite frankly we're real pleased with the pricing we're getting on the met as well as the industrial side.

How much does that, how much does the industrial market give you a boost to margins would you say.

Well, all I'd say is it's significantly above what we're seeing in the steam market right now. I don't really want to give you a price. But we're in the neighborhood of about a million tons right now committed for 2007. Price levels we're real pleased with.

Essentially it's steam coal, but you're selling it through a different end user.

Exactly.

One last question, I'm sorry. Is there any more rollover tons that you have to deal with either in Colorado or in any of the other areas.

Well, you know, certainly in western bit David our rolloff doesn't really start to occur until late 2007, so we will see that benefit, you know, as we move into 2008. I think you probably noticed our pricing a little bit down in the fourth quarter western bit versus third quarter, and it was really sales mix. You will see that move up more comparable to third quarter of '06 and the first quarter of '07. So -- but really you don't see a lot of rolloff in that region till really the end of '07.

Okay, thanks guys.

We will now go to our next question with Ian Synnott with Natexis Bleichroeder.

Yes, hi, good morning.

Good morning.

Hey, I have a macro question, just in terms of what do you see over the next say in 2007, 2008 in terms of potential growth out of the PRB. If we see a return to normal weather, you continue to see kind of base load demand growth at trend, we see kind of a reversion of some of that perfect storm of negative events last year, how how many more tons do you think could get demanded ultimately out of the PRB in 2007, 2008.

Well, if you look at recent history, and its not just PRB but underlying coal demand, except for last year, has been growing more or less 25 or so million tons, 30 million tons per year. Central App has been declining over that same timeframe several million tons and that continues to go given the reserve base. And, you know, so we sit there and say, you know, I think in 2005 the PRB grew about 23 million tons and 2004 I'd have to go back and check the numbers. But those numbers and demands certainly are foreseeable and I think some of our customers are indicating that giving a-- given normal weather and the economy that that would not be an unreasonable assumption for each of those next couple years. Again, the challenges are, you know, can we get it out of the ground and get it in the railcar and get it shipped. And things are better today than they were at this time in 2006 from a shipping perspective, but it is the congested corridor. Probably the most intense transportation corridor in the world and that's always going to be a challenge. I mean, I don't think we can delude ourselves to say things will be wonderful there any time soon.

Right, right. So I guess given that, I mean, and if also I guess this would get into supply side, what we know about production cuts that have been announced or slowing in production growth including what you announced this morning, how much of the inventory build up that we saw last year do you think we could see get reduced over the courses of 2007 and how do you see that kind of playing out over the year.

I'm not sure you will see the inventory get reduced. The question is does it continue to build as I look at it. I think many of our customers have indicated that they entered 2006 at such low levels and with the disruptions, and disruptions can happen literally with a hurricane or anything overnight, that they raised their targeted inventory levels. Now, they don't necessarily share, in fact they don't share in most cases, what those new targets are. But our general feeling is that some utilities are continuing to build above where they are today as we enter 2007, and some are at a more comfortable level than, or at their targeted level let's say. But there doesn't seem to be an indication there's going to be a burnoff of the inventory.

Got you. So do you think that that then feeds into kind of what utilities are willing to do on pricing and if they're, you know, if they're not really getting more, I don't know if you're not seeing inventories burning down, and they stay pretty flat, do you think that you can see, you know, we can see pricing start to firm or does that take, you know, I guess really when would you start to see that happening in terms of pricing out of the PRB starting to firm.

Well, just speaking of the coal market in general when supply demand balance kind of meet each other, and inventories in the short run can can always cause some indications up or down, but just looking at the spot market and the indices here, I mean the recent spot of cold weather across pretty much the two thirds of the eastern half of the United States, we have seen you know the spot market kind of jump meaningful numbers admittedly from pretty unattractive numbers. But, you know, as we wind down winter and roll into the shoulder season that's usually a time where utilities rebuild their stockpile burns from the wintertime. And then they start buying for the summer. So, you know, it's a hard one to call, but it depends on probably the next couple months of weather and then just maintaining the economy, which frankly has been rather robust here with the announcement of plus 3% for the fourth quarter.

Right. No, certainly. It was just, it was interesting to see your other neighbor in the Powder River area was talking about prices probably staying pretty weak into the summer. And I guess it depends on your viewpoint, but do you think that's relatively likely?

I think it's hard to say that things are going to have any dramatic changes. I think the adjustments will be slow. So, but, you know, it takes one event to turn things upside down in the energy world and that event can come out of places none of us think about. So the key is, you know, continued normal weather, if you will, in the very short-term, and I will tell you that our perspective is we can't run this business based on the next three months weather predictions, and we won't. But we look at the long-term trends, the long-term demand, the fact that utility base is starting to reach very serious levels on its reserve capacity for generating electricity, new plants are needed, most of those new plants recent announcements are coal plants, and we're very upbeat if you take 12 to 36 month viewpoint. I think there will be some transition period here in the zero to 12 month viewpoint.

And next is Brett Levy with Jefferies and Company.

You and everybody else is got kind of a expand into met coal strategy. What do you think the odds are that, you know, kind of this looks like steam coal nine months ago or something like that, where everyone is so sure that things are wonderful that they expand to the point that margins are compressed.

Well, we're not expanding, we're taking, you know, Arch is fortunate if you will to have coal of very high quality steam coal and a medium quality met coal that can go into either market. And we will always pursue the market that gives us the best margin for our shareholders and for the company. And the fact the world is needing more met coal, we have the ability to step in there and supply an extra million or two tons over time and that can expand further if the market stays strong. In some respects, you know, maybe we can learn from history. If we go back to I think it was 2004 we started seeing this occur in the met coal market, you saw people push coal from steam into met when they could, such as Arch and others. The met coal markets continued to stay pretty strong, perhaps soft end a bit in 2005, six timeframe, but was still robust. And, you know, it helped create some balance if you will, certainly drew some coal out of the of the steam coal market, let's call it that way. We see that maybe happening again. But really it's driven on what's the best margin for Arch and its shareholders and right now our ability to divert that coal from steam into met makes economic sense and we will do it.

All right. And then in terms of the relative attractiveness of the M&A markets you look at, you know, can you talk about sort of Illinois, Powder River Basin, Central App, Northern App, you know international, do you have kind of set of priorities in terms of where makes the most sense for you.

You know, we don't limit ourselves to an absolute set of priorities of which market or which region makes the most sense. At the same time, you know, the risk factors that are associated with a region that you're not operating in versus one that you're very familiar with go up and we would raise our required returns to address that. We continue to look East and West. We think there's going to be significant opportunities in the U.S. market during the next 0 to 24 months, as companies in this marketplace become more and more stressed. It's not that you even like all of their assets, but select pieces of their assets are, could be very attractive. And we think we're positioned to do that. On an international market, you know, we always look, it's always intriguing, certainly a huge market, demands continues to grow worldwide for coal, expected to continue to grow domestically and internationally, and from our perspective in human resources and financial resources I think you would look more for us to be in a partnership arrangement than trekking off on our own into regions that we basically don't have operating experience in.

All right, thanks.

All right, thank you.

We will now move on to our next question, which comes from David Gagliano from Credit Suisse.

Hi, thanks. What's the regional mix of the 11 to 16 million tons on price row seven and the 80 million tons on price row 8?

Dave, we're not going to be granular on that, but, you know, for modeling purposes using kind of historical mix certainly gets you in the ballpark of all that.

Okay. And then of that 11 to 16 on price row 7, how much of that is actually committed.

About half of that, David.

About half.

Yeah.

And then just my follow up question, in terms of the loadout at Black Thunder what is the actual production capacity at Black Thunder now and what will that capacity be once the load out, all the loadout changes are made in 2008.

Well, on you know Black Thunder has two loadouts, north and south loadout, we're pretty ingenuous us in our naming. And the capacity of the south loadout, which is the one that we have sold, is approximately 24, 25 million tons. And we're in the design process of the new loadout and the internal debate is as we progress further and further west, the north loadout becomes further and further away. So do we design for, you know, future capacity which has a higher cost or do we design for kind of current capacity. And frankly we're in that debate right now, we're just not ready to define those numbers yet. It certainly would replace current capacity of the south loadout of 24 million tons.

The debate is replace and/or go higher, is that --

And/or go higher for the future.

What's the upside potential there.

That's -- we haven't defined it yet. The guys are playing with the numbers. In the next six months that will get defined and we will share that when we have it.

Okay, thanks.

All right.

Our next question is from Michael Dudas with Bear, Sterns, please go ahead.

Good morning gentlemen.

Morning Michael.

Looking over the basins for 2007, just correct my math here, I'm looking at the western bituminous you are probably going to be up maybe 2, 3 million tons on volume because of Skyline and in Central App you might be down a million or two because of the continuous mining shift to Mingo Logan. Is that a fair statement?

That's pretty accurate, David.

So therefore it looks like in '07, given what you sold in 2006 at 127.4 million tons that the additional 3 to 8 million tons will come out of the Powder River basin. My question is, is that Coal Creek product, is that any productivity or extra out of Black Thunder and when you look back to six months ago when you had your 2007 expectations of shipments of 150 million tons, now you're down to 130, 135, where did that delta come from, did that come out of the PRB.

Again, Michael, we're not going to be granular on -- but it's spread across all the basins and it's everything from taking a continuous miner out of one mine or another to not making a capital investment for some additional trucks at another mine. But for modeling purposes using kind of historical weighted averages out of each of our basin, adjusting for the increase from specific mines, one of the things that we look at and play with in all of this is some mines we might be able to take more out of and it doesn't have as high of a expense and you can go out in the marketplace and buy coal. And most of our contracts that we have negotiated in this last several years allow us to do that. So we have an ongoing view of what is the most profitability or the least cost approach to supply the contracts that we have. You know, with Coal Creek specifically we ended up having a pretty significant base load starting back in 2005 and early 2006 to cause it to reopen. So it's pretty attractive what we have there. And we are splitting the I'll call it the pain to the least cost impact to the company for trying to meet market demands.

So is Coal Creek going to get up to it's full running capacity in 2007.

I would say it will share some of the pain.

My second, the follow up, is If you look at your committed tonnage currently at say 80 million tons, historically it looks like that by mid part of the year you have probably 70% to 75% of your tons committed for the following year. Do you think that's going to be a similar, is that how similarly it's going to turn out for Arch in 2007 and is that going to be dependent on some of the reaction in the near term to intermediate term markets relative to whether production cutbacks, etc., are you willing to be a little more further exposed going into 2008 given what it seems like a little bit of a change of tone on the pricing of the of the market in the first half of the year.

You know, we're comfortable with, we were comfortable where we were last year, we're comfortable moving into looking at '08, '09 where we are today. Obviously it depends on market conditions, individual bids and negotiations, but the underlying fundamentals of the marketplace are, you know, very attractive as we look out at '08 and '09. And one of the things we're looking at today and kind of debating internally is the weakness in the second half of '06 and as we enter '07 and the marketplace is I think causing certainly Arch and I can't speak for others, but I suspect others are thinking about their capital spending and their investments and the required returns. And will we be prepared for the marketplace that we see developing as some of these new plants come on line. And it's going to be a challenge.

Just one final follow up on capital spending, if you go through the numbers I guess Bob it looks like your maintenance cap level is between $105 and $140 million, is that a reasonable number? Or John or anybody?

You know, Michael, that can move around a little bit. I think on an ongoing basis we are going to say our maintenance capital is somewhere around 150 to 200, this year it might be a little below that. We're basically taking a hard look at our total capital program line by line and we're just not going to spend any capital we don't have to spend. We kind of structured our mines where we think we can do that, maintain our costs reasonably well, at the same time maintain a lot of flexibility. But I think on an ongoing basis our maintenance capital between $150 and $200.

I assume that's budgeting some of the capital inflation we have witnessed over the past 12 to 24 months, and do you anticipate that continuing in 2007.

Well, we, you know, we took a hard look at our capital during the budget process and we built in some pretty good inflation numbers. I would tell you we're not seeing significant softening right now on equipment prices, but we are seeing improvements in lead times. I would expect over time if things don't improve we might see some softening on the buy side from equipment suppliers. But right now we're not seeing that.

We will now move on to our next question and that comes from Jim Rollyson with Raymond James.

Good morning.

Morning Jim.

Steve, look at the Central App for a second, your costs operating wise have gone up somewhere around $1 a quarter this year. Every quarter. And just kind of trying to get a sense of how costs play out through, and that's been relatively stable shipment level, it's drifted down a little bit but not much. And when you look through 07, clearly when you get toward the fourth quarter and you get, you know, Mountain Laurel coming up, that starts to help out costs. Kind of trying to see what the progression of costs you might think would happen in '07 maybe how much Mountain Laurel brings costs down as we move into '08.

I'll turn this over to John in a minute, but, you know, clearly the inflationary pressure whether it was driven by, you know, labor, you know, [inaudible], diesel fuel, et cetera, et cetera. Impacted Central App more than many of the other basins and partly it's because of the overall production of the given mines vis-a-vis the size is of the other mines. Mountain Laurel, we think that Mountain Laurel is going to be the best low sulfur major mine east of the Mississippi and that once it reaches full production, I think you have to think about '08 as full production and all the bugs worked out in the longwall, et cetera, et cetera, that our average cost for the entire Central App should go down. And that's for every, you know, on the average for all the mines included and it's driven by Mountain Laurel obviously and the pull back of Mingo. John do you have...

Jim, I guess if you look at the cost of Central App over the year it's been relatively flat. There was about an $0.86 increase from third to fourth quarter that was primarily driven by an inventory adjustment at our river terminal, Arch Coal terminal. So we had to take a write down with the current weak market conditions. Other than that the the costs would have been flat quarter over quarter. And as Steve said, as we move in and get the longwall moving at Mountain Laurel our costs should improve pretty significantly. So I think long-term we feel pretty good about our cost structure in Central App.

Perfect. And then just as a follow up here, you talked about first quarter kind of being the weak quarter of the year. You have had sounds like transportation issues with the weather. Can you talk about maybe a little more detail on what you're seeing or what's going on in the quarter and maybe what you're expecting for volumes in the quarter, you know, relative to the rest of the year.

Well, we had a couple things that are happening in first quarter. I mean obviously the railroad had some weather issues early in January. We actually had an issue with one of our belt lines at the south loadout at Black Thunder that cost us actually 12 days of production. So that cost us pretty significantly on shipments during January. We have also got three longwall moves during the quarter, two of of had those in the west, one of those in the east, so with all that certainly first quarter will be our toughest quarter of the year.

Any thoughts on volume, overall shipments.

I would say volume will be down a little bit certainly in all regions with the longwall moves.

Okay, thanks.

And next is Justine Fisher from Goldman Sachs.

Hi.

Morning, Justine.

The the first couple questions I have are just clarifications on Cap Ex. Do you think that the Cap Ex for the year would be front loaded or back loaded or if at all or will it be spread out pretty evenly for the year.

You know, typically our CapEx is front end loaded. And then we've got the LBA payments that hit first quarter. We have got a longwall move in the western bit where they're delivering the longwall first quarter, so I would have to say it would be the first quarter or two that we see the biggest spend.

Okay, and those longwall moves, so you have one in first quarter and then, were the three that you talked about, when are the other two?

We have three in the first quarter and we have got one in the second quarter. I think two in the third quarter. No moves in the fourth quarter.

And Justine, to clarify, we're buying a new longwall. It gets delivered in the first quarter. So John was referencing for the Cap Ex piece of that.

Right, okay. Okay. And then as far as Cap Ex that could come from reserve additions et cetera, I know you're targeting $240 to $280 total, but I'm just trying to gauge the potential for that number to increase. With lease payments or reserve acquisitions there or anything on the cards or anything that we could look to that may increase that number.

We think that number will be somewhere between $150 and $200 with the biggest piece of that being our LBA payment during 2007. The $240 to $280 excluded those land additions.

So total expenditure for Cap Ex and those land additions could be closer to $500 million or like between $450 and $500 if you say --

Including the reserve additions, that's correct.

Okay. And can you forego those reserve additions? I mean just because I don't know, is it possible to say well, we're going to put off that spending or no.

On the LBA you can can, it wouldn't be wise, because you have invested. Some of that we just have a plug number for, and we think there's going to be some reserves that come available due to the marketplace conditions and we're presuming we can buy those at attractive prices and certainly you can forego those.

And you're talking about those reserves would be in Central Appalachia.

Well, they could be in several locations, but Central App would be one of the primary areas, yes.

The other question I had was just about unit cost. I know you mentioned in prepared remarks that you guys were looking to take actions at the mines to make sure that unit costs didn't go up despite lower production. I was wondering if you could give us a bit more detail, specifically in the PRB as to what steps you plan to take to make sure we don't see unit cost inflation? Because yours has done an excellent job maintaining lower cost in the PRB, and I was wondering what you were going to do specifically help keep unit costs down.

Well, what we have done is really looked at every region and we've tried to take out our highest production increment. I think we have done a pretty good job doing that. As we look at our mine plans, we look for opportunities to manage work schedules, cut out overtime, drop a CM section, drop a truck shovel spread, we have been able to do that pretty successfully and that will be our focus. And then we've got some process improvement initiatives that w have seen some pretty significant results on, you know, mostly tire life and I think we're pleased with where we are and where we're going. So, you know, I think we're pleased with where we are and where we're going. So hopefully we can manage these costs effectively. We have to manage these in good times as well as bad times, I think we're doing a good job. I mean, everybody is focused on it.

Yes, I know you guys don't on't give cost guidance, even if we see some inflation we're not going to see unit costs in the PRB go above $8 or something, right, I mean.

As long as it's not driven by, you know, the sales sensitive piece of the cost structure, which are driven by price. I mean, if that's the case it would be a good thing.

Right.

But, you know, we're focused on managing the cost and you can always have an event that shoots your costs up in a quarter, major equipment failure, et cetera, but, you know, I would agree John and his team have managed costs very effectively and, you know, the pressures in the west have been managed. And part of that's just the pure size of those mines. And you can do things there that just allows you to manage the costs a little bit more effectively.

We will take our next question from Paul Forward with Stifel Nicolaus.

Hi, good morning.

Morning.

What do you see is the likely volume impact of test burn activity and other events that can allow PRB to act as a substitute for eastern coal over the next one or two years.

You know, I think it's stepping up clearly one of the western roads has indicated that they're open for business. The other road seems to still be going back a bit. You know, there's been announcements with varying numbers of tests and we're unclear whether they're discussions and/or actual tests, but some are going on. I think of equal importance say just for an Arch perspective, we have scheduled some tests and have some discussions going on, and we're covered by confidentiality agreements where we're taking our west out coal and blending it with our PRB coal, Black Thunder coal, and right now all of the indication of tests we have run indicate that we can see a reduction in mercury emissions somewhere between 70% and 80%. We have scheduled some tests from recent discussions and the eastern utility guys are getting pretty excited about that as are we. But that's going to take, you get the right timeframe, that's a two year process.

All right, that's encouraging. And I know you mentioned earlier on the rolloff of older contracts in the western bituminous and you never really like to get too detailed on these things, but can you give us an order of magnitude as far as the benefit that you expect right now on, as those contracts roll off. I mean, I guess what I'm trying to get at, there's a big difference between $5 a ton on 5 million tons versus $10 a ton on 10 million tons. Can you give us any order of magnitude impact that you would expect from that.

You know, Paul we would rather not give you any volumes. Obviously you can look at the market, look at weighted average prices in western bit and kind of make your own conclusions. But I'm a little hesitant to give you actual volumes that are rolling off, but it's meaningful. You know, you have got a market right now in the low to I don't know mid 30s for western bit coal, which is kind of what the index are saying in the publications. So it will be quite a step up price wise.

All right. I tried. And on Mountain Laurel, is the for 2008 you still expect to produce5 million tons out of Mountain Laurel even with the reduced Cap Ex levels.

You know, Paul, you know, we're real excited about getting that longwall operating fourth quarter 2007, you know, '08 will be our first full year of production and we are going to be somewhere between that 4 and 5 million ton production level. I mean, you always have startup issues, we hopefully will work through most of those in the fork, that's still our targeted production level of the

Okay. Maybe one last one, how did your own inventories change during the quarter and was there any sort of regional difference in your own on site inventories.

I don't think there was a real material change in most of our inventories.

Might have gone down in the East. And probably flat out West.

Yes. I would say they've gone down a little bit in the East and fairly flat in Western bit and PRB.

Okay, thanks a lot.

And we will take our next question from Ann Kohler with Caris and Company.

Good morning gentlemen. Just kind of a question looking at your balance sheet and how you kind what your debt, your target debt to cap ratio is, and sort of how you know given the environment that we're in this year, you look at, you know, where that debt level should go versus, you know, funding your capital spending program, you mentioned maybe acquisitions, then also your share repurchase program. How do you sort of prioritize all of those needs and should we expect to see, you know, maybe some additional debt issuance for funding some of those.

You know, we really don't think there's going to be a need. Obviously an acquisition could meaningfully impact something, but we're pretty comfortable with the levels we're in, and we tend to look at the entire balance sheet and we look at the legacy liabilities, which for Arch are extraordinarily low vis-a-vis many in the industry. The debt itself is kind of in a nice target range. And, you know, the cash flow generation capabilities of the company are continue to be very strong. Obviously the the absolute magnitude of that strength are driven by ultimate pricing of the coal. But we're comfortable where we are in our funding abilities of CapEx as we see moving forward, you know, reserve acquisitions as we see moving forward, and wouldn't anticipate anything changing, and share buyback moving forward, but, you know, if there was an attractive acquisition that came up, sure, you know, we would then take a new look at that.

All right, thank you.

Next is Mark Liinamaa with Morgan Stanley. Please go ahead.

Thanks. The rails have been widely reported to be fairly aggressive with their pricing policy over the last couple of years. Are you seeing any noticeable change as they add capacity or in response to the weak market conditions that we have been seeing.

Well, you know, it's hard to say because the actual rail contracts are with the utilities and 99.9% of the time, so we tend to sell our coal FOB the railcar at the mine site whether it's east or west. And I think the utility sector would have to answer that. But I would guess as we're currently sitting here today that the rails are focused on the entire marketplace, but what they have done and their conversations with utilities I really don't know.

But you must get some sort of sense, because it it seems like they have been fairly aggressive in trying to take the lion's share of the economics.

You get a sense are you winning bids or not winning bids given your own price bidding. And you know from a practical perspective delivery costs of coal, whichever region you want to name, is so much cheaper than natural gas or any other fuel source that, you know, if all of the PRB goes up or down a dollar in rail it could affect perhaps where PRB competes with one of the other coals in the nation, but it doesn't change the entire marketplace. And given Arch's diversity east and west, I mean frankly there's a lot of bids that will put an eastern bid in and a western bid in or western bituminous bid in. We have had customers buy from all three on the same solicitation and we have had customers select one or the other. It gives us a very good sense of and competitive position for the marketplace. But we don't know what the rails themselves have done.

Okay. And thanks. And I would be interested in a quick comment about any thoughts with the legislative talk that's going on re carbon, and what have you. That will be it for me, thanks.

Obviously CO2 is one of the issues that, you know, the national debate is going on. You know, there's some who argue the debate is over. I always am skeptical on any argument when someone tries to challenge me that the debate is over. Clearly it is a rising concern. Our view of it is that coal is the answer to the CO2 debate, because if you reasonably take a world view, China will likely is pass the U.S. today, excuse me, this year or next year in CO2 emissions. India is maybe a year or two further behind. If you look at coal reserves of China, India and Russia, it's my belief that those governments are going to use their coal reserves. If you look at some of the efficiencies of the generating stations in those developing countries, or developing regions, they're about 20% less than what we are today in the U.S.. So, you know, is it reasonable to expect those countries to embrace CO2 controls and not use coal or embrace CO2 technology when they really are more focused on perhaps integrating some of the technologies that we develop and Europe developed in the '70s and '80s on NOX, SOX, that sort of thing. And, you know, we see the investment for the technologies having to occur in the U.S. and in Europe as well and then finding a mechanism to pass it to the rest of the world, because we can take any step we want. And if we don't grab the rest of the world it doesn't have an impact. And carbon capture, carbon sequestration technologies are going to be the key. Coal demand will continue to rise in the U.S.. Coal demand is going to continue to rise in the world. And if we're serious about trying to capture CO 2 we have to be serious about carbon capture and sequestration. And that's got to be led by the U.S., and that to me should be where our focus is. And if we don't do that I think the likelihood of an effective carbon policy on a global basis is very small ,and in fact it could become worse than, you know, let's say we have a negative impact on European and U.S. coal use and the research doesn't get done. I think you will see energy intensive industries migrate to the countries that have cheap energy, and given some of the efficiencies and issues that they currently face, you know, the unintended consequence could be not what people envision. So we're watching the debate, we will participate in the debate. We think we have some of the answers, but technology is the answer.

Thank you.

Thank you.

Next is [Sam Martini] with Cobalt Capital.

Hi guys. Just a question coming at it from a reverse angle. There's been a lot of -- throughout all the Western bit over the last 12 months a lot of insurance recoveries, et cetera, et cetera. And we have got the contracts rolling off, or being repriced, somewhat obscuring the top line. Could you give us what you think the cost structure in western bit normalized should be if we add back to 20ish a ton in cost in Q4, normalize '06 for all the insurance recoveries. Does that about put us what you think the run rate cost structure should look like? Or does it change -- or will it change meaningfully when the mix shift changes.

Yes, I think your perspective, from looking at the insurance pretty close. I mean we had almost a $42 million benefit in 2006. As we move into 2007, I mean we have done a very good job in managing our costs excluding the insurance out there, but we have the same cost pressures there we do in other regions. You know, I guess I would say we're somewhere in that 5% to 6% potential increase in western bit region.

That's on a unit basis or on a total, just gross?

Just total basis year over year. But we're doing everything we can to manage those costs. We have been able to do a good job managing it, so I guess I'm cautiously optimistic that we will do a good job in 2007 as well. But, you know.

Okay. And then just a follow up question, in terms it of, in terms of the capital in western bit as it becomes increasingly significant from an EBIT contribution perspective, it does look like the assigned reserves that are currently producing have a reasonably short life, so we would expect to see incremental production being brought on over the next three to four years, is that fair?

Well, I mean we have got a pretty good reserve basin in both of those regions. We've got bond life at West Elk that goes for quite some time. And if you look at the producing region in Utah we're also pretty well established there reserve wise versus our competition.

Okay. And just one final question on the buyback, was there any significance in terms of how you think about sort of mid $28ish price target, is it reasonable to assume that that's a significant level, is it just timing with capital availability or how are you looking at the buyback and the levels of attractiveness of your shares, thanks.

That was just the timing of our buyback at that point. Currently we're in a blackout period and we will have to determine what we believe is beneficial to our shareholders going forward on that issue.

But it seems like a fair assumption to make that you would be preferring to -- in Q4 you preferred to repurchase your shares and cut back your CapEx. I'm assuming because because you see a greater return.

Yes, we saw a greater return at that time.

I mean with current pricing and views, we're always looking at it as I look at it as another project of the company that is competing for capital, and what provides best risk for adjusted return for shareholders. And we're always thinking about that and we will continue to kind of take that approach. The $28 number you referenced was just the timing that it worked out on, but we continue to revisit it vis-a-vis the entire scope of investment opportunities for the company.

And our next question will come from Jeff Gildersleeve with Millennium Partners.

Good morning.

Morning.

Just a follow up on that question, you know, given the long-term thesis intact with the short-term weakness in the coal markets. When you look at the buyback would you look going forward to be more aggressive or how would you think about that or what is the timeframe that you hope to buyback the stock?.

We don't have a specific timeframe. It it will be driven by again kind of, you know, what, what are we looking at in other investments, what's our best risk adjusted return from an overall shareholder. But I would think that, you know, we will be active if you take it on a year basis, we will be active certainly in the next couple years on our shares.

Okay, great. And then secondly, can you remind us the unpriced tons that are committed, are any of those the index pricing or are they all open?

The unpriced committed which is about half of, you know, the number there, basically are index. It's driven by one contract that happens to exist out there.

Okay. Thank you.

And our final question today will come from David Conney Friedman Billings Ramsey.

Yeah, hi guys. Can you give me a number actually of how much inventories you have on hand?

Looking for tons?

Yes, just tons.

You have to remember pit inventory doesn't count any more, David.

Right.

So in the total corporation we have got 2.5 million tons.

And that's clean, ready to sell coal?

Yes.

Okay. Great. And then was there any push back on any deliveries in the fourth quarter from any of the utilities?

Not really David no. We didn't get a lot of push back at all. Really didn't have a lot of carryover tons. So...

That's great.

Not a lot of carryover, and what we did it see in the fourth quarter was some tonnage in the western bit that really during the fire outage that John referenced we got an insurance benefit of $42 million, but we also in the first quarter got hammered because we weren't running the mine. And those tons did basically get shipped in the fourth quarter.

You can't declare a force [majeure] on that I guess.

Well, some of them we could, some of them we ended up shipping, let's just say. That's always a debate with the customers, it depends on the fine tuning of the language of the contract.

It it looks like, I saw you got the Spruce permit is that correct.

We did.

So that's a milestone But I didn't see anything as far as timing of wanting to bring that out. I guess in this environment you're being cautious and holding back on wanting to put that out there I guess?

Right. And it will be substantial capital ultimately for its development. We wouldn't anticipate any time in '07 that that mine would necessarily start what we would call serious development. We may put a few million dollars in knocking in some sediment or environmental controls on some roads, you know, again it just dove tails into some of the previous comments on Mountain Laurel, it's about a 12 to 1 ratio. And our estimate is that in Central App the average ratios are approaching 20 to 1. And, you know, I haven't done the math lately, but it used to be that every ratio point raised your cost roughly $1 a ton. That was kind of one of the old rules of thumb. It's probably closer to $2 today, I don't know, I'd have to redo that. But we think the competitive position of Mountain Laurel will be fine. And Spruce when we ultimately just get it developed just is going to be very, very attractive. And it goes along the lines of some of the earlier questions about West Elk, will be -- given the marketplace, the legacy contracts, the new contracts, given the cost structure of Mount Laurel are -- they will have meaningful impacts.

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

Well, we appreciate everybody's time and interest today in listening to the call and participating in the call. I think hopefully you heard that we were very pleased with the pleased with the results of 2006. As we look at almost every financial measurement, every operating measurement, we are very pleased with what occurred. As we enter 2007 there's clearly some challenges, but we also see some significant opportunities forming, and we think Arch is positioned in the sweet spot to take advantage of those opportunities. As we look beyond the next six to 12 months and look at the marketplace in 2008 and nine, it seems to us that we're gearing up for a very attractive marketplace. And as the new plants come on line, as we get some kind of normal electric demand going on, we think our shareholders hopefully will be pleased when we have this call at the end of 2007 and at the end of 2008. So thank you forever your time and we look forward to talking to you in about three months. Bye now.

Thank you very much. That does conclude our conference for today.