Arch Resources Inc (ARCH) 2010 Q2 法說會逐字稿

Good day, and welcome to today's Arch Coal Incorporated second quarter 2010 earnings release conference call.

(Operator Instructions)

At this time, I'd like to turn the conference over to Mr. Deck Slone, Vice President of Government, Investor and Public Affairs. Please, go ahead sir.

Good morning from St. Louis. Thanks for joining us on this morning's call.

Before we begin, let me remind that you certain statements made during this call, including statements related 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 filed with the securities and exchange commission, may cause our actual future results to be materially different than those expressed in our forward-looking statements. We do not undertake to update our forward-looking statements, whether as a result of new information, future events or otherwise, except as may be required by law.

I would also like to remind you that you can find a reconciliation of the non-GAAP financial measures that we plan to discuss this morning at the end of our press release, a copy of which we have posted in the investor section of our website at ArchCoal.com. On the call this morning we have Steve Leer, Arch's Chairman and Chief Executive Officer, John Eaves, Arch's President, Chief Operating Officer, and John Drexler, our Senior VP and CFO. Steve, John and John will begin the call with some brief formal remarks and there after we'll be happy to take your questions. Steve?

Thank you, Deck. Good morning everyone, and thank you for joining us this morning.

As a first point, I would like to talk a little bit about safety. At Arch,, we continue to emphasize safety as a cornerstone of our Company culture. It's why we have consistently been a safety leader in the industry over the years, and is why we're on track to deliver record Company safety performance again this year. However, sadly, we lost a supervisor at our Lone Mountain operation, Jim Carmack, in a fatal incident at the Clover Fork Mine in June. Our thoughts and prayers are with his family, friends and co-workers. Personally, and as a Company, we remain deeply committed to eliminating all injuries at all of our mining operations. And to taking every possible step to ensure that every one of our employees returns home safely, every single day.

Turning now to our quarterly financial performance, we achieved substantial increases in several key metrics, sales earnings and cash flow, versus the second quarter of 2009. Revenues were up on higher volumes and pricing. And cost control was solid despite the challenges at the Dugout Canyon Mine during the quarter.

In total, we earned $0.43 a share in the second quarter, if you exclude sales contract amortization, related to the Jacobs Ranch acquisition, and generated $199 million of EBITDA. These strong results include a gain of $26 million after tax, for a reserve for equity exchange for the Illinois Basin coal producer, Knight Hawk. Our initial 33% equity investment in Knight Hawk has proved fruitful in terms of profits that it has generated and in terms of market intelligence that we have gained in keeping pace with the developments in the region. These benefits, along with our view of the long-term future of the Illinois Basin, are the reasons why we chose to increase our investment in Knight Hawk to 42%, in exchange for a contribution of 68 million tons of Company-owned reserves. Knight Hawk is one of the region's top 10 producers.

Arch and its predecessor companies have a long and successful history of operating in the Illinois Basin. We've maintained a sizeable low-chlorine reserve position there, in addition to our Knight Hawk ownership position. The Illinois Basin represents a logical future growth opportunity for Arch and we have strategically chosen to reenter the market in a flexible fashion as the market opportunities develop.

Turning now to the macro picture. Our strong operating performance was amplified by better coal market conditions that we've seen thus far in 2010. While the market is nowhere near the heights achieved in 2008, we've been encouraged by recent trends in the steam coal markets. It appears that the steam market, which bore the brunt of the economic downturn over the past 18 months, is gaining positive momentum. Domestic coal consumption has been strong for the first six months of the year, up more than 5% by our estimates. This growth was driven by favorable weather trends, a pick up in industrial activity, compared to the low levels experienced last year and market share gains versus competing fuels.

Weather in 2010 has been good for power demand and coal burn as well. It was cold and snowy across the country this winter, and it has been a hot summer thus far, in the heart of the coal-powered regions, particularly those that burn PRB. We expect electric demand for July to be near record levels. Industrial activity has increased this year as well, contributing to power demand growth, but is still below pre-recession levels. Furthermore, a lack of hydro availability and economics favoring coal over natural gas for power generation, have contributed to coal gaining back some of the market share lost in 2009.

The growth in coal consumption has been coupled with a decline in domestic coal production in the first half of 2010, versus the first half of last year. Based on released MSHA data to date, US coal production nationwide is projected to be down about 15.5 million tons through June. Central App. is leading the decline off by about 12 million tons, followed by the Powder River Basin, which is down about 2 million tons.

As a result, US coal stock piles at power plants are correcting at a rapid pace. Stocks have declined considerably since their peak last November, and are within target levels in some regions. In fact, stock piles dropped four times the normal decline in June alone and we expect a similar result in July. In the Powder River Basin served regions, there was an estimated 59 days of supply available for those plants at the end of June. In line with the five-year average, and the lowest supply on hand in the country.

July heat has kept the pressure on, and we believe PRB stockpiles will be below normal levels by the end of the month. The forecast for August looks hot as well. Consequently, PRB price indexes are up 25% for 2011 delivery and up 13% for 2012 delivery since the beginning of the year. Stock piles are coming down in other regions as well. In Central App., stock piles came down aggressively in June but remain higher than the five year average. In Western Bit., stocks fell in June versus a normal build in the region. However stock piles in the region, while small on a total tonnage basis, remain high in terms of day supply, due in part to cooler weather and delayed improvement in the underlying industrial economy in that part of the country.

Looking ahead, we expect coal consumption in 2010 to grow meaningfully versus 2009. Beyond the growth and demand at the existing power plants, we also have six gigawatts of new coal fuel generation coming on line this year alone. Three gigawatts of which is already on line. In total, we expect the build-out from new coal fueled generation from 2010 to 2012, to create an incremental demand of 44 million tons annually, much of which is being supplied by the Powder River Basin.

Moreover, we continue to believe that a strong sustainable US coal export story is developing. Despite a slight stalling in the global and domestic steel market utilization as of late, net coal markets remain relatively tight. We also forecast demand in global sea born trade to outpace supply over the next five years, creating more opportunities for US steam coal to move abroad off the east coast, through the gulf and off of the west coast.

Frankly, one of the reasons we're investing in reserves in Montana is to build a platform for future growth to serve both the domestic and export steam markets. It is also why we have a long-term supply strategy, -- long-term strategy of expanding in the Illinois Basin. With continued supply declines of high BTU coal from Appalachia, we expect the PRB, supplemented by the Illinois Basin, to be called upon to replace the lost eastern tonnage, and will fill a new demand -- and to fill new demand requirements. We also expect Illinois to compete in the sea borne markets, particularly reserves such as ours, which are low in costs and low in chlorine.

In summary, we have positioned Arch well to capitalize on such trends, with our unpriced sales position and strong operating platform. Looking ahead, we're confident that we can continue to manage through any near term operational issues and fully expect to build upon our solid performance in Q3 and Q4.

Before I close, I would like to take a moment to honor Frank Burke. An Arch Coal director who passed away suddenly last weekend. As an Arch director for 10 years, Frank was passionate about good corporate governance and the energy industry. In his role as audit committee chair, he was instrumental in forging Arch's strong, conservative and exacting financial controls. Frank was held in the highest esteem by the board and the management team alike. And I personally benefited from his leadership and good counsel many times over the years. He has left a lasting impression on our organization and he will be truly and deeply missed.

I will now turn the call over to our President and COO, John Eaves, for a discussion of Arch's operating performance in the quarter. John?

Thanks. As Steve discussed, we're starting to see positive momentum in the steam coal markets. Recent Central App. prices for 2011 are near $75 per ton, and indices for PRB coal for 2011 are over $15 per ton. Prices are moving up as coal market fundamentals improve. Due to the positive power demand trends, we're seeing an increase in RFP activity from generators that need to replenish stock piles. Since our last update, we selectively committed roughly up to 10 million tons of steam coal for delivery in 2011 and 2012, at or above the region's forward price curve that prevailed when the coal was committed. Approximately five million tons of the total committed result from a contract reopener. We also committed one million tons into the met market for 2010 delivery, at average net back mine prices north of $130 per ton.

Except for available met coal, we're effectively sold out in 2010, with 5 million tons committed, but open to market pricing in the second half of the year. We're also have roughly 5.5 million tons of coking or PCI coal committed to date. While met activity slowed modestly, we still expect to sell six million to seven million tons into the met markets for the full year. At present, we have between 55 million and 65 million tons uncommitted in 2011. In between 90 million and 100 million tons uncommitted on 2012. We also have roughly 20 million tons committed but not yet priced in each of these outer years. Looking ahead, we will continue to remain patient and selective in committing our open tons in future years. Preferring to layer in commitments during periods of market strength.

On the operations front, our mines achieved solid performances during the second quarter. In the PRB, prices improved modestly and cash costs were down again from a solid first quarter 2010 performance. In fact, costs have declined 12% since the second quarter of '09 and have declined consecutively for six quarters now. This step-down in PRB cost structure reflects a benefit of integrating Jacobs Ranch into Black Thunder, as well as lower diesel costs due to roll-offs of higher priced hedges.

In Central App., prices were up 8% from the first quarter of the year, and were up more than 20% from the year-ago quarter on higher met prices and volumes. We shipped more than 1.5 million tons of met coal in the quarter just ended, representing nearly half of our total shipments in Central App. We also expect met shipments to increase in Q3 and Q4 and we believe our total net coal sales capabilities could approach eight million tons by 2011 if market conditions warrant. Cash costs in Central App. were $49 in the second quarter, up slightly from the first quarter, due to increased met coal production, as well as higher sales sensitive costs stemming from the increase in realized prices in the region. Our cash cost structure remains one of the lowest in the region.

In Western Bit., second quarter prices rose and so did operating costs when compared with first quarter. The cost increase mainly reflects the effect of lower volume levels and costs associated with the outages at Dugout Canyon. During the quarter, we had two unrelated instances occur at the Dugout Canyon mine in Utah.

The first event, on April 29, caused us to temporarily suspend production at the mine when a small increase in carbon monoxide levels was detected in a mined out area that was in the process of being sealed. Upon permanently sealing the mined out area, full production resumed on May 21.

The second event occurred on June 22, when the mine experienced an ignition on the long wall that resulted in the evacuation of all underground employees and the suspension of production at the mine. Since that time, we've been working with MSHA to temporarily seal the active long wall panel, to render the atmosphere behind the seals inert. Inert status was achieved on July 17, and there has not been any indication of ongoing combustion. We estimate the impact of these events for the 36 days the line was idle during the quarter to be $6.5 million. It is important to note that we proceeded with an abundance of caution in each instance, with a singular focus insuring the safety of our employees. The systems that we have in place have allowed the employees to exit the mine both times without incident.

Going forward, the mine has been idle for a month of July so far ,and thus has impacted the third quarter by a comparable amount to last quarter. In the interim, we're working with customers where possible to ship from other mines in the region or reschedule shipments as the dug-out inventory has virtually been depleted by these two events. It's not clear when production will resume at Dugout, with MSHA's concurrence, we've had a small team of people working in the mine this past week to prepare for the re-ventilation of the long wall panel. It will take a few weeks to return the mine to full production once the long walls re-ventilated.

Turning now to West Elk, I want to briefly mention that the construction of the preparation plant is going well, and we expect to have the plant up and running in late August. Looking ahead, we would currently expect to be at the upper end of our $25 to $27 per ton operating cost range for Western Bit. for the full year of 2010. That is, assuming Dugout resumes production at some point during the third quarter.

Lastly, I would like to recognize the Black Thunder operation, which has worked for more than two years without a single lost time safety injury, and the Coal Creek Mine, which has worked for more than four years without an injury. These records are impressive and I would like to personally thank the employees at these locations for their commitment to upholding our core value of safety.

With that, I will now turn the call over to John Drexler, Arch's CFO, to provide an update on our consolidated financial results and guidance for 2010. John?

Thank you, John, and good morning everyone.

First, I'd like to address the quarter's cash flow and ending balance sheet and liquidity position. Our cash flow from operations in the second quarter, which totaled $166 million, was the highest quarterly result since the fourth quarter of 2008. A reflection of the ongoing strengthening of our business. Despite $140 million of capital spending in the quarter, which included an $86 million payment to the state of Montana for the Outer Creek reserves, we did not have any increase in our short term borrowing. Year-to-date, we have paid down debt by $24 million, and expect to have meaningful free cash flows for the remainder of the year. At the end of the quarter, our debt totalled just under $1.8 billion, and the debt to capital ratio was 45%. Quarter end liquidity was in excess of $850 million.

Also, I would like to highlight a few items included within our financial results this quarter. First, the transaction that increased our investment in Knight Hawk resulted in a pretax gain of $41.6 million, or $0.16 per share after tax. The gain stems from the contribution of [mina] reserves, which are required to be accounted for in the transaction at fair value. Offsetting this gain was the impact of the temporary idling of Dugout Canyon, which reduced operating profits by nearly $6.5 million, or $0.03 per share.

We also made a $5 million contribution, or $0.02 per share, to the Arch coal foundation in the second quarter, which drove the increase in SG&A. The foundation was originally established in December of 2005, with an initial $5 million contribution, to support educational and civic endeavors that enhance the quality of life in the communities in which we operate.

Furthermore, we incurred a pretax loss of $4.6 million, or $0.02 per share, associated with our trading platform. Let me remind you that a portion of the loss relates to trading activities associated with freeing up volume from some of our existing commitments, in order to take advantage of met markets.

With that, let me now discuss our outlook for the remainder of 2010. Our full-year guidance range includes the gain recorded on the Knight Hawk transaction, which is offset by a range of estimated impacts from the current Dugout idle. We expect the following. Volumes from company-controlled operations to be in the range of 147 million to 155 million tons. EBITDA in the range of $718 million to $790 million. Adjusted earnings of $1.10 to $1.40 per share. The adjusted EPS estimates exclude an expected $33 million or approximately $0.13 per share of non-cash and tangible asset charges related to sales contract amortization. DDNA, excluding sales contract amortization in the range of $372 million to $376 million. And capital expenditures, including reserve additions, of $315 million to $335 million. The CapEx estimate includes the payment for the outer creek tracks, along with additional land purchase requirements and incremental capital to expand met coal sales opportunities.

We continue to forecast even better results in the second half of the year and believe we're well positioned for the ongoing recovery in coal markets which we expect will continue into 2011 and beyond. With our improving results, and modest capital expenditures, we expect to have significant free cash flows for the remainder of the year. While we will continue to evaluate all potential uses of free cash, our immediate focus will be to continue to strengthen the balance sheet.

Executing on our strategy of operating safe, low-cost, environmentally responsible operations will continue to generate significant value in this improving coal market. With that, we are ready to take questions. Operator I will turn the call back over to you.

Thank you very much. (Operator Instructions) Our first question from Michael Dudas with Jefferies.

Good morning, everybody.

Good morning, Michael.

My first question to Steve, maybe you could share with us recent updates on the eventuality, participation from Arch and the opportunity if it is there, for WestCo support access into the Pacific Basin?

Well, we continue to look. We've certainly had discussions with all of the potential and existing force out there and continue to negotiate, so our expectation is that over the next several years, expanded port facilities will be installed, I think people are at different stages there than in the actual ports -- and it's a little premature to pick one or the other at the moment. But I would say we're actively engaged and our expectation is that over the next three to five years, we will see opportunities expanded for exports through the West Coast.

And your market intelligence gives you the comfort that that is where the global coal flows are heading?

Well, I mean, when you sit back and really -- our modeling and certainly not just ours -- but some of the people that we buy information from, in terms of consultants, et cetera, if the globe is growing at somewhere near 4%, it ends up that we have significant demands on coal and exported coal from around the globe and the Pacific Rim is clearly leading the way.

So -- we're forecasting actually shortages of both steam and to a lesser degree met over the next five years, on the assumption of global growth at -- approaching that 4%. So, yes. The short answer is we're pretty comfortable that that market is going to expand. But I don't want to diminish, as I made in my remarks or said in my remarks, that we see export opportunities off the East Coast and the Gulf Coast as well.

My follow -- my second question is for John. John, could you share with us your thoughts on your marketing opportunities in the second half of the year for your met coals and maybe with an eye towards PCI -- can you confirm some of the quality spreads widening that people are at least speculating or thinking about and you're foreseeing a relationship that would allow that to maybe tighten as we move to the fourth quarter this year?

Michael were -- we have seen a little bit of slow down in the met market, but as I said in my comments I mean we booked 1 million tons second quarter plus $130 at the mine and most of that was the high vol not the PCI. And I would tell you we expect that to be the case in the back half of the year. If we go to kind of the mid part of our range, the 6.5 million-tons we've got probably a little bit less than 1 million tons we need to place third and fourth quarter.

We're seeing some interest in the coal. I mean, clearly we're not seeing the prices we were until last quarter. But, domestically as well as internationally, I think the guys are cautiously optimistic we will be able to place that coal, at numbers that are well into the triple digits. The spread, it's anybody's guess right now between rank A and rank B, but we've seen somewhere between $20 and $30 spread between those two products. But clearly we've seen a little bit of a slow down, but we're not ready to panic. We think the back half will pick back up, and we're well positioned to place those tons. I mean, we really haven't seen any pushback on any of our met shipment through the first half of the year. So I'm optimistic third and fourth quarter we will be able to place all that and most of that will be in the high vol versus the PCI markets.

We'll take our next question from David Conney with FBR Capital Markets.

Hi, gentlemen.

Good morning, David.

Could you quantify what you think the extra burn -- coal burn is from winter weather, as well as summer weather and then kind of what you think year-end inventory levels will be?

I'm not sure I know the exact weather implications because we obviously, as I have stated a couple different times. If you look at '09, it was our view that coal generation was disproportionately impacted by the economic slowdown, because many of our industrial plants of America are located in coal fired power regions; simply because that has the lowest electricity, and it -- as a general statement. And so when you saw the decline in the recession impact of 20% and 30% in some of the industrial manufacturers, you saw coal burn take a proportion of that or all of that hit. As a consequence of that, we've also seen coal probably get a disproportionate gain as those industrial markets come back, even though they haven't hit pre-recession levels.

What we're seeing right now is the stockpiles come down, as the combination of that, plus the winter and summer weather, right now, we expect to end July with PRB stockpile below five-year averages, and probably see Eastern stockpiles more or less at the top end of the range of the five-year averages. Our total expectation is that we will end the year on a national average. I think the numbers are below 60 days and into the kind of the mid-to-higher 50's, in our modeling. And what is interesting on current trend rates, particularly on the supply side, as we look at it and project out assuming, no double dip, but just, anemic growth in the economy and normal weather pattern. The trend lines take us to very low levels and stockpiles by the end of 2011 and really kind of unsustainable numbers. So it's a dramatic view as we look forward compared to -- look forward 18 months compared to the last 18 months and it's almost a night and day comparison. So it builds on some of our positive expectations for the second half and then on into 2011.

One of the surprising things I think from our side, is that even though there is an abundance of PRB, maybe capacity -- maybe that -- sometimes that gets overstated. With the new power plants that have come online and plus the weather effect, you would have thought that you would have saw a PRB supply actually increase year-over-year instead of being down modestly. Why do you think that is?

I think, again, is that, I can't speak for other producers and PRB; but as we look at the market, we're cautious about adding any of our parts capacity and frankly, when you look at it, we parked the worst stuff. I mean, it is just natural for an operating group. If we have an -- well, I don't know what John 160 trucks or something like that?

Yes.

At Black Thunder complexes we didn't park the top 10, we parked the bottom 10. And so, even if they back, they typically aren't as good as your newer trucks. I think the other issue that gets often overlooked there is that, Powder River Basin slowly but extricably is progressing to deeper and deeper ratios that takes more equipment to move more overburden to uncover the same amount of coal and you've seen that have marginal impact out there. And then on top of it, while the markets improved and certainly, with the forward curve above $15, it has great positive views from a Company ike Arch, but nonetheless that is not a number that necessarily makes new capital flow into the region.

All right. If you look at the fact that you guys got a permit at Coal-Mac, which congratulations -- how long does that extend out the life of Coal-Mac?

David, we've got a pretty good reserve base there and I would say over the next four to six years, we're probably in pretty good shape. Now, getting that permit clearly will build a mine reserve but it will raise our cost. We will have to invest in some trucks. We have much longer truck hauls. But I think we're in pretty good shape with Coal-Mac for the next several years without any problems with permits.

David that was really a test on that permit in some respects. I mean, frankly we made significant -- significant changes to the permit as proposed. As John said, that does raise our cost. If that was a stand-alone operation, we would not put capital into it. It is because it is an extension of an existing operation that we could stretch and make it work. But -- it in no way changes our view of the permitting situation. In fact, in some ways it reinforced our view of what is going to happen in Central App in terms of permits.

It seemed like the EPA put out a pretty detailed press release about how stringent it -- and how they were very happy and putting very high restrictions in before you can get that permit. How much -- how much has things changed for you to be able -- and you talked -- you kind of highlighted a little bit. What did you do specifically to be able to get a permit?

Well, the biggest change we've knocked off a couple valley fills -- and then, there is a whole host of other things. But that was the biggest change. As John mentioned, there's a lot of haulback and increased cost as we progress forward. It's not going to affect the next couple years, but as those last four years of the permit it will impact the cost structure and again, when you look at it, it would be such that in today's world, if it was stand-alone, we wouldn't have pursued it.

We'll take our next question from Pearce Hammond with Simmons & Company International.

Good morning.

Good morning.

Given recent regulations from the EPA for coal plants, it is widely expected there are going to be a number of retirements over the next few years. When you look at your utility customers do you think they are in a better position to deal with these new regulations, or have your customers on average installed a little bit more in the pollution control equipment side, or do they feel better because they are burning Powder River Basin fuel?

I think most of them feel better if they are burning Powder River Basin fuel because it is lower cost and typically a very high dispatch for PRB plants. I think when you look at the total stock of coal plants in the United States and you look at the regulations which are still being promulgated, I think the biggest problem with the -- that our customers are relating to us is that they -- we still don't understand what the rules are going to be and they're wrestling through that.

But nonetheless if you take the top -- excuse me there are like 300 plants that are 200 megawatts and under and as we move forward, we would expect some of those to be impacted by the transport rules and others. We'll have to see, and some of those might close. But when you then look at the actual coal burn and capacity utilization of those bottom plants and it's a big number of plants when you just look at it alone. But the actual coal burn is something like 10% of the US coal burn.

So some of those might close. Certainly we wouldn't think all of them. You would also see some capacity increases at other existing plants that are kind of in the middle of the result, so, our customers are still sorting that out and probably will be for the next several years so -- the knee-jerk we wouldn't want to portray it as positive, but it's not as negative as one might be led to believe if you believe -- read certain publications.

Pearce, I would say generally conversations with some of our customers would be -- the initial reaction would be that it should help low sulphur coal. Without digging into it and fully evaluating it, it should be a benefit to say PRB so -- we will have to wait and see where this all sorts out. But initially, I would say that would be the case.

Great. And then my follow-up question is -- Steve, what do you see as European interests for Illinois Basin coal longer term? And do you think Illinois Basin coal could travel to the Asian market?

You probably need the expansion of Panama, to make Illinois Basin competitive in a longer term basis, or a consistent basis. But the -- I think the Europeans are starting to face the issues of, as you've seen the Pacific Rim, again notably India, draw off more and more of the South African coal, and then, Asia also pulling in some of the Colombian coal, I mean once the European recovery occurs and we can certainly debate when that might be, but, there is a nervousness that we're seeing by some over there that are starting to say, Where is the coal going to come from? It's going to come from the US and certain customers will be able to take the higher sulphur Illinois Basin type coals and then others will take PRB -- I mean, we have exported PRB through the Gulf before, as have I believe some of the others, but I can certainly speak for ourselves. And then you'll end up seeing East Coast exports as well.

So it really comes to a changing of the coal flows that we're seeing starting with South Africa moving to Asia and backed up with some Colombian coal. So, yes, we see that as a potential long-term market for Illinois Basin, PRB and East Coast.

Yes, some of the discussions that we've had with some of the European customers are looking very hard at Illinois Basin and I think there's actually been some real volume go out of the Gulf from Illinois to Europe. But they're also looking at the Illinois PRB blends that we think has merit. As the inventories in Europe come down, the economy starts to improve, we think there is opportunity for Illinois and PRB into Europe.

And we have actually set up a terminal -- or have interest throughput rights at a terminal for doing that and in fact did it in 2008.

We'll take our next question from Curt Woodworth from Macquarie.

I was wondering -- followup on some comments made earlier -- if you look out to 2011 and assume you get a little better volume in the PRB, either from extend of inventory liquidation or some share gains from Central App -- now the incremental margins given the scale on the PRB are pretty high, but you also talked about some degradation of the mines and some high cost capacity that maybe you're not running right now. So net-net when you look at the benefits of operating leverage for some of the factors you mentioned earlier would you think that, cost performance in that environment would kind of be similar to where you are now or -- how should we think about that?

I think incremental capacity moving forward will have a higher cost after you kind of clean out that noise that you talked about there. But, in -- and it's always been our view. If you think about future reserve acquisitions or -- they are going to be higher costs than a lot of the current reserves that are being produced and equipment. No one has focused on it, but in longer term it has implications for the Powder River Basin because of the global expansion -- not so much for the US. Right now, lead times for large mining trucks are near a year and in talking with manufacturers, the expectations are that that will continue to climb, as we go through 2011. And in those markets, when the backlogs are building, we've always found that equipment doesn't get cheaper in that process. So it will have implications on costs.

I think the advantage of a mine like Black Thunder, particularly is just -- it is an enormous volume and throughput and the guys have done a great job in managing the cost structure while the mines been at -- at really reduced production levels and so, as we would see it, our next increment of production would -- the higher cost would get offset by the higher volume, just because where Black Thunder's operating today.

I mean, it is -- in my closing remarks I will make a few comments about cost but -- really, if you look at the quarter and John didn't -- certainly talked about it but, I mean, the mines did an outstanding job across all the cost structures. We had normal mining issues in many of the mines and then we had, more or less extraordinary issue at Dugout and again the costs were great. And really, the cost increases in Central App, while not very large, if you adjust for sales sensitive, that kind of eats up half of it and the other half was more or less moving steam into met. So, I'm very pleased with the cost structure and think we're in good shape moving forward.

Yes, I know the cost performance was excellent. Then on the Western Bit -- can you just remind us the timing of the contract rollovers? I think you have 8 million to 9 million-tons that rolled over this year I think around $30 a ton. Can you just provide the specifics on the timing there?

Yes, as we progress through the back half of the year we have pretty significant contract roll-off. I would tell you the one thing that is a little bit of a concern right now -- we really haven't seen the demand in that market that we were hoping for. Clearly at an average $30 price, as we roll that business off and reprice it and you look at the indexes today, they're in the mid $40 range. So, we would hope to reprice that at much higher levels. But I certainly want to see the demand start to improve the back half of the year as we look at repricing that business.

And what was the volume there? That it rolls off?

It is pretty significant. I think you're in that range, the number you mentioned.

Okay great. Thanks very much, guys.

We'll take our next question from Shneur Gershuni with UBS.

Hi, good morning guys.

Good morning.

I guess my first question is just -- with respect to your intentions with respect to contracting for 2011. Given the direction of inventories we've seen the pricing curve step up to over $15 at PRB and so forth. Are you interested in logging up tonnage at these levels, or are you going to sit there and say, let's wait until the end of the summer and see where the inventories end up. Maybe we can get a little higher. I kind of wanted to understand your philosophy. And then as a follow-up to that, if you could talk about your idle capacity in the PRB. Would you be looking to bring that back on, given the strength in the market right now or would you wait first until you're contracted up on the existing tons before considering that?

I think I can kind of answer all those together but, we said publicly that our capacity in the PRB for Black Thunder is about 140 million-tons. Clearly we're not running at those levels right now. We said Cold Creek is in that 10 million to 12 million-ton range. We said we could get to 15 million with very little capital at all. We still think that's the case. The way we look at the market -- we've been very patient in our marketing approach and we will continue to do that.

As we indicated in our release, we sold 10 million-tons for 2011 and 2012. Half of that was one contract reopener that we repriced. So, we are selling coal into the market. We still think there's are a lot of room for PRB prices to move upward. We're not willing to go out and mortgage that for long periods of time. We've always said we would like to book everything at the top. We're really not smart enough to do that. So, we layer business in as we see markets improve and clearly we're encouraged by the direction of the market, the $15 plus. But we think there's a lot more room there before we start really locking in serious tons. So, it's something that we're always looking at. But, I would say we're cautiously optimistic right now in what we're seeing in the market movements.

Okay, and then I was wondering if -- two additional questions. One is a follow-up to David's question, about the permit that you recently received. Is -- is it your understanding is that is what it is going to have to take to get a permit now out of EPA and the Army Corps at this point? Obviously you followed some pretty strict rules, with respect to the water connectivity issues and so forth or do you think there is still some negotiating room to go with respect to these standards?

I don't know what the EPA standard is to be quite frank. It was a long drawn-out negotiation. It was very difficult. Our view is that the permitting system in Central App is -- will remain very, very limited. You may see a permit or two squeeze through the system. But, there is no -- there is simply no indication that many of the permits are going to be released. And, we'll see.

But, our expectation is that you will continue to see permit pressures in operations in Central App and it is going to become very acute I think for the industry, in 2011, and certainly by 2012. And some press and other comments out there in the world publicly have indicated that. And normally what you see happen is people go back and mine higher reserve ratios because they're trying to keep their mines open and that raises their costs and then, you -- at some point you simply don't have anywhere to go. And that ends up closing down the mine. It was nice to get the permit. It was a difficult process. We felt that we gave a great deal in that process and for the next one I wouldn't expect it to be easier and we'll see.

And then just one final question -- with respect to Jacobs Ranch, do you feel that there are any synergy opportunities left at this point, right now? Or are we just going to see the annualization of those synergies roll through the balance of this year?

I would say if you look at the step-down in costs, second quarter 2010 versus second quarter of 2009, a 12% decrease and I would say a large percentage of that decrease was synergies. So, we continue to get those synergies we advertise, which I think we're getting more than that. So, we're cautiously optimistic as we move through the back-half of the year. We'll continue to make improvements.

If I was modeling our costs in the PRB right now, I would model it in that mid $10 range, plus or minus. We hope we can improve on that but I'm very pleased with the synergies we've gotten out of this transaction so far and we hope we can continue to improve on those. From an equipment efficiency standpoint, from a blending standpoint, from a (inaudible) standpoint, we're pleased. And I would like to give kudos to the operations teams at Black Thunder. They have done an incredible job in getting those costs really at much lower volumes than we anticipated.

Great. Thank you very much.

Thank you.

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

Hey. Just one quick follow-up on the Coal-Mac question. You had mentioned some -- that there would be some capital requirements as you -- as you move into newly permitted areas over the next couple of years. Just curious, when you think about budgeting that, is there -- can you anticipate given how difficulty it is to get a permit, that there is going to be some kind of lightly used equipment out there on the market, that has no home?

Hey, Paul. Really when I referenced some additional capital I was talking about maybe a couple trucks. We tried to plan for that. Beyond that, we don't see any really major capital. Now obviously we'll have to retool when our equipment gets older. But, in terms of this permit and any additional requirements, I think, max, probably two trucks to get that done. And, with lead times we're seeing that is kind of in our planning process right now. So I don't really see a lot of impact from that.

All right. On the -- I guess a question on the Central App pricing during the second quarter. You had a big mix shift toward met coal during the quarter and prices -- average prices were up about $5.50 a ton. Can you talk about, why the mix shift didn't maybe offer a little bit more of a step up in pricing in the quarter? Is that just a question of timing of higher priced contracts and as you look to Central App, average realized pricing in the second half, kind of where do we go sequentially after the second quarter?

Yes. Well, I mean, I think we shipped about 1 million tons first quarter met. We had 1.5 million tons of met second quarter. We would expect to step up those volumes third quarter and fourth quarter. We indicated that we sold about 1 million tons during second quarter plus $130 at the mines. So pretty attractive pricing. We still have the 1 million or so we have to place second half of the year, but we committed 5.5 million tons with a mid target range of 6.5 million. So clearly we're going to have to step those met volumes up the back half third and fourth quarter. So, yes I would expect to see those. As I mentioned earlier we think the demand is out there, maybe not at the prices we have seen but, we'll remain to see what happens there. We're -- but clearly the met volumes will pick up in the back-half of the year.

Right, well, that's -- on volumes. But when we see an average pricing effect, though, relative to the second quarter?

I think, Paul, you're going to see a step up on the pricing as well. At this point I think it's too early to tell. It depends on what we sell that million tons for, but I clearly think you're going to see a step up from second quarter average Central App prices.

As a reminder please ask one question and one follow-up so all questions can be answered. We will take our next question from John Bridges with JPMorgan.

Good morning, Steve, everybody.

Good morning, John.

Hi. Just wanted to fall up on the Knight Hawk sales. You mentioned Panama. But Panama is in construction and not that far away and and you must be planning for that. How do you see exports from Knight Hawk and the rest of your Illinois Basin holdings and what sort of volumes do you think you can get down the Mississippi?

Well, again, I mean, I'm not sure there is an absolute limit on -- I'm sure there is in some sense volumes on Mississippi but for us, it comes down to throughput through the various barge loading facilities and we haven't encountered that. If you look at the history -- the long history of Arch, we've put coal in the ground in Mississippi or Louisiana and more often than not, we use the midstream and I'm not sure there's an absolute limit on midstreaming. So, it's a longer term development. We see that as an opportunity for some millions of tons down the road. But we'll let the market really dictate that and play it out.

But, our view and we're still consistent with our view of the Illinois Basin, is that as Central App declines, the first place customers are -- will reach to in the next three to four, five years of Powder River Basin, there will be some additional expansion in the Illinois basin during that time -- call it 10 million-tons or whatever number you want to model. And when you do all the math, and the increases in overall demand out there, driven by the new plants coming along, the other East Coast and West Coast exports, met crossover tons, we see a nice market developing. But it's -- still we're thinking out three to five years, not one to two significantly.

Okay. And as a follow-up, the wash plants at West Elk. What is the quality of the coal that's coming out of there now? Have you got through the bad patch? Will it just be an insurance policy or will it be working?

John, we just moved into the second panel of the e-seam as we indicated earlier. We would encounter some higher ash coal. We can blend that off over the next couple of weeks. Our plan is the preparation plant will be on I think around August 20, -- back, the last week or two of August. The quality there is in the 11.4, 11.5 BTU range. So we think we're in pretty good shape there. We'll probably have maybe a two-to-three week gap where we have to blend off this higher ash coal. But we've taken that into account in our planning and feel like that won't be any problem at all. So, the plant has really come on budget, on time, and we're excited to get that up and running.

Okay, thanks, guys, and congratulations.

Thank you.

We will go next to Mark Liinamaa with Morgan Stanley.

There is a perception that the PRB painted a fairly good story but it's going to be chronically over-supplied. You've got most of the tier 1 capacity that is not running now. Can you -- I guess on just a very simple level -- talk how quickly and how much you could bring that on?

Well, I -- we're not going to get into too much detail on that. But our view of it is that we're pleased with the way the markets have developed. It hasn't reached a number that makes us want to put additional capital or bring additional equipment back into the mines. But we're getting closer to that.

But the trucks and equipment that's been parked realistically could be brought back, in a four or five-month timeframe if you had to go through and refurbish anything or do repairs on it. But the next big increment of additional capacity would be new equipment, new shovel truck spreads and that's a year to two-year process as we sit here today and it looks like that could be lengthening, particularly in the very large equipment truck availability.

Okay. Thanks. And just quickly, you specifically mentioned low chlorine a couple of times in your commentary related to the Illinois Basin. Can you just -- for me anyway -- I think I understand it all -- but how big an issue you expect that to be? That's it for me, thanks.

We think it's going to be an enormous issue as Illinois develops. Many people forget -- I mean, Arch really in many respects cut its teeth in Illinois, if you go back and and we have mined almost continuously -- I won't say continuously in the Illinois Basin for 40 years. And chlorine is a big deal when it goes into the utility. There's a lot of folks trying to develop technology to handle chlorine better, but you basically make hydrochloric acid and it eats up the tubes and the boilers on high chlorine content coal.

We have always -- just like part of our strategy has always been focusing on, substantial low sulphur reserves, in the Illinois basin, high sulphur but we always focus on lower chlorine. Because we think over time, as the market really starts to expand and you see significant amounts of Illinois Basin reenter the market place, the low chlorine will sell the a premium.

Okay, thanks for that, bye.

We'll take our next question from Jim Rollyson from Raymond James.

Good morning, everyone. Most of the stuff I had has actually been asked and answered, but a couple of follow ups. John, you talked talked about getting to 8 million-tons, possibly by next year if the market is there for met. Can you remind us what the break down is on that, between kind of grade A, B, and PCi.

Really Jim, it's between three operations. The bulk of that would be Mountain Laurel. Most of that is targeted for the rank B high vol market. The second piece of that would be Cumberland River. Again, most of that would be targeted for the high vol rank B marketplace. Some may be PCI. And then the Lone Mountain, the third piece of that, is pretty much destined for the PCI markets which, we've participated quite a bit this year. So the combination of all three of those get us to plus 8 million-tons on an annualized basis of net/PCI.

Very helpful and then just -- on the cost side for the Western bituminous -- it sounds like first or second quarter you had the ability to ship out of inventory at Dugout Canyon, maybe kind of mitigating how -- what the full impact of that outage might have been and that's not necessarily available to you today. When we think about the cost, you said probably in the higher end of the -- maybe closer to the $27 average for the year. Should we assume third quarter is probably going to be the highest level of the year, just given the outage?

Well, Jim it is hard to tell. I mean, we're down I think 30 days today. You would assume we're going to be down awhile longer. But we were $26.50 second quarter. I would assume that we would probably be a little bit above that for third quarter. But, again, I think if things go well we can manage within that range. We have depleted all our inventories at Dugout right now. We're shipping from other locations; whether it be Utah or Colorado. We may have to start deferring some of those shipments. But, right now, I'm comfortable at the higher end of that $25 to $27 cost range.

Okay, very helpful. Thanks guys.

Thank you.

We'll go next to Brian Singer with Goldman Sachs.

Thanks, good morning.

Good morning, Brian.

Wanted to go back to the PRB and maybe ask a question a little bit of a different way. It seems like if we look at your production between Black Thunder and Jacobs Ranch you're at about 110 million-ton annual run rate. Realize prices at least during the quarter are about $11.80. Should we assume that if prices stay in the $12 to $13 range that that represents a floor for your production and if you can continue to contract at $15 why -- how much of your 140 million-ton capacity would you save for a potential spike versus get a little more aggressive?

Well, right now, if you look at our -- in the release our uncommitted position, for 2011 and 2012, we look at that as a real upside opportunity in the market. It looks like it is developing and particularly as we see that forward curve and the plus $15. As John mentioned, our philosophy is always to be in the market of bid and to layer in. I think you'll continue to see that in third and fourth quarter. But if the market continues to develop like we think it has the potential to, we could see that forward curve move up, again, and -- but we will layer in and each layer, probably get a little more aggressive in the marketplace.

I think as the floor -- the markets are going to be the markets in a year or two timeframe, that's probably a realistic view of the world. Just because the way contracts roll in and out. 2014 or 2015 we'll have to see where the world is at.

But I think the emphasis is really two points. One, when you look at the marketplace, it appears that the demand side is growing, which is good for pricing. And the other side as we have emphasized a couple points here is just a cost structure, running at reduced rates which is, as I look at it a huge positive. Because, John and I talked many times we look forward to that day when we turn the mine loose to see what its real cost structure will be when we operate it at full capacity, but that is still a ways away.

Great. Thanks. As a follow-up -- shifting to the met side -- can you talk about geographically where you signed your met volumes during the quarter and if you look at the market currently, for your various qualities of met coal. How the market compares to the $130 a ton price you signed during the quarter?

I would say during the second quarter if you look at the 1 million tons about half of it was domestic and the balance was international. As we focus on the back-half of the year, we'll continue to look at both of those markets. In terms of pricing, I don't want to speculate a whole lot there, but what I will tell you -- everything we're seeing, 50,000, 100,000 ton opportunities are well into that triple-digit range for our rank B coal and then we would expect that to maintain or improve on that the back half of the year.

We will go next to Kuni Chen with Bank of America Merrill Lynch.

Hey, good day, everybody.

Good morning.

Most of my questions have been answered, but I just wanted to circle back on the permits that you have received for Coal-Mac. Can you just talk about the increased cost there? You mentioned that if it was a stand-alone operation that you would not pursue it. I'm just interested in knowing -- kind of on an apples to apples basis -- if you look at existing surface mines in the region versus what the cost would be, theoretically, if you were to develop it stand-alone, what would be the -- the cost per ton, step up?

I don't have that answer off the top of my head. I think that the issue becomes we would not put the infrastructure in. Because the way the permit is set up, is, it's good for one valley fill, which adds a couple years to the mine lives. But, you would never be able to put in, $50 million or $100 million worth of infrastructure that you can't move based on the one valley filled concept. And, the EPA said, we might give you another one at some point in time if you meet all these requirements but you just can't commit the capital because you don't have enough time in the permit to and the surety that you can get a new permit, or an additional permit to put that infrastructure capital in. The mobile equipment, you can sit there and say a couple trucks, $3 million a pop. So if you need three or four of them you can look at that and say and if the world doesn't work out and you can't get any further permits, then you would end up moving those trucks to another operation. Which, given Arch's size and breadth, that's relatively easy to do.

So that's kind of the basis of my comment there. So if you take the trucks at capital and say there are two to four of them and divide it by current production, that 's kind of your cost increase. You'd have of course the operating and maintenance type costs related to that, too. So, it would be a little above the depreciation. But -- so -- I mean, we just see the system in Central App, which we've been pretty consistent on, is that, permitting is accelerating and already depleting decline curve of production. The reserves were dictating that was going to occur. The other issues are simply accelerating.

We will go next to Meredith Bandy with BMO Capital Markets.

Hey, guys thanks for taking my question. I just wondered if there was any update on the Spruce Mine?

Good question, Meredith. You know, it's--.

I guess the laughter is the answer?

They are not in any of our plans; let's put it that way. We -- the EPA -- the ball is in EPA's court. EPA has indicated that they will make a decision on whether they will move forward with a veto of the permit, an already issued permit thats undergone a full-blown EIS. Probably the only full blown environmental impact statement of a coal mine at least in Mississippi at least that we know of. 11 years in the making now, I think, since we started the process. And we will find out by the end of September I think is the view. And then, depending on what EPA does, we will probably go to court with EPA with that -- and I can pretty well assure you that we will and then that will work its way through the court system. There have been some other court filings and other things but that's kind of the timeline. The shell of it. It will be a great coal mine and we do expect it to occur at some point in time but not any time soon.

We will take our next question from Jeremy Sussman with Brean Murray.

Yes, hi, good morning.

Hey, Jeremy.

Can you give us a sense of how your customers are looking at things right now? I guess first of all have we-- with declining production in the East are we seeing sort of increased test burns out there and secondly obviously PRB prices are up right quite nicely and inventories are coming down, yet you didn't find a whole lot of tonnage. So, is this mostly you turning down utilities at these levels based on what your forward outlook is? Or how should we kind of think about this conceptually?

I would say a lot of our customers are watching inventories and the drawdown there and I would tell you that we're seeing much -- a lot more activity in terms of inquiries. Certainly for 2011, 2012. We're being patient. I mean, if we look at the cost structure in Central App, the reserve depletion, over the next couple years, we think there again, those prices have a lot of room on the upside as well. So, we continue to be a patient there, we're watching the thermal markets. We're watching the met markets and we'll see how this plays out. But, I would tell you over the last 30 to 45 days certainly activity has picked up in terms of interest and buying activity for Eastern thermal coal.

Due to time constraints our last question will be from Brian Yu with Citi.

Thanks. Good morning, and I applaud your endurance. Well, it's afternoon now -- at least in the East Coast. I want to circle back to the question earlier about Western bit. You mentioned that interest is a little bit lower than expected. Can you just comment on what the reservation is that you're sensing from customers?

Well, I think if you look out West they have had a little bit cooler than normal weather. Some of their inventories are a little bit higher. We're starting to see those come down. I think they're being patient right now. But we would expect as we move into the back half of the year into 2011 that that activity would pick up but -- currently, it needs to pick up. We're -- we haven't seen a whole lot of activity. We placed some tons during the second quarter, not a lot. You look at that and the customer mix, it came to about $30 a ton but -- clearly, we want to see more buying activity in the Western bit region over the next six months.

If you look at the winter weather last winter, I mean, the southwest, actually had a pretty mild winter. They didn't get a lot of cold weather, which often they don't. And then, even the summer heat, they were later to the party, if you want to call it that, than most of the eastern half of the United States. With the heat is built in now, from their normals. But, really, it is probably the economy as much as anything. I mean, Las Vegas is still running 14% unemployment I think or something to that effect. So, you can still see a slower recovery economically, in many of the regions out there that would use the electricity produced by our coal. So -- we just think that's a little further behind the economic recovery than we're seeing elsewhere in our region.

This does conclude the question-and-answer session for today. At this time I would like to turn the conference back to Steve Leer for any additional or closing remarks.

Again, I will apologize to one or two that were on the line that didn't get in. I think we have gone about 10 minutes over as it is. But let me close by thanking everybody for their time and their interest in Arch today.

As I reflect on the quarter and I would like to perhaps just leave two thoughts with you that we certainly touched on and in some cases talked extensively on. But John and I are very pleased with the Company's cost performance at all our operations. This was in an environment that was certainly robust in terms of regulatory inspections, safety and environmental. The mines responded. I think it reflects really on Arch's superior views and how we deal with safety, how we deal with the regulatory environment and really our performance speaks for itself there.

But I think the strong cost performance in the quarter sets up the second half nicely, as we progress forward. We are seeing an economic recovery in our coal region and our coal consumption regions. Which really ties to the second part or the second point, which is, the markets are gaining significant momentum on the steam side. We've seen a softening in the met coal, but it is still reasonably tight. And, in fact, there are some signs out there that maybe it touched bottom. But the real issue is, the forward curve, particularly in Powder River Basin and our unsold position that $15 I think, that $15 plus has significant implications for value for Arch and its uncommitted position and it should be meaningful.

So, we look forward to reporting to you on the third quarter, here in three months and for the rest of the year. And thank you for your interest in Arch and thank you for today. Bye now.

This does conclude today's conference. We thank you for your participation.