Arch Resources Inc (ARCH) 2012 Q4 法說會逐字稿

Good day, everyone and welcome to the Arch Coal, Incorporated fourth-quarter 2012 earnings release conference call. Today's call is being recorded. At this time, I would like to turn the call over to Ms. Jennifer Beatty, Vice President of Investor Relations. Please go ahead.

Good morning from St. Louis, thanks for joining us today. Before we begin, let me remind you that certain statements made during this call, including statements relating to our expected future business and financial performance, may be considered forward-looking statements according to the Private Securities Litigation Reform Act. Forward-looking statements, by their nature, address matters that are, to different degrees, uncertain. These uncertainties, which are described in more detail in the annual and quarterly reports that we file with the 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 we would have posted in the investor section of our website at ArchCoal.com. On the call this morning, we have John Eaves, Arch's President and CEO, Paul Lang, Arch's Executive Vice President and COO, and John Drexler, our Senior Vice President and CFO. John, Paul, and John will begin the call with some brief formal remarks, and thereafter will be happy to take your questions. John?

Good morning, everyone. Today, I'd like to spend a few moments highlighting the milestones that Arch achieved in 2012, despite the market downturn we've been facing. Last year, Arch generated $688 million in EBITDA. As 2012 unfolded, it became clear that we were going to see a can a contraction versus 2011, thus we began cutting our capital spending significantly. As a result, we ended the year in only slightly negative territory for free cash flow, even while moving ahead on the Leer mine development.

We are also successfully bolstered our cash and liquidity resources in 2012 to ride out the storm, and to emerge as even stronger players in market recovery. John Drexler will highlight those financing initiatives in his prepared remarks. Of course, one of most important milestones that Arch achieved in 2012 was another strong performance in safety and environmental stewardship. For the seventh year in a row, we ranked first among our major diversified coal peers for our safety record, and garnered 24 external awards for outstanding achievement in our core values. In addition, five of our complexes completed 2012 without a single safety incident or environmental violation. What's more, we advanced the build-out of our low-cost high-quality metallurgical coal platform in Appalachia, and held the line on costs in other regions. We believe the addition of Leer will further enhance our competitive position within the industry, and will serve us well in the coming market up cycle.

Lastly, we're building momentum in the seaborne coal markets. Our exports hit a record 13.6 million tons in 2012, that's a fourfold increase since 2009. We sent met and thermal coal to Europe and South America, and to new places in the middle-aged Middle East and Asia. Our top destination for exports in 2012 was South Korea. Our increased participation in the seaborne coal trade reflects t growing worldwide consumption of coal, as well as the strengthening of Arch's position in the competitive landscape. With our low-cost operations and growing port access, we are well-positioned to benefit from the changing dynamics in the seaborne market. We see exports as a long-term development opportunity, as a way to diversify our customer base, and as a way to unlock further value for our reserves. Growth overseas will also help offset our expectation for a relatively flat coal use here at home.

While these international net back prices don't always offer a substantial return today, we believe prices will rebound as market fundamentals improve. In fact, we continue to field inquiries about shipping our coal overseas, and are building new business in this rapidly-growing arena. That's why we think US exports will continue at an elevated levels and certainly exceed 100 million tons in 2013. Whether we approach the record levels achieved in 2012 remains to be seen and will ultimately depend on the evolution of coal markets throughout the year.

Turning now to a discussion of coal market fundamentals, 2012 could well prove to be in the trough. Global benchmark medical metallurgical prices declined 50% since their peak 1.5 years ago, while US thermal coal consumption declined to levels we haven't seen since the mid-1990s. Muted economic activity, unseasonably warm weather, and low natural gas prices all converged to dampen coal demand, causing coal stockpiles to grow to read near record levels by May of last year. However, we are encouraged to see stabilization in the back half of 2012. Based upon these dynamics we believe that we are moving off the bottom as we head into 2013. Net coal markets are beginning to show some signs of life, inquiries that were nonexistent six months ago are emerging. Utilization of US steel mills is improving, and China's economy seems to be picking up.

On a supply side, production cuts and constraints are beginning to take hold and should start to have a greater impact as the year progresses. Thermal coal markets appear poised for better days as well. While winter weather has not been very cold, it has been better than last year. So far this season, heating degree days are up 5%. We estimate coal stockpiles into 2012 at 182 million tons, well below the peak from last May, but about 10 million tons higher than they were at the end of 2011. Thus we expect to exit this winter season with coal inventories above normal, but are forecasting drawdowns in January and February. That's still a lot better than the 30 million-ton build we had from last winter.

In addition, prices for natural gas are high enough to give Western coals an economic advantage on the dispatch curve. At the same time, we believe that natural gas prices are unsustainably low today, as companies cannot make sufficient returns to justify continued investment, as evidenced by the rig count decline. Over time we expect market forces to move gas prices higher, which should further bolster coal's competitiveness in the power sector. We also believe that US generators entered 2013 with conservative burn forecasts, and could potentially find themselves needing coal as the year progresses. This development should initially help to reduce the stockpile overhang, but could eventually lead to more active and dynamic market in the second half of the year and into 2014.

One area that's definitely helping to turn coal markets around is supply shut-ins. By our estimates, met coal supply cuts totaled nearly 35 million metric tons annualized. On the thermal side, the cuts are even larger. According to recent MSHA data, the US coal industry reduced production by nearly 80 million tons in 2012. PRB led the way with 38 million tons of volume reductions, and central app was close behind with a decline of 36 million tons. In fact, central app produced just 148 million tons in 2012, but even more striking is the fourth-quarter run rate is below 130 million tons annualized. For 2013, we expect global supply to fall further, as high-priced contracts roll off, trader inventories liquidate, and the higher cost supply exits the market altogether. These trends should help rebalance supply and demand as the year progresses, setting the backdrop for regrowth.

In closing I want to reiterate, while it's never fun at the bottom of the market cycle, we as a company have been here before, and we know what it takes to manage through the trough so that we're ready to capitalize on the market rebound. Underlying fundamentals, and begin to improve first and our financial results will follow. In the meantime, we'll continue executing the strategy that has allowed us to mitigate the headwinds that we've been facing. We will stay focused on what we can control, capital spending, costs and commitments. We also look for ways to optimize our portfolio, and won't rule out further curtailment or divestitures as we focus on unlocking value for our assets.

With that in mind, I will now turn the call over to our COO, Paul Lang, for a discussion of Arch's recent operating performance and outlook for 2013. Paul?

Thank you. As John mentioned, I'd like to highlight our continued focus areas in 2013. These are keeping our cash costs and capital spending levels low, and continuing to strengthen our sales commitment portfolio. In the fourth quarter, our overall cash cost per ton declined from third-quarter levels and represented our best quarterly performance of the year. Driving these results was an exceptional fourth-quarter performance in our Western bituminous region, which helped offset higher planned maintenance expense in the Powder River Basin.

For full-year 2012, we held the line on costs in all of our operating regions. This was a notable accomplishment, when you consider how significantly we reduced production over the course of the year. As you know, spreading highly fixed costs over lower volumes affects unit costs, and that is reflected in our operating performance of 2012. In our largest volume regions, the Powder River basin, our cash costs in 2012 were up 7% year-over-year, while our sales volume declined 11%.

We proactively mitigated the impact of the weak coal market by idling equipment, and took other steps to contain costs. During the downturn, we stepped up our reclamation efforts and received the benefit of completing this work faster and at a lower cost than would have been incurred with contractors. Our efforts will also allow us to sequence future reclamation work with greater flexibility. Going forward, the demand outlook for this region is expected to improve, but at this time, we have two drag lines and eight shovels, as well as their related support equipment idle at our operations. As the domestic supply overhang corrects, we expect to deploy this equipment and recapture some of the lost volume, which will benefit our cost structure over time.

In our Western bituminous region, we successfully reduced our cash cost per ton year-over-year, despite running at lower volume levels in 2012. Late in 2011, we significantly restructured our operating profile in the region, by reducing production out of our Dugout Canyon mine and shifting volumes to other lower-cost mines. We also transitioned to a new mining area at our Skyline mine in the fourth quarter of 2012, successfully completing a major transition at that operation. Looking ahead, we are optimistic about the market for Western bituminous coal. We're seeing a slight pickup in domestic demand due to improvements in the construction sector, and higher natural gas prices. In addition, export opportunities are improving for this region, and should increase further as port capacity materially expands in 2014.

In Appalachia, our sales volume declined in 2012, as expected, with our portfolio realignment in the region. During the year, we closed 10 higher-cost thermal and incremental metallurgical operations, we decreased production at other active operations, and we reduced our overall workforce by nearly 17%. Our overall cash cost per ton increased in Appalachia during 2012, which is consistent with our ongoing shift to a higher metallurgical coal output. Even with this cost increase, our Appalachian segment represents one of the lowest-cost operating profiles in the region. Looking ahead, we continue to optimize our assets in Appalachia, and anchor our thermal production at our lowest-cost asset, the Coal-Mac mine. Our metallurgical platform will consist of our lowest-cost mine, Mount Laurel, along with operations producing higher quality coal such as Beckley and Sentinel.

As John mentioned, our coking coal profile will further be enhanced by the addition of the Leer mine. As that operation reaches full production in 2014, we project the cost structure will be in line with our overall average for the region. In the fourth quarter, we continued to make solid progress on the development of the Leer mine, and we completed the slope construction in December. We've also started the process of test marketing the coal with steelmakers in North America, Europe and Asia. Just like Mount Laurel, we believe Leer will be a sought-after premium brand in its category, given its large reserve base, good cost structure, and homogeneous quality. We also recognize that it takes time for steelmakers to introduce new coal into their blends. Currently, we expect the longwall at Leer to start up sometime during the third quarter and continue to monitor the state of the coking coal markets closely.

Turning now to capital spending, we have cut about $200 million out of our capital plans of 2011, and our actual spend in 2012 came in $25 million favorable to the target. For 2013, we expect capital spending of $350 million or less. That level allows us to adequately maintain our existing operation, and still lets us spend on value-enhancing projects, including the Leer development, as well as the replenishment of our reserve base.

Lastly I want to touch on our sales commitments. On the metallurgical side, we sold 7.5 million tons at an average price of $113 per ton in 2012. We are targeting higher sales in 2013, mainly due to incremental volumes from Leer. At the same time, our product mix is improving. In 2013, 40% of our metallurgical sales should be a blend of low-vol and high-vol A coal, and we expect that percentage to increase in the future. To give this change some context, our product mix is already up from roughly 33% of low-vol and high-vol A in 2012, and it was less than 20% in 2011. We are not only producing more metallurgical coal, but we're producing a higher-quality product mix.

We've booked nearly half of our targeted metallurgical sales in 2013 at an average price of $93 a ton. While that pricing is lower than what we've garnered in 2012, it reflects a higher blend of high-vol B and PCI sales than we had last year, as well as some carryover volume. For 2013, we've strategically left open a larger percentage of our higher-quality brands, such as Beckley. Although international prices are lower at the moment, we expect those markets will strengthen as we progress through 2013, and remain optimistic about the placement of those products, both domestically and overseas.

On the thermal side, we've layered in some sales to run our mines efficiently in 2013, while continuing to produce at significantly reduced volume levels. We're roughly 90% committed, based on the midpoint of our guidance range, and have maintained sales leverage where we believe opportunities will present themselves over the course of the year.

As discussed, we are encouraged by what we're seeing in the domestic and international arena for Western bituminous coals, and in Appalachia, the domestic industrial sector remains solid, which is helping to provide an offset to soft thermal markets in the region. In the Powder River basin, we've placed some business for 2013 for both 8800 and 8400 coals that will reduce our sales exposure in near-term and position us to operate our mines more steadily. We've also leveraged those sales for outer year commitments at more attractive prices, and have retained the productive capacity to significantly benefit from improving market fundamentals. While our sales profile in 2013 will likely be weighed down by lower realized prices on export sales, we continue to pursue key contracts to fulfill our longer-term strategic goal of increasing our stake in the seaborne coal trade.

As John noted, South Korea is the single largest country we did business with on the international front in 2012. We believe this relationship will continue to grow as that country builds out a coal generation fleet that is designed to burn sub-bituminous coal. With its consistent quality, high reliability and expansive reserve base, the Powder River basin will increasingly play a larger role in Korea, as well as the broader Asia-Pacific region. With that I'll now turn the call over to John Drexler, Arch's CFO, to provide an update on our consolidated financial results and liquidity position. John?

Thank you, Paul. As John and Paul have described, we are beginning to see some signs of improvement in coal markets. However, the timing and magnitude of a recovery remain uncertain. This reality is what prompted us to undertake the financing transactions that we completed in the fourth quarter. We increased our cash on hand by nearly $370 million, and decreased our short-term borrowings by $100 million. At the end of 2012, we had cash and short-term investments of just over $1 billion, and no borrowings under our credit facilities. Our available liquidity totaled $1.4 billion at December 31, which was up $400 million compared to the third quarter.

Following these strategic moves, we are in a very strong liquidity position, with the majority of our liquidity in the form of cash. In addition, these transactions relaxed the financial maintenance covenants in our revolving credit facility, creating ample financial flexibility to manage through the market headwinds. Although we don't expect the current cycle to be prolonged, we are prepared for that contingency. We have a structure in place that will allow us to fund our operations and our ongoing growth plans with Leer, while aggressively allowing us to pay down debt as market fundamentals improve.

Turning to our quarterly results, Arch reported adjusted EBITDA of $71 million for the three months ended December 31. These results were impacted by a $58 million charge, or $0.17 per share, that reflects the rejection of a customer supply contract by the US Bankruptcy Court and the assumption of the contract obligation by Arch. Absent the charge, EBITDA would have been $130 million. Other notable items in the quarter's results were intangible asset impairment charges totaling $231 million, or $0.97 per share, with the vast majority of that charge related to goodwill. We are required to perform a goodwill impairment review on an annual basis, or as conditions warrant. The results of our testing indicated that a portion of our goodwill was impaired, mainly due to the material decline in benchmark metallurgical coal prices. This one-time non-cash charge does not act our cash flows, liquidity, or ongoing business operations.

Income taxes for the fourth quarter included a charge of $24 million, or $0.11 per share, to increase the valuation allowance for certain state net operating loss carryforwards. Our evaluation of our deferred tax assets indicated that these loss carryforwards were likely not recoverable, requiring them to be written off.

Finally, the income statement line for coal derivative and trading activity reflects an expense of $13 million in the fourth quarter. As I discussed on the third-quarter call, this paper loss was primarily due to the expiration of in-the-money API 2 swap positions that we entered into, to hedge the price of export shipments. The cash income we receive from the settlement of those positions more than offset that loss, but for reporting purposes, the corresponding income is reported under the other operating income line.

Lastly, I'd like to discuss our guidance for 2013. We expect thermal sales volumes in the range of 125 million tons to 135 million tons, with met sales to the 8 million to 9 million tons. Cash costs in the range of $10.75 to $11.50 per ton in the Powder River basin, cash costs between $24 and $27 per ton in the Western bituminous region, cash costs of $66 to $72 per ton in Appalachia, and cash costs of $34 to $36 per ton in the Illinois basin. DD&A in the range of $510 million to $540 million, SG&A in the range of $130 million to $140 million, interest expense between $360 million and $370 million, and capital expenditures of $330 million to $360 million. Given our current outlook and the impact of percentage depletion, we expect the tax benefit in the range of 30% to 50%.

Our guidance assumes that we will continue to manage costs and capital in 2013, as we successfully did in 2012. Depending on the trajectory of markets during the course of 2013, it is likely that our operating cash flows will be below that of last year. We will continue to work towards improving cash flows for the year, from continued expense reduction and ongoing capital discipline, to even more stringent working capital management, to asset divestitures. We are confident that Arch is well-positioned to weather this downturn, and to outperform and create substantial shareholder value as market conditions improve. With that, we are ready to take questions. Operator, I will turn the call back over to you.

(Operator Instructions)

And our first question will come from Brandon Blossman of Tudor, Pickering, Holt & Company.

Any more detail available on what was sold on the met side for 2013? It sounds like more than, per the prepared comments, more than the average amount of high-vol B. Is that indeed the case? And then what can we think of as far as netbacks to the mine and price at the port, in terms of rail transport charges? Are you still seeing some differentials there between high-vol A and lesser grades, and should we expect that on a go-forward basis?

Brendan, this is Paul. I'll try to answer your question. I probably won't get too far into the pricing, but I'll try and help you on the volume question. We've committed about half of our metallurgical volume for 2013, at an average price of about $93. If you look at those numbers, this would include, these sales were about 60% PCI low-vol B as well as some carryover from 2012. The remainder of the sales was roughly 25% high-vol A and 15% low-vol coals. We've done a good job of maintaining our domestic sales position, and as a rule, we have only our higher-quality coals left to sell. Just round numbers what's left is about 15% low-vol, about 30% high-vol A, and about 55% high-vol B.

This is John. Your question on the railroad too, most of the sales that we made on the met side thus far have been domestically, all that transportation actually contracted with our customer. We're now entering the negotiating season with our international customers, where the rail transportation comes more into play. I would say that we have seen the railroads be pretty proactive in terms of facilitating more thermal and met volumes in the international market.

Thank you. That's all very useful. Paul, real quick, ERB cost range is exactly the same as it was a year ago. On a forecasted basis, lower volumes year-over-year 2013 to 2012. Any expectations, you fell exactly in the middle of that range for 2012, is that a fair expectation for 2013? And what would move it one way or the other?

As I mentioned in my comments, Q4 was the best cash performance of the quarter. And the guys did a pretty good job. In the Powder River basin, our volumes were down and our costs were up a little bit, and we were able to mitigate a lot that by idling equipment, taking other steps. The reclamation we did can't be understated. Although it took care of a short-term issue, it should help us going down the road.

My sense on 2013 is pretty much where we're at, we're expecting the volumes to be about the same, and we think with a little uptick in volume, we'll be able to offset most of the minor inflationary things that will come along. I think there's a lot of positive things on the cost side, but despite all that, I'm definitely not satisfied where we are in controlling costs, and it will remain our focus for 2013.

Okay. Thank you very much.

Our next question will come from Mitesh Thakkar of FBR.

My first question is on the Western bituminous costs. Paul, obviously good job during the quarter. When I look at the guidance, though, it looks like there's a significant bump, not only versus the full-year 2012, but meaningfully higher compared to the fourth quarter. What is driving that? If you can give us a bridge on that, that would be great.

We had an extraordinary cost quarter in Western bituminous. Quarter-over-quarter cash costs went down 22% while the sales volume decreased 18%. The net result was an $18.68 per ton cash margin and $13.47 for the year. I don't want to take away anything from the great accomplishment by the team, but there were some nonrecurring items that occurred in the quarter, the biggest of which was the run-out of the Dugout longwall. Obviously, we're not forecasting operating the Dugout longwall on 2013, but we are keeping our options open. And we really remain encouraged by the market in this region. I guess taking all that into account though, we're still forecasting a cash cost of $24 to $27.

Great. And just looking at the contracting, obviously, when you do the math on the PRB coal, it looks like you sold 15 million, 16 million tons at around $10, which is kind of below your cash costs. Can you give us some color about what is in there? Is it a function of mix, or like the week export markets which you talked about? Can you talk about the netbacks right now on the export side, as well?

As we work our way through this trough, we remain focused on the longer-term opportunities and still view the PRB as a long-lived asset that's going to support us for a lot of years. I guess, without any apology, we took some volume off the table for 2013 and reduced our exposure so we could run the mines at a reasonable rate. But we also had success in leveraging the 2013 numbers for volume and price in the outer years. For a little more color, the numbers are weighted down by a couple of things. Some of it's market-based agreements, some of it's the blend of 8400 and 8800 coal, as well as the drop in the international prices.

When you think about it, at the end of January, the Indonesian 4900 kilocal coal was in the mid-60s. About a year ago, that was $80 or $85, and obviously $15 or $20 of the PRB is a huge number. And we continue to want to pursue these international things, and we don't want to be a swing supplier in the trade. But I think if you stand back, the very positive thing on the pricing is, we've seen significant production response to current pricing, and that includes Australia and Indonesia. And I think as we work through our gradual stockpile drops in the PRB utilities, we should see some price recovery later in the year. Looking at 2014, we've been able to take this and we're sitting at about 55% or 60% of our thermal position committed based on 2013 guidance, so I think the strategy is paying off.

Great. And one last follow-up if I may, on the Leer Mine, have you contracted any coal from Leer? And if not, what is your expectation in terms of pricing, given where the markets are currently?

Without going into specific pricing, we have not contracted anything, but I wouldn't have expected to either. We're focused on the early production out of the mine going to steelmakers to do test burns to get it into their blends, so I wouldn't have expected to really sign any term agreements for that operation until next year.

But we do has have some tests going with coal that are going well.

Great. Thank you very much.

And our next question will come from Shneur Gershuni of UBS.

Just a very quick follow-up to Mitesh's last question with respect to the PRB costs versus what you sold. The actual tonnage that you booked, was that actually technically done at a loss, or just given the fact that there are pricing differentials, royalty calculations and so forth, and fixed operating leverage, that those tons are not actually booked at a loss or close to breakeven? If you can talk about that for a sec?

Shneur, you hit on an item that you do have to taken today into consideration. Paul touched on, that it can be a variety of factors as we look at each of the individual sales, including mix, 8400, 8800, BTU coal, but another important item that you mentioned, as well, are the sales-sensitive cost impact of what we're looking at. So, a third of the sale price is sale-sensitive costs. You need to take that into account into what we report from a cash cost perspective over the course of 2012, with the realizations that we had at that time, also. And I think when you adjust for those items, you'll see that maybe we weren't selling these at a loss in that region.

Great. Just two quick questions here. What if we can start with contracting? You had mentioned that you've kept some of the better higher quality met coal back for the market, as you expected to move up and so forth. When we think about where benchmark pricing was for metallurgical coal, and where you booked the high-vol and PCI for the domestic contract and so forth, was it better than expectations or the relationship between the two, was there a contraction or widening of the spread at all? How we think about how you contracted those specific tons?

I think it was about as expected. As Paul indicated, a lot of it weighted down with the high-vol B and PCI, and as we see the international market materialize, we hope that the price will improve. We believe right now at the 165 benchmark, there's a large percentage of the suppliers in the seaborne market that don't have a cost structure that can play in that market at that price.

So we think you're already seeing moving along the bottom, maybe bumping up a little bit if you look at spot prices, so with the 35 million tons we've seen come out of supply, maybe some more coming out versus second quarter, we do think there's a real possibility for prices to respond, particularly in the back half of the year. And that's why strategically, we tried to manage and maintain more of a high-vol A and low-vol open at this point, whereas last year, we had committed a higher percentage of it.

Great. One final question, you've definitely made some great strides with respect to CapEx and so forth. Once Leer is up and running, and let's assume you don't make any land acquisitions, it seems you're running at about $170 million maintenance CapEx number. Is that how we should be thinking about 2014 and beyond? Does this low CapEx or maintenance CapEx run rate impair your ability to ramp up production if you see a pricing uptick?

Clearly, we're focused on the debt reduction, as well as cost control, and if you look at the buckets, 2013 maintenance CapEx is about $170 million. If you recall though in October, we are also getting the benefit this year of about, you could argue the number, $40 million or $50 million of equipment that we idled at some of the mines in the East and were able to transfer and take advantage of. So, I think you take that into account, you're looking at a normalized maintenance capital for us next year.

And as we think about growth capital, once we do have the Leer up and running at steady-state, we have some land additions, which would be LBA and some smaller stuff at about $60 million to $80 million a year. Beyond that, it would be just maintenance capital, until we saw some improvement in the market that really justified spending more growth capital. We're fortunate when we think about the next several years of having the Tygert Valley reserve, which is just to the west of Leer, could be another longwall, another continuous miner. And then we have the big block in Southern Illinois called Lost Prairie. Both of those are very attractive projects, but until we see some improvement in the market, the ability to go put some of the thermal coal to bed longer-term, that we're going to sit where we are right now.

Great. Thank you very much.

(Operator Instructions)

Our next question will come from Brian Yu of Citi.

My first question is just on the net coal sale, what's the anticipated volumes that you would expect to produce and sell out of Leer this year?

I think we're going to have about 1 million tons in total.

Okay. And that would be both production and sales?

Yes. Obviously, that's going to be very heavily weighted to Q4 when the longwall starts up.

All right. And so, if you're doing some development type of things, you mentioned you are doing some test burns now. Would that accelerate once you get into the second and third quarter? And then would that be geared towards international markets, or would you try to play some of those domestically?

Brian, as far as the accounting for some of those sales that occurred during development between now and the start up of the longwall, from an accounting perspective, those aren't booked through on P&L. Those are an adjustment to CapEx. That's, traditionally in our industry as you develop a longwall, how the accounting for that is. As far as the target for test burns and whether it's domestic or international, I'll turn it back over to Paul and John.

I'll clearly say we've had a lot of interest, particularly in Asia out of this coal and I think -- I'm just going to have to take a shot, but I'd say about 70% of what we shipped has gone to Asia for test burns.

Okay. Switching topics real quick, on the PCX related tons, which you took the charge for, is any of that, can you provide a little more detail on how that may or may not impact your future operating results as you deliver on those contracts?

Brian, this is John Drexler. As far as what occurred during the course of the quarter, there was a contract with the customer being serviced from Patriot, that ultimately had an obligation of Arch attached to it. We've been very explicit in what our what our exposure to those contracts has been over the last several years, and specifically over the last quarter since the bankruptcy. During the quarter that contract was rejected it bankruptcy so the obligation came back to Arch.

The way the specific contract works, as it's been amended over the years is that it's a required fixed payment schedule between now and 2017, for which we have obligations to make those payments. So, once that was rejected in bankruptcy, the obligation came back to us. We recorded the full liability for that amount, and we'll just make ongoing payments between now and 2017, not material to any given year.

Okay. Thank you.

(Operator Instructions)

Our next question comes from Caleb Dorfman of Simmons & Company.

First off, it seems like you're getting more encouraged by 2013 on a burn expectation. So, when you're looking at that 15 million-ton expectation, how much of that do you think will come from new business, versus coming from burning down existing stockpile levels?

I think it will be a combination. We finished the year at 182 million tons, and depending on where you call target levels, we think that's a good 30 million to 40 million tons above normalized levels, so some of it's got to come off existing inventories. And we would expect a draw in January or February. But we would expect as the year progresses on that there would be some new business opportunities to sell coal, as well.

But clearly, we need to draw the next 45 to 60 days in inventory to make that happen, because we go in the shoulder season. So, I think it will be a combination, but I think the first order of business is to pull down the inventories that we ended the year with. So, we see that happening, and if we did encounter some mild weather for the next 45 to 60 days, it's possible that it could delay that. But we're hopeful that we continue to get some cold weather here.

I think we're clearly getting a sense from several customers that they're being cautious on their contracting in 2013, and they're going to be careful. As John said, as the burn comes off, or stockpiles come off, I think that will determine what we see later in the year, as far as new sales.

A lot of these guys got burned a few years ago and they've been pretty conservative in their buys. And if you did see inventories come down, you actually could see those guys come back to market in the third and fourth quarter, and be some pretty heavy buying activity.

Great. That's very helpful. Just following up on that, obviously, you've had a lot of changes in your Appalachian thermal footprint over the past year with all the mine closures. What do you think is a good run rate to think about the actual production in the basin right now? If we do see the stockpiles get drawn down, a lot of spot needs, how long would it take you to ramp up this production capacity, and how much could you ramp it up?

Well, we're going to be very cautious. We're not going to bring production on for short-term opportunities. We're guiding to 8 million to 9 million tons of met. I think you could see a comparable level on the thermal side. I think it just depends on what we see from a market perspective. Paul and his guys are encouraged by what they're seeing on the industrial sector, and you saw that reflected in our pricing that we did during the quarter.

So, we'll see how it goes, but I think if we saw an improved sustained market, there's an opportunity that we could bring on some additional volume back half of the year. But as you know, cap as a whole was off about 36 million tons from 2011 to 2012, and we're forecasting another pretty significant step off in cap as we move into 2013. As I mentioned in my opening comments, if you just take fourth-quarter run rates and annualize them, it's below 130 million tons in Central App, which is pretty significant from where we've been over the last five plus years.

Great. That's all very helpful.

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

John, going back to that inventory question, when you look at your internal modeling, and assuming normal weather, where do you think inventories get down to from that under normal weather scenario this year, and maybe what do you think they need to get down to, to really jumpstart some opportunity for better pricing?

Jim, as we look at normalized weather, we look at natural gas prices, where they are now and at mid-3s, our internal forecast would have is somewhere around 155 plus or minus at the end of this year, which is maybe slightly above normalized levels, but getting much closer. I would say we're really set up a pretty nice first half in 2014 in terms of buying activity.

As far as getting back to some sense of pricing, obviously we need gas prices to cooperate as well, but what do you think normal levels are today? It used to be the 140s, 150s. Do you think that's more like the 130s, given reduced burn?

Well, you've had some generation come off, obviously. So, that number's probably gone down a little bit. But I would say it's probably mid-130s to mid 140s range for normalized. Depends on the customer, but with some of the plant closures we've had thus far, I think that number is a little bit lighter than the old 150 number.

All right. And as a last follow-up, could you refresh us maybe how we should think about the cost contribution from the Leer mine? Obviously, this year, you're going to be working on getting it up and running. But, as you go forward into next year and get it running at a full run rate, how do we think about Leer costs in relation to your overall App costs?

Jim, what we've been saying -- I guess with any new mine, you want to be cautious, but what we're saying is the average cost will be in line with our regional average. So, I think that's a good number to start modeling with.

Okay. Very helpful. Thank you.

Our next question will come from Lucas Pipes, of Brean Capital.

My first question is on potential asset sales, maybe if you could give us an update on what type of assets you're looking at, what transportation assets also you've considered?

As we've said in the past and we continue to look at our asset base, and we've always been not only buyers of assets but we've been sellers of assets, and that's something that we continue to look at. I don't want to set the expectation, there's something that's definitely going to happen. But if there's an asset, it is not necessarily strategic to what we are doing. Somebody could come in and provide value that we don't see certainly something that we're willing to consider.

I will say that we are not in a position where we have to fire-sale assets and will not do that. But we are always reviewing our portfolio and making sure that it fits with what we're trying to do. If you look at our diversity, we think we are well-positioned in the US with our production base in the PRB, our improved performance in Western bit, a growing presence in Illinois, and then if you look at our almost 1 billion tons that we have in appellation of which about 40% of that is low-cost met, we do think that we're pretty well positioned. So, if there's something in that asset base that doesn't fit, we would certainly consider a monetization of it.

Great. And then a quick follow-up question. A lot of prognosticators see US met coal exports a little bit lower this year. First, what is your take on that? And then secondly, you actually increased your met coal guidance year-over-year. Do you expect first, do you expect to us to take market share from your peers? And if so, is that a result of your cost structure within the basin?

Well, obviously 2012 was a big year. On a short-ton basis we shipped 124 million tons. I think it's too early to say that we're going to be in that level. What we're saying is going to be a 100 million ton market. And how the market evolves over the balance of the year will determine where those final numbers shake out. I guess I would tell you that based on what we see in global demand, we are bullish longer term.

When we look at the new coal-fired generation that we see being built around the world, to the tune of about 300 gigawatts, we think over the next three or four years, there's going to be an additional 900 million tons of coal that are going to be required to service that growth in demand. And when you look at steel production, we are forecasting about a 3% increase in steel production from 2012 to 2013, so we do see some improvement in China, we see some improvement in Europe, and a little improvement in South America.

So, as a Company we want to make sure that we're well-positioned to take advantage of those opportunities. And here in the US, if you listen to some of the auto guys, they're forecasting low to mid 15 millions in terms of units being produced in 2013, which translates into a good met market for us. So, we're cautiously optimistic and watching the market, and we'll be selective in taking new business.

And our next question will come from John Bridges at JPMorgan.

I wonder if you could give us a bit more detail on the Korean exports you were talking about. Is that PRB? Is it squeezing out of the West Coast or is it coming out of the Gulf? And is that going Panamax, because I would think the rates would be a bit tight now?

John, this is Paul. I'll start your question. We look at Korea we exported both thermal and metallurgical coal to Korea. The thermal coal, obviously came out of the PRB. The met coal came off the East Coast. The majority of it went through DTA and Curtis Bay.

And the PRB is going onto the West Coast?

Yes, sir.

Okay. And then just as a follow-up, the two drag lines that are idle, just is a rule of thumb, how much production would that represent?

John, I guess I'd rather not go there on specific numbers. I think you can just look at our overall guidance, and look at our history, as to what those volumes would amount to.

Our next question will come from Kuni Chen of CRT Capital Group.

First question on the PRB, obviously on the fourth quarter, you layered in some tons here to run it at an efficient level for 2013. Are you basically there already, or do you have to layer in perhaps a few more tons in the first half to keep your cost structure within the range?

I guess without citing specifically, we're sitting at about 90% committed, which is really one of the better positions we've been in in a long time. And I think the market outlook and the volumes we have to sell our baked in our guidance. So, I think we've taken it into account.

Okay. Fair enough. And then on Central App, looks like you committed some tons in the fourth quarter at a high $70 per ton type of range. Is that something that the mix there -- can you give us some more color on that?

Yes. I think there's a little bit of noise in those numbers. But what you're seeing is, I think what you're seeing particularly in the East is a bit of a combined impact of volume dropping off and gas pushing up the industrial accounts, and some of those customers going back to coal. Obviously, since we have some higher-quality products, we've been able to capitalize on this, and pick up some of that market segment in otherwise what's been a pretty tepid thermal market.

Bottom line is, our marketing guys did a good job. And what you see is clearly a great effort, but I think the number probably is a little high from what you're seeing in the market.

Our next question will come from David Gagliano of Barclays.

My first question, back on the PRB volumes that were priced in the fourth quarter, I just want to step back for a second. Even if we assume for example the sales base costs come down, and et cetera, et cetera, it looks like it's still at best a breakeven commitment on 16 million tons. My question is, the obvious question obviously, can you just walk us through the logic of why that's better than shutting it down, leaving it in the ground and selling it at $1 or $2 per ton margin in 2014 for example?

This is John. A couple things. Paul touched on it, I think the fact that were able to turn that into additional business in 2014 and 2015 at very attractive prices -- you have just seen 2014, we're not showing 2015, but we really have turned it into a multi-year business. I think the second piece is that we're trying not to be shortsighted as we look out strategically in terms of our global customer base, and we don't want to just show up when things get good. We want to make sure that we've established long-term relationships with some of our international customers, that we're ready when the market does turn, and we know it's going to turn, because when you look at the new coal-fired generation being built around the world we're struggling on where all the supply's going to come from.

So, Arch has been very proactive in developing that international customer base. We've been very proactive in going out and getting port capacity, and we want to be part of that, because as we look to the US over the next three to five years, let's face it, demand's going to be pretty flat. And if we're going to grow, we have to look at that market, and we can't wait a year or two down the road for markets to improve to be part of it. So, I think the marketing guys have done a great job in developing relationships all over Asia, long-term relationships, port relationships, that we think will serve us well. And we don't like the prices either, but we do think strategically, it's important to do that now versus wait.

Okay. I have just a two-part follow-up question. First of all, the midpoint of your full-year volume target implies another 14 million tons, obviously, to go. I'm assuming that's all in the PRB. It's related to one of the questions earlier. The first part of my question is how should we think about that? That's going to be sold at whatever the prices are? Or is there potential for that to be shut-in? That's my first question.

Then my second question along the lines of your commentary, I'm just curious. Over the last 14 years, since I've covered the Company, it has changed in terms of the view towards the PRB. This is the same Company that for the first 12 years I looked at it, 13 years or whatever, would consistently say, we are not going to sell the coal if it's not at that the right price, and we will leave it in the ground. What's changed in the last year such that now it's more about maintaining long-term relationships, et cetera?

Well, I think it's both. We always evaluate every transaction and make a decision accordingly. And we'll continue to do that. As Paul mentioned, we've got a lot of idle equipment in the PRB right now, that we don't plan on bringing back on until we see sustained demand.

But I think what has changed is the marketplace. And the marketplace has changed to gear us more towards the international market. And to establish that market, we've got to go out and develop relationships and sell coal. And that has put us in the position where we've done some of that we think will serve us well when the market turns. Is it a given that all the uncommitted coal at our midpoint is going to be sold? No, it's not. We're going to evaluate the market, and we'll make a decision at the time whether we sell it, or we leave that production in the ground.

Our next question will come from Dave Martin of Deutsche Bank.

I was hoping you could give us a little color on the moving parts related to your App cost guidance for 2013. Is it essentially that a change in mix offsets the benefit of high-cost mine curtailments? And then I was going to ask about Leer startup cost impact, but I think John, you said earlier, those don't get reflected in average costs.

Yes. From the startup cost impact, David, you are correct. Under the accounting, those essentially get capitalized into the development of the operation.

I think just to add a little color, if you look at our costs, they went up about $6 compared to 2011. And a lot that in 2012 will be in 2013, the shift to a higher percentage of metallurgical production. You can garner from the numbers, will be about evenly split in 2013 between met and thermal in the East. Met's got an obvious cost impact.

Okay. And then secondly, just wanted to come back to the earlier comments on sales-related costs. Don't take my question the wrong way. What I'm trying to understand is where those sales-related costs are embedded. Because I look at your, for example, your SG&A cost guidance and there's really no difference year-over-year.

David, from sales-related costs, the royalties and taxes that are paid on the sale of coal in any of our regions and any of our operations all flows through the cost of sales line, and is considered a cash cost. So, as you look at, as an example, our regional per ton analysis, the sales sensitive costs are part of that cash cost per ton. SG&A is really all corporate overhead related items. Anything associated with the sale of that cost is flowing through our income statement on cost of sales, and is reflected in our detail analysis, regional cost analysis and the cash cost per ton.

Okay. Thank you much.

Our next question will come from Andre Benjamin of Goldman Sachs.

I was first hoping to maybe clarify how you're thinking about the balance sheet and the use of cash that you have built up. I know you've indicated that you'd like to be capitalized to handle a potentially extended downturn. So should we continue to expect that you'll just hold that cash until the market stabilizes and then prepay the callable debt? Or when things stabilize, could we see you turn around and use some of that cash on some of the growth opportunities you have highlighted, like target value reserves or the Illinois Basin?

It's John Drexler. Clearly, as we indicated, we felt it was prudent in the fourth quarter to go and bolster liquidity on the balance sheet for the market downturn, and for whatever the extension on that downturn is, even if we don't expect it to be prolonged. So right now, we're in a position where we're going to be managing to that liquidity closely, as indicated in my prepared remarks. We expect operating cash flows to potentially be below where they were last year, so we'll watch this closely. But as we've indicated over the course of the call, we're beginning to see signs of improvement, and given the positioning of Arch as things do improve, as markets do turn, we think the earnings potential, cash flow potential is significant.

A very primary focus for us, once we begin to see that turn, we begin to get confidence in those markets moving forward in a very positive way for an extended period of time. We'll have the ability then to go and address what we believe is higher leverage than what we would like to have. So, that will be a primary focus for us. However, clearly wherever the markets are going, we'll weigh the opportunities we have with organic growth projects, et cetera. As we've indicated, numerous times, our primary focus will be delevering as we move forward as the markets do turn.

(Operator Instructions)

Our next question comes from Chris Haberlin of Davenport and Company.

In your release, you talked about consumption, coal consumption increasing this year by approximately 50 million tons. And it sounds like you're looking for an inventory draw through the year of 25 million tons to 30 million tons. That kind of leaves sales at 20 million to 25 million tons. And how do you think that incremental sales volume should be distributed across the major thermal basins in the US?

Well, I think it depends on where gas prices are. I would tell you that with that kind of inventory draw, natural gas prices in the $3.40 to $3.50 range, where we've been seeing them, we think that the PRB and probably the Western Bit coals will do pretty well, and we're actually seeing that today. If you look at the marketplace, both of those coals are dispatching on the curve. And as that inventory comes down, I think the buying activity will only improve, and you should see improvements in both the PRB and the Western bituminous for Arch.

Our next question will come from Meredith Bandy of BMO Capital Markets.

One question I had was, in Appalachia in 2014, you gave us new sales guidance there of 1.7 million tons sold at $53.98. I was surprised that number fell so drastically. When was that sold? Would you see the current market as being -- is that indicative of the current market? Is the current market better or worse than that?

I believe that's some carryover volume that we got through the ICG transaction. And we see markets better than that in 2014, but that is for the most part carryover from ICG.

Our next question will come from Justine Fisher of Goldman Sachs.

My question is on the production plan, given potential outcomes in 2013. It seems that most of the coal companies are not planning to increase production this year, even though we hear a lot of talking about how the second half could be stronger, especially with natural gas. So, I know why you're not, because you've answered other questions that you don't want to do it unto you see a meaningful increase in demand. But the question is, how quickly could you bring that tonnage back if you did see meaningful demand? Also, would you, or would you just say no, I'm sorry we're not going to produce that much, and get let prices get really high? Or do you think you would produce into that higher price environment?

I think the answer, how fast that production could come back depends on the basin. And the PRB, obviously, I think we're poised very well to respond to whatever the market brings. And, obviously we'll be very careful. Same in Western bit. We have the longwall that's idle at Dugout Canyon and we saw how effective it was in Q4 of 2012.

The East, I think, is a tougher issue. I think a lot of the production -- I know the stuff that we shut down, some of that's not coming back very easily. And I think it would take a significant market shift for us to even think about Eastern operations bringing back thermal coal.

I think you've seen some structural changes in the East. To Paul's point, you're going to see a lot of those tons that will not come back, and that's why we're optimistic about what's going to happen in the PRB, and to a lesser extent maybe Western bit. And we think as that demand starts to reassert itself, we think the PRB comes into play pretty quickly.

We'll now move on to Evan Kurtz of Morgan Stanley.

Just a quick question on met coal. In 2012, what was your split between export tons versus sales of domestic steel mills, and how do you see that changing in 2013?

I think our export in 2012 was 65% thermal and 35% met. My guess is 2012 -- 2013, my guess is the metallurgical volumes will tick up a little bit as compared to thermal volumes on the export side.

Okay. Got you. And then could you provide any color perhaps on how domestic met coal contracts shook out this year? Maybe on a differential, from a like-quality basis?

I'll just say, in terms of volume we did a very good job of maintaining our market share. And I'm very pleased with where the guys shook out. And if you look at it, what we did was we took off the table in the domestic market, most of our PCI, and lower quality high-vol B coal. And obviously, that's with the anticipation that the higher-quality coals will travel overseas better, and garner better prices.

We'll take our next question from Lance Ettus of Tuohy Brothers.

Just wanted to know just on the asset sales side, you have a lot of excess reserves in PRB, and also in the Illinois basin. Those basins are obviously still viable, and the Illinois basin reserve's, obviously, dwarf your high per volume properties. And that area is may be considered non-core. Would you elaborate a more in the potential for selling these assets, and the interest you're seeing out there for approaching about those assets?

We're talking to a number of people, as we have and will continue. I wouldn't -- in this environment, I think it's pretty challenging to try to monetize assets. Again, I don't want to talk about any particular region. I do think the Illinois over time could very well become a core operating region for Arch Coal, depending on how we see the market evolve. Obviously, we're very bullish on the PRB.

Another area that might be somewhat challenged based on our comments is the East, and the way we see the thermal market potentially. But we'll have to evaluate the opportunities we have to monetize assets and see if they meet our needs. If not, as I indicated earlier we're not in a situation where we have to fire-sale assets, so somebody's going to have to provide more value than we can provide, in order for us to do a transaction.

We'll take our final question from Dave Katz with JPMorgan.

Just wanted to confirm, you guys still are, with the amendment that was put through on the credit facility in November, you have the maximum senior secured leverage ratio in 2013 with 3.5, right?

Correct.

And do you anticipate being able to comply with that throughout the year?

We don't anticipate having any concerns with that. The other major items there is the minimum liquidity measurement of $450 million, and we feel comfortable with the structure that we have in place.

At this time I'll turn the conference back over to John Eaves for any additional or closing remarks.

Thank you. We certainly appreciate you joining us today. We feel good about the way we've positioned the Company. First of all, our safety and environmental performance for 2012, again, showed our leadership in that area. Our ability to maintain costs and capital in a low-volume environment, our ability to go out and put additional cash on our balance sheet, we think all these things position us very well to continue to weather the storm, and be positioned when the market does turn. And it will turn, so we look forward to updating you in April on our first-quarter results. Thank you.

And that does conclude our teleconference. Thank you all for your participation.