Arch Resources Inc (ARCH) 2013 Q3 法說會逐字稿

Good day, everyone, and welcome to the Arch Coal Incorporated third quarter 2013 earnings release conference call. Today's conference is being recorded. At this time I would like to turn the call over to 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 SEC, 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'd 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 posted in the investor section of our website at www.Archcoal.com. On the call this morning we have John Eaves, Arch's President and CEO; Paul Lang Arch's Executive Vice President and CEO; and John Drexler, our Senior Vice President and CFO. John, Paul and John will begin the call with some brief formal remarks, and, thereafter, we will be happy to take your questions. John?

Good morning, everyone. Our operations turned in a solid cost performance during the third quarter helping to mitigate the impact weak coal market conditions. Quarterly cash cost per ton in the PRB were the lowest in 10 quarters, helping us to lower our full-year cost guidance range for that region. Our Appalachian operations also continue to hold the line on costs which aided us in lowering our full year cost targets there as well. And our new bituminous thermal segment comprised of the Western Bit and [ellenization] assets is positioned to further complement our strategic focus on PRB and metallurgical assets will providing Arch with consistent cash generation.

In August we finalized the sale of our Canyon Fuel assets demonstrating our ability to deliver long-term value for our stakeholder by divesting non-core mines that we believe will face market, operational and transportation challenges going forward as well as require substantial sustaining capital needs.

We received $423 million in cash from this sale and can now shift our focus towards assets where we see better value and growth potential over the next five years. In the near-term the proceeds from the sale improve our liquidity and should ultimately help us our reduce leverage when coal markets turn more favorable.

During the quarter we made progress on our asset in devolvement the Leer Mine and expect the long well to start up in December. Earlier this month we also extended the life of the Leer Mine with the announced acquisition of the Guffy Reserve for $16 million. This bolt on acquisition is contingent upon Patriot's exit from bankruptcy and will provide Arch with the ability to produce up to an additional 8 million tons at Leer over the life of the mine.

As you can see we are reshaping our portfolio on Appalachia to include top quality competitive metallurgical assets while restructuring our thermal assets in the region to focus on a profitable core. Beginning in the second quarter of 2012 we shuttered eight thermal mines in the East that we believe were not likely to compete from a cost, quality or transportation perspective. Since that time we have further pruned the portfolio by idling contract mines, reducing shifts and realigning production with the market demand expectations.

In the third quarter of 2013, we recorded a non-cash impairment charge at Hazard Thermal operation in Kentucky where we reduce the workforce and output of the mine to respond to current conditions. John Drexler will provide further details on those charges in his prepared remarks.

Arch is transitioning into a metallurgical coal play in Appalachia, and we expect to take another step forward with Leer. At the same time, our thermal production remains concentrated in our low-cost thermal asset Coal-Mac.

Beyond that our thermal output in Appalachia represents byproducts from the met mines that can be blended and resold into various applications or coal that can be sold in the industrial markets as is the case at Lone Mountain. There is no doubt that our thermal footprint in Appalachia has become smaller but more sustainable.

Turning now to our coal market outlook, I would like to make a few comments on recent trends we're seeing that should impact our business going forward. First, PRB coal is competitively positioned versus natural gas. PRB coal plants have been running all year with gas prices averaging in the $3.65 range. Days of supply at PRB [sur] plants declined to 60 days at the end of September and are likely to fall below this this winter.

On a national level, customer coal stockpiles could end the year at around 150 million tons. That is more than a 30 million ton draw down during the course of 2013. US coal demands exceeding production and supply curtailments particularly in central App are accelerating.

Looking ahead, even if we play at a scenario where coal demand is flat in 2014, we are on pace for another 30 million ton draw down in stockpiles next year all else is equal. With such a drop, inventories would fall to levels not seen since 2005. That's why we believe coal markets could be become much more dynamic next year as compared to what we have seen during the last 18 months.

Shifting gears into the metallurgical side of the business, it's no secret that we are in the midst of a global cyclical downturn, one that is probably more supply driven. That being said, we do expect markets to continue improving over the course of the next 12 months, and that improvement is likely to be driven by continued rebound in demand and ongoing supply rationalization.

Certainly in the US steel market, a key market for Arch, it has held up rather well with consistent utilization at steel mills. Forecasts suggest that there will be further growth in 2014 for the North American steel industry driven by the energy, automotive and construction sectors. Of course Europe's steel industry has been under pressure the last several years, but we expect some stabilization there in 2014.

Finally, projected continued growth in China, India and in overall Asia should help further tighten global coal market fundamentals. While we are seeing some signs that coal markets are poised to improve, we are not ready to predict that turn around will occur. For now we are focused on managing those factors under our control, containing cost and capital spending, prudently managing our sales portfolio and proactively protecting our liquidity and selectively streamlining our asset base to its most profitable core. At the same time, we are mindful that those markets could turn quickly, and we are positioning ourselves to capitalize on those opportunities as they arise.

With that I will turn the call over to our COO, Paul Lang, for a discussion of Arch's safety and operating performance. Paul?

Thanks, John. I would like to start off with a discussion about safety. The safety of the employees at Arch is our top priority, and every day we are committed to living our core values. Sadly, two of our mining subsidiaries had incidents in August that resulted in fatal injuries. We are grieving the loss of colleagues Lenny Gilliam and Jacob Dowdy. Our thoughts and prayers are with their family, friends, and coworkers. In the wake of these tragedies, we are all committed to working even harder to prevent incidents such as these from occurring again.

With that said, we continue to make good progress on safety elsewhere in the Corporation. During the third quarter, are West Elk mine achieved a new safety milestone by completing 2 million employee hours without a lost-time incident. In addition, our Coal Creek and Hazard operations each completed one million employee hours without a lost-time incident.

Our 2012 efforts will be recognized with two national Sentinel safety awards at a ceremony tomorrow evening in Washington DC. We remain sharply focused on continuous improvement in safety and are striving for the ultimate goal of zero reportable injuries and zero environmental violations at every operation every year. These are our core values, and we will continue to pursue them with passion.

Turning now to our operational results, I would like to spend a few moments discussing each region's performance and outlook. In the Powder River Basin our mines turned in a very strong cost performance, their best since the first quarter of 2010. Even with a milder than expected summer, we shifted higher pace in the third quarter. This trend is not surprising given that generator stockpiles are moving down and in some cases are likely below targeted levels. Though stockpiles will also probably not be replenished due to the snowstorm in Wyoming in early October, the weather has affected shipments in the PRB, and only recently does the region appear to be back to normal.

Certainly our costs -- our strong cost performance in the third quarter reflects the benefit of increased PRB shipment levels, but it also reflects the success of ongoing productivity improvement initiatives. For example, we are lowering maintenance costs and extending the useful life of equipment components by using technology to accurately predict part replacement rather than waiting for parts to fail or using an hourly baseline.

We are also continuing to find success in extending the tire life on haul trucks and have improved tire life by another 10% through improved road designs and specialized training of personnel. These initiatives along with others have allowed Arch to successfully reduce our full-year 2013 costs expectations for the region. Of course this cost performance in the PRB helped offset the out impact of lower prices in the third quarter which reflected an average sale price based on market price tons and the increased shipments to Asia out of Ridley. Export net backs were not nearly as favorable as domestic opportunities.

Looking ahead, we place a small amount of tonnage for the remainder of 2013 partially driven by increased brokerage activity where made sense to do so. We have also successfully locked up or priced additional business for 2014 that will allow us to run our operations in an efficient manner. As of now, 80% or so of our volumes are committed based on current run rates. What's more, we have had success in placing business for outer years into the forward curve that remains in Contango. We do expect a more robust and dynamic domestic thermal market going forward, and Arch is levered to both volume and price recovery in the Powder River Basin.

Turning to Appalachia, our metallurgical realization in the third quarter improved sequentially to $90 a short ton, but our quarterly shipments of 1.5 million tons were below our expectations. Part of the volume shortfall was customer related including a force majeure. The situation has been resolved and should result in incremental sales during the 2014 calendar year. Beyond that, our metallurgical sales volume shortfall was production related.

Mining conditions at Mountain Laurel in the third quarter were less favorable than in the second quarter which slowed the advance rate of the long wall. We expect those conditions to normalize for the remainder of the year.

For full-year 2013, we are reducing our estimate for coking coal and PCI volume to 6.9 million to 7.3 million tons. This new range reflects a shift of some personnel from Sentinel mine to Leer displacing contractors at Leer as we begin to ramp up that mine for the long wall start. This shift will result in a lower level of metallurgical sales out of Sentinel going forward but will allow us to move the crews back when the market demands.

We are also looking to optimize the placement of tons between the PCI and industrial markets where net backs and opportunities are most compelling. This trend has resulted in some tonnage shifting back into our thermal volume channel.

While our metallurgical volumes are slightly lighter than we forecast, so, too, are our costs. Strong performances at several mines in the third quarter such as Beckley and ongoing restructuring of our mine portfolio in the region, have allowed us to lower our cost expectations for the full year of 2013. We remain on track with the development at Leer and expect the long wall to start up in December. We started to take the long wall components underground and should begin setting the face up in the next two weeks.

From a sales perspective, we are in active discussions with our customers regarding our placement of our metallurgical volumes in 2014, and we plan to update you further in the next call. In addition, we have layered in some thermal sales in Appalachia for 2014 and beyond that provide us with solid book of business for our operations while maintaining upstock for potential domestic or export market rally.

Lastly, our new bituminous thermal segment includes a partial quarter contribution from our legacy Canyon Fuel assets as well as a full quarter of performance from the West Elk mine in Colorado and Viper mine in Illinois. This segment does not reflect the joint venture with Knight Hawk where Arch owns 49%. That investment is accounted for under the equity method and reported in other operating income. We expect this new segment to provide us with consistent cash flow generation as well as exposure to both the Pacific and Atlantic coal trades.

In summary, we will continue to focus on controlling what we can throughout the full market cycle and positioning Arch to benefit from the changing dynamics of our industry as they occur.

With that update, I will turn the call over to John Drexler, Arch's CFO, to provide an update of our financial results and full-year guidance. John?

Thank you, Paul. The most significant event of the third quarter of course was the divestiture of our Canyon Fuel thermal assets. That sale provided us with more than $400 million in proceeds allowing us to further increase our already strong liquidity position. In addition to the cash proceeds from that sale, we recorded a pre-tax book gain on the transaction of $115 million adjusted for taxes, the net gain was $75 million or $0.35 per share. And that gain is reflected on the discontinued line in our income statement.

Also, as anticipated, Arch delivered positive free cash flow in the third quarter. After accounting for capital spending, our free cash flow totaled $80 million for the three months ended September 30. That figure excludes the cash proceeds from the Canyon Fuel transaction. At quarter's end Arch had $1.4 billion in cash and $1.6 billion in available liquidity.

Another item of note in our financial statements this past quarter was the non-cash asset impairment charge of $200 million. Those charges primarily relate to the reduction in the carrying value of thermal coal assets in Eastern Kentucky that were deemed impaired. In addition, we also recorded the value -- reduced the value of our equity investment in a coal conversion project that has yet to progress. These one-time, non-cash charges do not affect our cash flows, financial maintenance covenant calculations, our ongoing business operations, and are thus excluded from our reported quarterly EBITDA.

Finally, the income statement line for coal derivative and trading activities reflects an expense of $10 million in the third quarter. This paper loss is primarily due to the expiration of in the money API 2 swap positions that were entered into to hedge the price of exports shipments. The cash income we received from the settlement on those positions offset that loss, but for reporting purposes, the corresponding income is reported under the other operating income line.

Turning now to our expectations for full year 2013, we have provided updated guidance in our earnings release. Our ongoing success in containing costs has allowed us to reduce our cost expectations for our key operating basins. In the Powder River Basin we expect to have cash costs in the range of $10.40 to $10.60 per ton representing a reduction of $0.15 per ton from the midpoint of our previous guidance range.

In Appalachia, we expect cash costs of $65 to $69 per ton, a reduction of $0.50 per ton from the midpoint of our previous range.

Upon the sale of our Canyon Fuel operations, we have combined the reporting for our West Elk and Viper operations. Our new bituminous thermal segment should have blended cash costs between $23.50 in $25.50 per ton. In addition, we have reduced our SG&A range from $126 million to $130 million, representing a reduction of $7 million since the start of the year as we begin to realize benefits from realigning our corporate functions following the sale of Canyon Duel. We have also tightened our capital spending range to between $290 million and $300 million.

Also, we now expect DD&A in the range of $420 million to $450 million, interest expense between $370 million and $375 million, and an estimated tax benefit in the range of 30% to 50% given our current outlook and the impact percentage depletion.

Our third quarter results and updated guidance demonstrate our ability to continue to manage our costs, expenses, and capital spending. We are also prudently managing our abundant liquidity as we navigate challenging markets. As fundamentals improve we will have the flexibility to opportunistically address our capital structure.

With that, we are ready to take questions. Operator, I will turn the call back over to you.

Thank you.

(Operator Instructions)

Brandon Blossman, Tudor, Pickering, Holt & Company.

Is there any way we can parse out the Powder River Basin price realizations to a greater degree of detail for the quarter? And obviously, what was priced in the hedging was higher than what was realized, and I heard some was spot sales and some was Ridley. Is there any order of magnitude that you can put on that?

Brandon, I think it was a combination. It was index tons, it was tons that we put through Ridley, and they certainly had a downward pressure the weighted average. In terms of more clarity, I don't know that we can break it out any more than that.

Does the realized price number reflect the fair value hedging also or was that incremental to?

The fair value hedging did not apply into the PRB region. It applied into Appalachia and Western Bit shipments.

Okay. My last follow-up question, this is a big picture question for John and John probably. What fundamental change would you need to see in the market to be more comfortable with not having such a large cash balance on your balance sheet?

Well, Brandon, we are certainly seeing some positive sides in the PRB. Inventories are coming down, with [like ore] natural gases prices are now, with normalized weather the balance of the year, we think we could really be setting ourself up for a much better 2014 where PRB is concerned. We did see positive direction in terms of the benchmark from $145 to $152, that is certainly something that we are not celebrating, but directionally it is going the right way. I think we need to see it will be more improvement on the met side, certainly inventories get down a little bit more in the PRB, activity pick up in the PRB, see some price appreciation out there. Those two things would help us getting the long wall up and running at Leer, having more runtime with that for a few quarters. All of those things combined, Brandon, I think would give us a little bit more comfort. But, with the uncertainty we are seeing right now, we think the levels of cash that we have are prudent, and that's the way we are going to manage the business. But obviously as we see the market turn and we get comfortable with that, we are quickly going move to delever our balance sheet.

Brandon, this is John Drexler. As we saw the markets turning negative, you saw us take steps over the course of 2012 essentially to grow our liquidity at the time of 2012 to extend our maturities. We had maturities coming due in 2013 which we addressed, and, very importantly, we transformed the majority of our liquidity to cash. And with all of those goals having been achieved, a big focus for us was also to have the capital structure in a position to aggressively address once markets began to improve. We think we are very well poised to have excess cash as we see markets improve given our low-cost operation base that we operate from. And as John indicated, as those things do start to head the right direction we will end up in a position of excess cash which, as we have indicated, is one of the first priorities for us would be to deleverage.

Great. I appreciate all the detail, guys. Thanks.

Michael Dudas, Sterne Agee

Good luck in Boston this week.

We're going to need it. Got to win two games.

Exactly. John, could you share your thoughts about the Powder River Basin and the ability for the excess capacity in that region to limit whatever pricing recovery that some of these fundamentals that you cite, which I agree with in your commentary to generate more sustainable pricing, because that's a topic that is of course, I'm sure you're aware of will come up in other discussions with other producers.

Michael, I'm going to really speak to Arch's position. We probably have more idle position the most out there. We said and we have continued say that we're not going to be bringing that idle equivalent back until we see a sustained improvement in the market, and that is not a quarter or two. It's where we can go out and sign longer-term agreements at prices that we think make sense. I don't think there is the excess capacity out in the PRB that maybe people think there is.

I think you have got idle equipment that would require maintenance, timing to get back in to operation. You'd have to go out and hire people, I think people are faced with higher ratios as they move west. All of those things make it tougher and tougher I think to bring operations back in or bring idle equipment back into production very quickly. It would take us probably months to do that and, not a lot of capital, but it's not something that we could just flip a switch. I think that's pretty indicative of others as well. Paul, you got anything to add to that?

My sense across the industry and not just in the PRB is that equipment replacement has slowed and clearly there's been maintenance deferral's. Those are going to ultimately eat into any reaction time we are going to see. What's more, as I've said in the past, this isn't the basin I left 7, 8, 10 years ago. It's not quite as easy to turn up production as it was then. The biggest issue has been the advent of pre-strip; the fact is ratios are higher. I still -- I think it's going to surprise people how difficult it is to bring back some of this production in a fast fashion.

Michael, just a follow-up. I do think we see the inventories come down the balance of year assuming we have normalized weather. Gas prices really don't have at to do anything other than they are doing today. You really could, we think there's quite a more coal that needs to be purchased in 2014. You could start seeing some price appreciation as we move into next calendar year.

Appreciate that. My follow-up, John, is and maybe for Paul, maybe a little inside into Knight Hawk and what, with your minority position, what the plan is for their production, outlook for expansion, capital cutbacks, things going on in the Illinois basin that might be different or similar to what we are seeing elsewhere. That would be helpful. Thank you.

Let me -- Paul can jump in here. He actually sits on their board. It has been a great investment for us, Michael. We've got 49% investment in that operation. We've been very pleased with the way the companies managed. They have a good cost structure. They've been very prudent in the way they market their coal. They have got a good industrial as well as a utility base, and they are actually in pretty good shape from a sales standpoint over the next couple of years. They don't have a whole lot of market exposure.

In terms of our situation down there, we had the Viper operation which runs roughly at about 2 million tons in the central part of the state. We have got a good customer base in place there, not real active in the open market there. And then beyond that, down the road we have got a significant reserve base called Lost Prairie which is a low chlorine, high quality coal we think would have good cost structure. It is fully permitted and ready to go, but, given the volumes that are coming out of Illinois today, we don't think it makes good business sense to go ahead with that. But I would think down the road when we see the demand improve domestically as well as internationally you can see Illinois being a future core operating region for Arch. We are certainly pleased with our investment in Knight Hawk and what is going on in Viper. We have made some real improvements on the cost side at Viper over the last couple quarters. Paul?

Yes, I think they only thing I would follow-up -- I'd just emphasize what John said. Knight Hawk has been an outstanding investment for us and it offers -- we have stated in a market that has been a little bit under the radar. We kept production somewhere between 4.5 million, 5 million tons a year. It's all low chlorine coal. We've also had some relatively low sulfur coal for Illinois. We've been able to keep a low profile and do very well. As John said, we tend to be a little bit more committed down there, and we really haven't seen the impact of some of the other operators in Illinois.

And, Michael, this is John Drexler also, if you look back over the last several years at some of our disclosures Knight Hawk has contributed roughly about $20 million a year of income to us as well.

Mitesh Thakkar, FBR capital markets.

Congratulations on all of the cost improvement in the PRB and Appalachia. Taking a step back on a more stable level, when you think about your met volumes, how should we think about your ability to ramp up the volumes as well as how much of the tonnage has shifted to the steel market, what used to be a met capacity before? Can you talk a little bit about that including how to ramp up is going on earlier and when do you expect volumes to be fully producing there?

Mitesh, this is Paul. I will start this one out. If you look at our changing guidance, roughly about half of it was due to the customer driven issues and about half of it was due to either what we decided to do with Sentinel or the issues out at Mount Laurel. And imbedded in that also was the switch from PCI to industrial. The fact is you have if you stand back and look at the PCI market right now, which we are large player in, the netback's at the mine kind of give you a range of about $68 to $73. The industrial market which is a little bit of a niche market, and we play out very well at of Cumberland River and Lone Mountain. Those prices probably right now are somewhere in the $73 to $77 range. Clearly, some of this switching from met to thermal is a little bit of -- it's just a change of names but on a revenue basis it was the right move.

As far as Leer, every long wall I've been around there's always a ramp-up period. I think we still feel good about the 3.5 to 4.5 million -- 3 million to 3.5 million tons production, but clearly, there's going to be a ramp-up at a long well. It usually takes one to three months, sometimes four months to really get things clicking.

Mitesh, I think this really speaks to how nimble we can be as an organization. If you look at our met portfolio, you look at our cost structure, our ability to take coal from PCI and put it in industrial markets, the ability to take work force in Sentinel and put it over to Leer. When the market improves we can move that work force back. I think it really, as we get closer and closer to bringing Leer out, I think it's going to be clear that we are going to be a major player in the met market. We have a variety of quality of coals from PCI to low-vol to high-vol B and high-vol A at a cost structure that we think plays not only in the domestic markets but in the international markets. I think it's a real credit to Paul and his team that when we see changes in the markets, we react quickly and make those changes and really do it generating positive cash margin.

Great. Just on the PRB side, it looks like you are a little better contracted than what you were last year at this time and have a good view of what the sales book looks like. Paul, a question for you. What would it take in more contracting, if you will, to get really good control over the cost to make sure they don't drive from here and stay at an optimized cost, that you will?

I will tell you, Mitesh, I feel really good about where we are contracted in the PRB. Just rough numbers, it's about 80% based on current run rates. I have to be honest, for us to even consider ramping up or bringing back equipment in any fashion, prices have got to be quite a better than what they are today. The numbers just don't support any further investment -- excuse me, any further volume pickup.

Holly Stewart, Howard Weil.

First can we start in the PRB? A nice ramp in sales during the quarter, can you talk about the operations, how they ran during the quarter and looking at those operations to head into '14?

Cost in general, overall the guys did a great job lowering costs. Obviously that's helped us drop our cost guidance across the Company. I'm particularly proud of the Powder River Basin. The team down there dropped -- our costs were down $0.72 from a year ago. That equates to almost $60 million. Having said that, though, none of us can be satisfied with where we are on costs, and in this market as in any of them we have really got to keep pushing. As you look forward to '14, we don't really see the headwinds we had in the past as far as cost pressure. The workforce is stable. We are seeing pretty good things from -- as far as vendors, I think everybody understands that things are pretty tight. I guess there's always the variability in the commodities such of diesel and that. We continue to focus on the things we can control at the mine, and the guys turn in a good result.

That's helpful. I'm sorry if I missed the realized price is a on the met side during the quarter, can you give us that number and then, maybe quantify those force majeure tons as well as the production impact for Mt Laurel?

The price is about $90. Mountain Laurel, the force majeure at Mountain Laurel, Holly, are you talking about the production impact at Mountain Laurel?

Yes.

Mountain Laurel, if you look at it, since -- when we moved to Cedar Grove, we had said there was going to be a step change as far as the production. We also thought there would be a little bit more variability. If you look in the third quarter we ran about 580,000 tons. It wasn't a disastrous quarter but it wasn't a good -- particularly coming off the second quarter which was the best we have run which was about 740,000 tons. Just kind of round numbers, about 10% of that impact would have fallen on Mountain Laurel. As I said in the earlier comments, about half of our volume dropped within the customer force majeure and other customer issues.

In Mount Laurel, we expect it to continue to be an important piece of are met portfolio. We think from a quality standpoint, from a cost standpoint, the coal does very well in the US and international markets, and we would expect it to do so as we move into 2014.

I appreciate the color.

David Gagliano, Barclays.

I have two. First of all, given the moving parts with Leer coming on and perhaps scaling it back a bit at some other operations, can you give us a sense of your range of expected 2014 met coal volumes? That's my first question. My second question is for John Drexler. A missed the impact from the hedge that flowed through this quarter. Was that a gain or a loss, and if so, how much flowed through the results in Q3?

David, let me take that first piece, and then I'll kick it over to Drex for the second. On the met volume, we are still in the planning and budgeting stage for 2014. I would be hesitant to give you a volume for met right now. I think a lot of that is going to be driven by where we see the market opportunities. We are in the early stages of discussions with our domestic customers. We haven't really concluded anything yet. I think will have more clarity when that gets concluded and we start discussions with the international customers. All of that about the time that we get Leer ramped up in December and work through the kinks, as you have with the new operation so, I think that is something we would have to update you on in the January call. John?

David, as far as the question on the swaps, we have a line item on income statement, changing fair value of coal derivatives that is showing a loss of $9.8 million dollars. The vast majority of that loss is a paper loss on the expiration of in the money hedges. There were gains recorded previously there, mark to market gains, that as those positions came to fruition we got the cash flow. The benefit of those gains are flowing through the other operating income line lower on the income statement. So net, net it is not a loss, it's essentially a wash for the third quarter.

Got it. Just one quick follow-up. Could you just comment a little bit on how your domestic met coal contract negotiations are going 2014 in terms of the directional movement pricing? If you could give us a range, that would be great.

I would be hesitant to give you much color on that other than to say our domestic customers continue to run their plant at pretty high capacity factors. They have been in the mid to high 70s most of the year, so we think the demand will be there. We've enjoyed a long-term relationship with our domestic customers, I think, I would characterize the discussions as productive at this point. I would be very hesitant to given the price direction at this point. Is that a fair assessment?

I think that is probably the best (technical difficulty), John.

Caleb Dorfman, Simmons & Company.

Costs in the PRB were incredibly good compared to when we look back one or 1.5 years ago. Paul, could you give is a breakdown of the driver in the different buckets between like fixed costs spread, and underlying costs savings, and maybe raw input costs? And then when do the increase stripping costs start come into play and put upward momentum onto these costs?

As you look at the PRB, the cost kind of all into the four big buckets. Labor and benefit are about 20%; maintenance and repair are about 20%; explosive and fuel are about 35%; the remainder is kind of the bottom five. As you look at the PRB over the years, labor and benefits are always -- have always had good control. Those might a relatively predictable with all the maintenance and repair expenses. As you look at the things that we focused on cost, it is generally in the area of maintenance and repair and explosives and fuel. As I've talked in the past, those are the big cost drivers in the PRB.

And at what point do you think start need to repair some of the equipment which you have been -- which you had previously parked and then are using [part] now?

I don't -- as I said earlier, I think the step back up -- the bringing back online of production in the PRB is a little bit of a step functions. Some of the equipment is going to be easier to bring on that than others. As that they, I think we are going to have to see a pretty good market change before we get serious about a lot of this equipment.

John Bridges, JPMorgan

I was wondering what was the problem at Laurel? Is this a one off? Are you going into a more difficult part of the coal seam?

Hello John. The mine struggled with the rock parting on the long wall face that cut our advance rate. As I said earlier, if you recall, we did have a step change when we move from the Alma to Cedar Grove. Last quarter we had the best production -- in Q2 we had best production quarter since we've moved up, plus 700,000 tons. This dropped us down to about 586,000. It was a tough quarter and the cutting was a little harder than we wanted, we had a little bit rock coming in on the face. I think in general as I said it's not a disastrous issued just one we had to work through. It looks like we are coming out of it, and I'm looking for a little more normalized production in Q4.

Is this a known parting in that part of the world?

What it is, John, there's a rider that comes down at certain points, that parting will get a little thicker, and as the rider comes downs that parting tends to drop out on the face. It's relatively predictable where it's at.

Okay, as a follow-up you moved labor from central to Leer. Is that helping you on the cost side as well? Is your longer-term labor more affordable than the contractors?

That was a good move for a lot of reasons. I think contractors tend to be a little bit of a necessary evil but, we had kept a pretty good contract workforce there to have some flexibility. As you know, the two mines are relatively close to each other. They are about 12 miles apart or 15 miles apart. We are able to displace a pretty good workforce of contractors and move in about an equivalent of a section of the Sentinel people. Really what we did is we were able to upgrade quite a bit. We brought in very skilled people, and we are all getting ramped up for the long wall startup that is coming here in the next six to eight weeks.

Curt Woodworth, Nomura.

In terms of the Leer ramp up, could you talk about the timeline there. When do you think you would get to full capacity, and what sort of customer commitments do you have at this point for that coal?

As I said, we're still looking at a December start up of the long wall. We started taking the equipment underground and will actually start setting the face up. A few of the other things going on at Leer, we had actually set up kind of a short space on the surface where we had roughly 10 shields as well as a section of pan line, head tail drive and the sheer, so we start the training last couple of weeks. One of the things that we did with Leer is that we built the long wall identical to Mountain Laurel. That has a lot of benefits. Set aside the inventory and the maintenance issues, we are bringing people from Mountain Laurel to train our people at Leer.

I think typically we look at a ramp up time of a couple months for a long wall. I still think we have that built into our plan, but I'm optimistic that hopefully with the fact that this is identical pace we can bring up people that will cut that back a little bit. As far as commitments, we are really just in the heart of negotiating with the domestic players. We are really about two months out on the international side.

But we continue to get positive feedback from our customers on the test and how the coal is behaving, and the quality, and it's certainly are encouraging what we're hearing.

Okay. Just one last question on the potential monetization opportunity. Would you guys look to divest your reserves in the Illinois basin just given the interest level there? Do you see asset sale opportunities elsewhere in the portfolio?

Curt, we are always looking at that. I think we proved with the recent CFC transaction that we are willing if someone comes in and provides more value on a particular asset and we see, and it is not strategic to execute our strategy over the next three to five years, we will consider monetizing. That goes for Illinois as well as other parts of the Company. But again with our liquidity position, our cash position, we really don't have to be forced into doing anything. We can be patient, make good prudent business decisions. And again, if somebody is going to come in and give us full value for an asset that we don't think is strategic, yes, we will monetize it.

Lucas Pipes, Brean capital

My first question is on the discontinued ops that you had during the quarter. It looked a little high even after accounting for the Canyon Fuel transaction. Could you elaborate on what is in that bucket?

In the discontinued ops, as we indicated, the largest piece was the impairment charge we took writing down the Hazard operating complex. In addition, our coal to liquid facility that we indicated was also written down. Those two items represent the line share of the charge flowing through the asset impairment and the mine closure line on the income statement.

That's helpful. And then, a few points on the PRB to follow-up. First, what is your sense of why prices are still relatively weak at this point in time considering you had substantial inventory correction? And on the back of that, how much do you expect production to actually increase and have to increase in the PRB in 2014? And then lastly, Ridley seem to have a pretty big impact on pricing, how should we model that going forward?

We still think there needs to be a draw on inventory, Lucas. If you look back over the last several quarters, back into the second and third quarter of 2012 prices were $10, $10 and change. Today they're probably in the $11 range. So you have seen some improvement, not near what we would like to see. I think as you go through the balance of this year into the winter months, with normalized weather, natural gas at $3.50, $3.60, they will continue to pull those inventories. I think you could very well start to see some benefit as you go into 2014 season.

We are in the budgeting, planning stages right now, but we think the PRB production in 2013 will be pretty flat. We're not really forecasting any meaningful step up in 2014 as well. As Paul said earlier, Arch is not planning a bring additional volume on until we see a sustained improvement in the market. So, with the challenges of bringing on idle equipment and other things, we think the opportunities there to see some improvement in the price in the PRB.

The only comment I would add John is that we are seeing customers being very careful about what they are contracting this year. And as near as we can figure it's probably on the low-end of what they think they will need. They are just being careful about what their burn is going to be, and they are being careful about what the gas prices are going to be. I think that's why, if you want to paint kind of a positive scenario for pricing, the winters, a more about winter and gas prices stay where they at, which ought to go together, I think you could see attention pricing in the PRB happened very rapidly.

And, Lucas, this is John Drexler, I have a trusty staff here that let me know that interpreted your question incorrectly. So let me clarify before I confuse anyone. We have two line items in the income statement that I will discuss. First is the asset impairment and mine closure cost. Through there is Hazard and the coal to liquids facility that we discussed flowing through there. And the discontinued op line, that is the vast majority, if not all of that, is Canyon Fuel. We talked about a gain of $115 million, but what flows through that discontinued top line is net of taxes. The vast majority of what you see flowing through there is that gain adjusted for taxes coming through.

Brett Levy, Jefferies

Just on the cash front, can you talk a little bit about, under your covenants what is your maximum ability to add additional senior debt? Also, is there any opportunity to bring some cash to working capital and then on the Canyon Fuel sale, you mentioned book taxes. What are cash taxes like today to be?

Brett, this is John Drexler. A couple items there. From a secure position the most restrictive notes that we have are the 2016 notes. They have a 20% consolidated net tangible asset limitation on secured borrowings. If you work through the numbers roughly, it essentially indicates that we have $1.8 billion of available capacity. So you have got a $1.6 billion secured term loan, and then you have additional capacity of roughly $100 million to $200 million. That's the extent that we have right now.

So clearly as we move forward we will be looking at the opportunity as we look at our capital structure and what will address, those 2016 notes are callable, they're the most restrictive of the CNTA limitation. They are also in relative terms, some of our highest cost debt that we have in the books. So that clearly is going to be a focus for us as we move forward. The next most restrictive limitation is a 30% limitation in some of the longer dated bonds. There's a 10% increase in secured borrowing capacity that will occur once those 2016 notes are addressed at some point in the future.

As far as cash taxes, on the CFC, transaction, we are not expecting, given our tax position with significant deferred tax assets on our books, we will be able to utilize those. So we will have very limited if not any cash taxes associated with the Canyon Fuel transaction.

Brain Yu, Citi.

My first question is if you look at the fourth quarter met coal sale in it was a little bit better. If you compare that the cost structure implied in this year's met guidance of 6.9 million tons to 7.3 million tons, do guys think you can do better, the same, or worse net coal volumes in that for next year, assuming the demand is there but prices are where they are or 4Q?

John, I think it depends on how we see things evolve. We were certainly encouraged with the step up from $145 to $152, we continue to look at the global markets. We think the demand has been reasonable there. But there is currently an oversupply, and depending on whose numbers you look at, we think that is somewhere between 15 million tons and 20 million tons. We think, given a market of that size of 300 million tons plus, we think that is not a significant oversupply, and one event, whether it's a flooding or production issue could correct that pretty quickly. What we're trying to do is make sure we're positioned as a company when we see this changes in the marketplace that we can react. And that is what we've been doing with conversion from PCI to industrial market, work forces from Sentinel to Leer. All of those things are really reacting to what we see out there.

We do think there is probably additional supply that's going to come off whether it's over this fourth quarter or into next year. We think that oversupply gets rationalized whether in the US, Canada, Australia, or Mozambique, but clearly over time we don't think these price levels work. We think there's a pretty significant percentage of suppliers in the seaborne market that have cost structures at $152 are not getting any kind of return.

That's helpful. I was more tying to get a sense of how you guys would look at a given year cost structure. At $152 for next year, do you think you would still view the 6.9 million, 7.3 million excluding Leer or maybe a little bit better given that Mountain Laurel will perform more favorably?

I still think it's a little early given that we're in a budgeting process, and it gets back to our ability to react to what we see out there. I would tell you right now we are generating positive cash margins with our portfolio. That is what Paul and his team have worked hard on, to make sure we have got to a size with our met portfolio that we generate positive cash margins, and that's where we are today.

(Operator Instructions)

Luke McFarlane, Macquarie.

You have mentioned that you think there's going to be up 130 million tons of coal production out of central Appalachian in 2014. Can you give us any sense of what you think that looks like into 2014?

I continue to think there's what to be pressure on Central App if you look the average cost structure. We are fortunate to have some of the lowest cost there, and we have actually pared down our thermal portfolio, to really basically Coal-Mac and some peripheral coal that we are taking from some of the met mines. If we see any improvement in the thermal markets, we don't see any improvement in natural gas prices, I think there's another pretty significant step down in 2015. We are down from 148 million tons in '12 to about 130 million tons this year. I think you could see a comparable step down in 2015 if there's no improvement in the market. There are people in Central App that have cost structures that, when you're competing against natural gas in the Southeast at $3.50, it doesn't work.

As John said, we're basically down to Coal Mac as far as Arch is concerned. Coal-Mac has a very competitive cost structure, but thermal production in Central APP is becoming extraordinarily difficult.

Over the remaining tons that will likely come out, if they do come out, do you think it's a mix, or do you know what the mix would be between like a listed coal producer and the smaller private companies that are operating there?

That has been a hard thing to get a handle on. Obviously there has been consolidation in Central App, but there are still a large number of small players. What is always hard with those smaller operators is to guess if they have got contracts that have kept them going for a period of time, when there is real loss. That is a very difficult thing to get a hold of. But what is clear, on a sustaining basis people are not going to invest in thermal mines in Central App, and the ones that are there have a tough time staying with production they have now.

Jim Rollyson, Raymond James.

John, you guys have done a really good job of squeezing costs out of your system here in the last few quarters, no thanks to the market probably pushing you to have to do that, but you have done a good job in the less. Where do you think you are in that ball game in terms of being able to get costs out? Are you mostly there on what you think you can do, or are there still levers that you can pull?

It's something we look at everyday. I think you could see what Mr. Lang has done on the operating side. We continue to make improvements quarter after quarter. The fact in the PRB we have been able to sell some volume has certainly helped, but some of the initiatives that they looked at out there are not only short-term initiatives, I think there long-term initiatives that we can carry into an improved market. That is what we expect to do.

On the admin side with the CFC, we indicated that we would drop our G&A about $10 million which we have and will. I think the challenge there is that we were already running pretty lean. If you look our G&A relative to others, we already had a pretty flat organization, with not a lot of fluff there. That doesn't mean that we won't continue to look at those opportunities to cut but, we are in the planning budgeting stages right now. We actually have another meeting next week and will be talking more about that. But let me assure you, Jim, we never quit looking at those opportunities, period, whether it's on the operating side, G&A said, because in this kind of environment you have to manage your costs. And I think we proven thus far that we can do that, and we will continue to focus on those things.

Great. I appreciate the answer. Thanks.

Neil Meadow, Goldman Sachs

Can you talk about the international export opportunity both for met and for thermal? And just from a net back perspective how much higher do you think you need to see Newcastle or international coal prices to make the PRB exports in the money?

I will kick it off, and I'll let Paul jump in. As we look at the international markets, we think it's an important segment for us in terms of demand growth. Let's be honest when we look at the US markets we think over the next six to eight years demand levels add about 900,000,000 tons, and that is where we're focused. We think we can make a lot of money in that given our asset base, but when we look at purely growth, they are building 280 GW of new coal part generation around the world over the next 48 months. You've got World Steel Association predicting 35% to 40% improvement in steel production over the next six years. Those are all things that are driving Arch's behavior. Last year we exported almost 14 million tons. This year we'll be closer to 12 million tons. The industry as a whole exported I think about 124 million short tons.

Is something we think is important. In saying that though, there is early going to be ups and downs, and this year has been tough. Current API prices are in the low $80s. We think they need to be much higher to really provide opportunities for us particularly in East. When we look at PRB coals going off the West Coast we benchmark ourselves out the 5000 kcal out of Indonesia. Those prices are in the high $50s, to around $60 range. It really doesn't work right now when you to them net backs. We have been very proactive with the marketing team in Asia to make sure wherever the customer, doing transaction, when sometimes they don't make pure economic sense now, but we think developing those relationships now is a prudent thing to do when the market turns.

It hasn't been 15 to 20 months since the 5000 kcal was $80 or $90, and I can assure you that works very well. In fact, there was a pretty time will we were getting a lot better pricing in Asia than we were getting in the domestic market. In summary, I do think the international markets are going to be very important to Arch coal over the coming years, but they won't be without pain. We will have ups and downs, and we have to have the flexibility, the cost structure to be able to react to those when the prices come down.

The only thing I would add to that, I think John hit API 2 and the Indonesia markets fairly well, but we have had success that we have recently shipped some coal to Japan from West Elk. Those [at best] still work and aren't that bad. When you think about it, West Elk has a lower ash and a lower sulfur than some of the Australian coal, and it does bring a little bit of a premium to the Newcastle coal. So that's a markets, we keep looking for the small things, and that has been one of the gains that we have had this quarter.

Timna Tanners, Bank of America Merrill Lynch.

I wanted to just follow up if I could on the Leer Mine and wanted to make sure if I understood if it was going to be incremental or if you're looking to replace existing capacity, and if there's any additional costs into the fourth quarter that we need to understand?

I think we've indicated publicly that, that mine will be 3 million tons to 3.5 million tons of mostly met. We are in the process of 2014 planning and budgeting right now. We will see where the market conditions are, but, given the margin enhancement, the quality coal, the market opportunities we see from Leer, we are very excited about that going forward.

So, understanding that you're still in planning process, have you ever quantified or do you have an updated amount of information about the supply that you have in the domestic industry for our own edification?

On what now, excuse me?

On met coal supply to the US market?

I think if you look at our met portfolio about 40% of it goes to the US markets, and the balance goes into the international markets.

US and Canada is 40%.

Matt Vittorioso, Barclays

I was wondering if we can get some high-level color on your met costs, thinking forward into 2014 once you have Leer coming online, I think Arch uniquely has a lot of its met coal coming from long wall operations, if you're -- if you think of Arch being sort of a mid to high 60s Eastern cost profile what, how does your met coal differ from that mids to high 60s? Particularly once you get Leer Mine is it significantly higher than the average or just above? Could you quantify that in any way?

What we have said in the past is that Leer will follow to the range with our current cost structure. I think until the mine is up and running that is probably as good a guidance as we should give.

Can you comment at all on what you think that Leer quality coal will net back to, to you guys at the mine in today's market?

What we found, this is a little bit better quality. It's been one of the pleasant surprises at Leer. The quality has come in better than we thought. It has had good reception with all the customers as John indicated. The quality of this coal right now, if I were to call it, probably is in the mid-90s.

On a mid to high 60s cost, it fits in line with the average?

Yes.

Yes, that's a good model, pretty good cash margin, even in a tough market.

Thank you.

Dave Martin, Deutsche Bank.

Had a follow-up question on the earlier discussion about exports. John, I think you mentioned that you think your exports this year will be about 12 million tons. I was wondering if you could give us some level of detail by-product what will make up that 12 million tons?

I am trying to do the math in my head. Do you know the breakdown of the 12 million for 2013 on exports?

I do not have that off the top of my head.

I concluded from your comments on met coal that about 4 million tons is going exports. I just didn't know what other remainder was left in East, but I can follow-up with you. And my second question, related question, is at various times in the past you have talked about [fort] and terminal contracts. I am curious as to if any of those contracts or relationships are due to expire?

We have got various agreements that have various terms on them, so we're always in discussion with these guys. They don't all drop off at the same time. So, as we have indicated in the past, we exported 14 million tons last year and had revenues associated with those exports of about 1.2 billion tons. We could not have done that without those type of agreements. That is something that we will always have out there. As I indicated earlier, there's always going to be ebbs and flows, and we just have to manage against those.

Due to time constrictions, we will take our last question from David Lipschitz with CLSA.

Quick question and just to follow-up, most of the questions have been answered. In terms of the PRB realization for 2013, does that mean there is a big step up in fourth quarter for PRB realizations based on the average for the year?

I would not model that, David.

Okay because you have 1255 obviously, you are much lower than the rest, for the first three quarters on average. I was just wondering.

That would not take into account any incremental sales or open market sales we could do out of Ridley.

Okay. Thank you.

At this time I will turn the call back to John Eaves for closing remarks.

Thank you. We certainly appreciate your interest on the call today. Let me assure you that the management team is focused on the things that we can control. That's managing our costs, our capital, our liquidity. It's really focused on the assets that we think can create the most value and he most growth over the next five years, and that's our PRB and our met assets. We are pleased with the progress we are making on the cost side and the capital management and certainly pleased with where we stand today with liquidity. We look forward to updating you in January on the progress on all those fronts as well as the update on the start up at Leer. Thank you. We will talk to you in January.

That concludes today's conference call. Thank you for your participation.