Arch Resources Inc (ARCH) 2014 Q2 法說會逐字稿

Good day, everyone, and welcome to the Arch Coal Incorporated second quarter 2014 earnings release conference call. Today's call 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.

Thank you. 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 Privates 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 result of new information, future events or otherwise, except as may be required by law. I would just 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 which we 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, we will be happy to take your questions. John?

Good morning. Today, Arch reported adjusted net loss of $0.46 per share in the second quarter and generated $65 million in EBITDA. These results reflect the ongoing impact of weak metallurgical coal markets and our success in adjusting our operations in response to these conditions. Last week, we announced the idling of our Cumberland River complex. We regret the impact this will have on those affected, but the decision was necessary as continued soft metallurgical prices have rendered the complex uneconomic in today's operating environment.

Going forward, we have chosen to concentrate our metallurgical production in our lowest cost, highest margin assets to further benefit our already low cost structure in Appalachia, and enhance the overall quality of our metallurgical product mix. This action will create a sustainable metallurgical coal platform that can earn strong cash margins even under soft market conditions. This action also positions Arch well to respond as markets rebound. By preserving the valuable reserves at Cumberland River, we have retained the option to restart that mine when coking coal markets strengthen in the future.

Of course, we believe that we are close to the bottom in the met markets today. Global production curtailments have accelerated in 2014, and by our account total nearly 20 million tons thus far. These curtailments will help offset the growth in supply that is stemming from capital projects that were justified when prices were materially higher. As we look ahead, we expect a much more balanced market, with steel production growing, capital projects being delayed or canceled, and high-cost coking coal capacity shutting.

That being said, with no near-term catalyst pointing to a material improvement, we have elected to reduce our sales expectations further in 2014. In the first half, we ship 3.3 million tons of met coal at mine prices around $82 per short ton, putting us on pace to ship 6.6 million tons of met coal this year at the midpoint. While our met coal capacity lies well above our current sales levels, we simply don't want to push tons into an already saturated market at this time. Turning now to domestic thermal markets, we expect coal consumption to be up by 20 million tons or so over last year, and that's with the cooler summer weather that's been playing out to date.

Current estimates suggest that cooling degree days could be down as much as 5% versus last year, and 10% versus the five-year average. While these trends will impact power consumption and coal demand, we continue to see increased interest from our customers. Western goal remains in the money compared with current natural gas prices, and coal stockpiles at generators are on the low end, and in some cases, well below targeted levels. Nowhere is the increased demand for thermal coal more apparent that West Elk. Based on opportunities we are seeing in the marketplace, and our sales to date, we've elected to increase production at West Elk to the 6 million ton level.

This increase allows us to run the mine at close to its capacity, which is having a beneficial effect on that region's cost structure and raising our margins there meaningfully. We are also seeing more RFPs for our PRB coal, and continue to lock in future business in that region at higher prices than that we've seen over the past several years. At the same time, the lack of sustained summer heat, a slower-growing economy, waning natural gas prices and rail service issues are all likely weighing on PRB markets to some degree.

While we are forecasting a gradual improvement in PRB rail service in the back half of the year, it has not been satisfactory to date. This issue has led to some stockpile conservation measures at our customers. Given current trends, it is like you that we won't ship all our contracted coal this year, resulting in some rollover into 2015. We have tried to contemplate this impact in the cost ranges we provided for 2014. However, as transportation bottlenecks ease in both the East and the West, and we're confident that they will, we expect customers to reenter the market in a more significant way to supplement their inventories.

We are forecasting utility coal stockpiles to end the year at or below 50 days of supply, with inventories in some regions, such as the PRB, dipping below normal levels. At the same time, we project that US coal production will fall below the billion tons for the second straight year in 2014, which should help further tighten up domestic and sea-borne markets. In closing, we are pleased that we are managing what we can control and proactively responding to current market conditions. The metallurgical market is challenging right now.

We have positioned the Company well to withstand this cyclical downturn and provide substantial upside as markets recover. As our second-quarter results demonstrate, we are taking aggressive steps to control cost and improve operational efficiencies. We are also focused on managing our liquidity position in reshaping our operating mine portfolio to a smaller but more sustainable low-cost platform. With that, I will now turn the call over to Paul Lang, Arch's COO, for a discussion of our regional sales and operating performance. Paul?

Thanks, John. On the operational front, we expanded our cash margin per ton in each of our regions during the second quarter as shipments improved, cost containment efforts were successfully implemented, and domestic thermal demand increased. Our unwavering focus on cost control across the operating platform is also the driving force behind our reduced cost guidance expectations in both the Appalachia and bituminous thermal segments for the full year.

Specifically in the second quarter, we reduced our cash cost in Appalachia by more than $3 per ton versus the first quarter, by concentrating production in our lowest cost mines, such as Leer, and executing on process improvement initiatives. In addition, stronger pricing on industrial and thermal shipments in the region [ranged] our average realized price per ton. Combined, these efforts drove a threefold increase in our cash margin per ton in Appalachia in the quarter just ended. In particular, our focus on process improvement in recent years has allowed us to advance the overall efficiencies at our mines.

As just one example, our managed rebuild program has driven down the cost of rebuilding underground mining equipment, which includes longwall components, continuous miners, and roof bolters. So far this year, the campaign has reduced continuous minor rebuild costs almost 45% as compared to historical levels, and helped us ensure maximum performance and life of the machinery. Looking ahead, we expect our full-year cash cost in Appalachia to decline by roughly $1 per ton at the midpoint versus our prior guidance. However, we are currently forecasting cash cost in the region to temporarily trend up in the third quarter, as both the Mountain Laurel and Leer mines have scheduled longwall moves during the period.

The Leer longwall move will be completed Thursday, and our longwall move at Mount Laurel is scheduled for later in the quarter. In addition, we anticipate recording the impact of idling the Cumberland River complex during the third quarter, which is projected to add slightly more than $1 per ton to the region's cost during the period. The impact has been embedded within our revised cost guidance range for the full year, though. Turning briefly to the metallurgical side of the business, we shipped 1.7 million tons of coking and PCI coal, at an average price of $81 per ton in the second quarter, with about half of the sales mix comprising low vol and high vol A coals.

We also committed another 700,000 tons and an average blended price of $77 per ton. This brings our total 2014 metallurgical sales commitments to 6.2 million tons. As mentioned, we have lowered the top end of our metallurgical volume range due to Cumberland River's idling, and we are now forecasting coking coal and PCI sales of 6.3 to 6.9 million tons in 2014. Turning to the bituminous thermal segment, we had a strong performance at our West Elk and Viper mines in the second quarter, which allowed us to reduce our cost guidance by $2.50 per ton in the region for full year 2014.

In particular, West Elk is benefiting from increased domestic customer interest. As John mentioned, we've elected to run that mine at a higher rate in the back half of 2014, as demand from industrial and utility accounts remain strong. In fact, we've committed more than 1 million tons of coal for 2014 delivery, at prices in the high 20s, helping expand our margins. We also continue to receive inquiries from international customers who favor West Elk's quality. But we've chosen to reduce our exposure to the export market, as current net-backs do not provide sufficient return at prevailing sea-borne prices.

We are well-positioned, however, to increase export shipments from our Colorado-based mine, as International market fundamentals improve. In the Powder River Basin, we improved our first-quarter cost performance, driven by a slight increase in rail shipments and the ongoing success of our cost containment efforts. As John mentioned, we expect shipments to improve gradually through the back half of the year, which should have a beneficial impact on our cost structure. To date in July, however, rail performance has not met our expectations.

Given this cautious view of the pace of the recovery in railroad service levels, we've elected to modestly reduce our cash cost per ton guidance range for the PRB to reflect the fluidity of the situation and the challenges it has imposed on us and our customers. We are encouraged, however, by the continued interest from generators, who are trying to replenish their stockpiles this year and want to secure the anticipated deeds for future years. We have signed multiple term agreements with customers, some of which have extended through 2020.

During the quarter, we committed around 6 million tons of coal, and priced approximately 2 million tons of indexed volumes for 2014 deliveries. These new commitments include a combination of domestic and export sales, with a product mix of roughly 70% Black Thunder and 30% Coal Creek, at an average blended price of $12.50 per ton. For 2015, we locked in a significant portion of our future sales at attractive prices that are meaningfully above current realizations. To date, we have approximately 75% of our volume committed in 2015, based on current run rates.

Lastly, I'd like to recognize our employees for another strong performance in our core values. We had six operations and facilities complete the last quarter without a single safety incident or environmental violation. In addition, both Mount Laurel and Leer reached 365 days without any lost time incidents. I'm proud of the hard work, focus and dedication that our employees exhibit every single day to accomplish our safety and environmental stewardship goals. With that, I'll turn the call over to John Drexler, Arch's CFO, to provide an update on our financial position and guidance. John?

Thanks, Paul. Despite the ongoing challenges in the marketplace, Arch is successfully executing a plan that has positioned and continues to position the Company well to manage through the downturn. John and Paul have already discussed our operational achievements and continued focus on reducing cost. I'll spend some time discussing our management of both liquidity and capital expenditures.

As we discussed during our first-quarter call, we expected the second quarter to have the heaviest cash outflow for the year, as we made the third of five annual $60 million LBA payments on the South Hilight reserve in the PRB. That capital expenditure, combined with over $100 million in cash payments for our scheduled semiannual interest payments on all of our unsecured bonds, led to the anticipated higher levels of cash outflow in the quarter just ended. Looking ahead, with an expected stronger operational performance during the remainder of 2014, combined with lower levels of CapEx, we anticipate meaningfully lower levels of cash flow use in the back half of the year.

Moreover, we continue to have abundant financial flexibility. We ended the quarter with $1.25 billion of liquidity, with $1 billion of that in cash or highly liquid investments. We have no major financial maintenance covenants until June of 2015. At that time, a relaxed senior secured leverage ratio covenant steps back in on the undrawn $250 million revolver. During the interim, we have only a minimum liquidity covenant of $550 million in place that is tied only to borrowings under the revolver, and we have no meaningful maturities of debt until mid-2018.

We have positioned the Company on solid financial footing to provide the flexibility necessary to execute our strategy over the next several years. On the capital front, we continue to prudently manage our capital spending. After adjusting for our second-quarter LBA payment, CapEx spending was just $21 million during the second quarter. Through June, excluding the LBA payment, spending was $36 million, representing a meaningful reduction from this time last year. While we expect modest increases in the back half of the year, we have been very aggressive in managing our capital needs.

Moreover, if coal markets continue to remain weak, we believe that we can sustain our annual capital expenditures around the current guidance levels for several years, since we are not running equipment as hard, we have redeployed idled equipment into other operations and reduced current maintenance needs. We are achieving success in the process improvement initiatives that Paul discussed. And we have no plans for major development projects at this stage of the market cycle.

One item to note in our quarterly results. As we continue to manage through challenged export markets, we incurred charges of $11 million in the second quarter, and other operating income on the income statement, related to minimum obligations on various port and rail commitments. Year to date, we have now incurred charges totaling $23 million. Given the prevailing weak prices in sea-borne markets for both thermal and metallurgical coal, we believe that incurring these costs rather than moving coal into over-supplied markets is the right strategy.

We will continue to work to mitigate these costs, but absent improvement in those markets, we would expect to incur comparable charges in the second half of 2014. Over the long term, we believe our investments to access the sea-borne coal trade will create substantial value for all our stakeholders. Turning now to our updated expectations for full year 2014, most of which were outlined in our earnings release today. With the ongoing challenges related to shipping in the PRB, we expect cash costs in the range of $10.80 to $11.10 per ton, representing an increase of $0.10 per ton from our previous guidance.

This range contemplates gradual improvement in rail performance over the back half of the year. In Appalachia, we are reducing our cash cost per ton range. With the successful ongoing ramp-up of the Leer longwall offset by the cost of idling higher-cost production at Cumberland River, we now expect cash costs of $62.50 to $64.50 per ton, a reduction of $1 per ton from our previous range. We are also reducing our cash cost per ton guidance in our bituminous thermal segment. We now expect cash costs in the range of $21 to $23 per ton, a reduction of $2.50 per ton at the midpoint from our previous guidance, as a result of continued strong market interest, combined with excellent operational cost control at our complexes there.

In other financial guidance, we expect our 2014 CapEx range to be between $170 million and $180 million, which includes the $60 million LBA payment for the South Hilight reserves, as discussed. DD&A in the range of $410 million to $430 million. Total interest expense between $382 million and $392 million. We note that our cash interest expense will be between $360 million and $370 million for 2014. SG&A between $118 million and $124 million, representing a reduction from our previous guidance as we continue to drive down our overhead costs. And a tax benefit for the year in the range of 20% to 40%.

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

(Operator Instructions)

Neil Mehta, Goldman Sachs.

Good morning.

Good morning, Neil.

Congrats on a great quarter here. As you talk about the rail situation in the PRB, can you give us a little bit more color in terms of what the pace of a recovery is likely to be? And what gives you confidence that this is a temporary logistics issue, as opposed to a structural issue that we might be dealing with for long time?

Neil, I'll start off it, and see if John wants to add. The story in the Powder River Basin this quarter is effectively the meltdown in rail service. And to give you little bit of color, the joint line performance deteriorated Q2 as compared to Q1. The trains per day, I think, were off almost 4%, to 54.5 trains.

[Bowl] shippers struggled, but I think this was being BNSF's worst month since, I think, about a year or nine months, so they've really struggled. And you look at as compared to the NCTA forecast, which were the volumes our customers nominate, the joint line as a whole saw an 80.6% service record, which is pretty low historically. Comparing Q1 to Q2, BNSF dropped from 79% to 76%, but also troubling was UP drop from 91% to 85%. Net result, I would say we lost between 4 million and 5 million tons of shipments in the first half of 2014. Obviously, the service has been devastating to us, our customers, but it has also been tough on the railroads.

Neil, this is John. Let me just follow on to what Paul said. It's had a real impact on our results, not only from a volume standpoint but from a revenue standpoint, as well. Certainly, the improvement has been a little bit slower than we anticipated. That's why we are building in a gradual improvement in the back half of the year. We've got weekly, if not daily, contact with the major railroads, particularly the one that is being the most challenged, really from the Chairman, CEO on down. I know Paul and I both are talking to them frequently, as well as our team.

Your point, are we going to a structural change? There has been some things happen to them that I think it really impacted their performance. One would be hauling oil out of the Bakken, grain season, weather congestion in the Midwest. And then they had a lot of their track fall out and they had to reconstruct a lot of their track. I do believe that they are going to fix the problem. They have told Paul and I time and time again the problem will get fixed. They're spending about -- one of the railroads is spending about $5 billion of capital to bring power and crews back on. It takes time to get those crews trained.

So I guess I feel that it will get resolved, but I think we're going to be late 2014, going into 2015, before we see the results that we'd like. So it is something that we are frustrated with. We continue to work with them. We've been through this before. This is about the third time in the last 10 years we've had a meltdown at the railroads, and they do tend to get it fixed. It's just a little bit slower than we would like.

And can PRB prices improve until rail service is back to that run rate or more normal levels?

I do think it's put impairment on the pricing this year. We've seen that recently. And then with the slow start that we've had to the summer, natural gas, we've seen a little pressure. But as Paul indicated, we went out and we continue to see a lot of interest, 15, 16, 17, in the marketplace, that we think our going to be pretty decent pricing. So something short-term, I think, it is having an impact. I think the buyers are reluctant to go out and commit any additional volume, at least the balance of this year, until they can get what they've contracted for.

All right, guys. Thanks for the color.

Thanks, Neil.

Mitesh Thakkar, FBR Capital Markets.

Good morning, everybody. And good job on the cost. Paul, my first question is, how sustainable is this cost improvement? And part of that, like in the PRB, is sales price-driven. But outside of PRB, how do you feel about Leer ramping up and having a full year potentially next year, versus this year, where they are still ramping up? And its impact on cost as we go forward?

It's pretty broad question, Mitesh, but I will dive in. Overall, I think the team did a great job lowering costs. And obviously, that allowed us to drop our guidance in two of the regions. As I sit here today, we've had a lot of success in the process improvement efforts we've had. And you look structurally around the industry, skilled labor is plentiful. We've got some very strong alliances with our vendors and suppliers. They are feeling the pinch also, and they are working with us and together to both improve our situations.

And I think I'm pretty optimistic about what we can hold going into the future, when the market returns. There's always going to be variability in the commodity and diesel prices. But in general, what we're doing should carry forward, even when times turn around. Relative to Eastern cost, obviously, we are seeing some great results out of Leer, and I feel very good. You think about the second quarter, we had some headwinds with Mount Laurel. We also had a few of the other things slow down.

But at the same time, we are able to drop our cost, and really what you are seeing is the benefits of the Leer operation coming online. And I would say we are through the ramp, or getting through the ramp up period. It will continue on the next two quarters, but feel very good about where we are at.

Mitesh, this is John. Just follow on to what Paul said, we have made a lot of tough decisions in the last 12 to 15 months. We've reduced our manning, we have closed coal mines. All those are very, very difficult on the management team. But in an effort to refine our portfolio, where we've got low cost structure, not only on the thermal side but on the met side, it really sustains us through this difficult market. We think was prudent. And you're starting to see the benefit of that. And it is really a credit to Paul and his team, and how hard they've worked on cost control and measurement of our capital. And you are really starting to see that. So I'm confident that we can carry that, not only in the back half of year, but as we move into 2015.

Great. And just a follow-up question. On the 8,400 coal, how is that market holding up? And I know Coal Creek is your only mine which produces that quality of coal. It looks like MSHA as so far as showing that the volume was down dramatically. Is that a conscious decision you guys made? Or is that something we should be looking out for?

Mitesh, just on the Coal Creek data and MSHA, I think there's an error in it. Coal Creek, I think, ran at a nominal rate to Q1. But having said that, we are seeing increased interest in 8,400 versus 8,400 coal. And I think what's been surprising to me is the pricing. The spread has stayed relatively wide, sits about $2.50. I think some of this is the result of rail service, where generators who have a choice tend to be taking the 8,800 coals, if they are limited on their deliveries.

And I also think there's a little bit of a residual of what I've seen in the past. And that is when the market gets a little tough, the 8,800 mines tend mind tend to cannibalize the 8,400 mines. So I don't think there's anything structural. And I think some of these things will turn around. But during the quarter, we did place some tons for Coal Creek at prices I felt were pretty attractive.

Was it longer-term coal -- like are we seeing a solid pricing in 16/17? Or was it more 14/15 kind of coal?

Mitesh, we sold Coal Creek coal at 15, but the term agreements we've done have been for Black Thunder.

Okay. Perfect. Thank you very much guys. I really appreciate it.

Thank you.

Lucas Pipes, Brean Capital.

Good morning, everybody.

Good morning, Lucas.

So with met coal prices bouncing around here at pretty low levels, I wondered if you could maybe give us a sense on where you are selling? What price levels you are selling your various products?

As Paul indicated, we sold 700,000 tons or so during the quarter about $77 on a blended basis. I would tell you, with third-quarter benchmark at 120, we are seeing spot around that 112 to 114 range. We are certainly disappointed in the pricing, but we don't think that this pricing is sustainable. When you look at the percentage of suppliers that -- in the sea-borne market that are not generating any positive cash, that percentage is pretty significant. You can look around at the independent consultants and pick different numbers, but no matter which one you pick, there's a lot of people that aren't generating cash.

We have seen about 20 million tons announced in terms of curtailments. We think that will continue, as we move through the earnings season into the back half of the year, because people just can't make it. And it's not only in the US; we think it is Canada and Australia,, as well. Currently we see about, call it, 25 million tons, plus or minus, of oversupply in the market today. We think that, as we move into 2015 and you get a full year of these curtailments, that that will have an impact. 2.5% to 3% growth in steel demand will have an impact, and you will see this balance out.

We don't see a whole lot improvement for the balance of this year. But as we move into 2015, there's one thing that we know about met markets is they correct, and they often over-correct. And the goal of this management team is to make sure that we have this Company positioned, when it does correct, that we can capitalize on that. And that's what we've been doing with our met mines. If you look at our portfolio of qualities, you look at our cost structure, we think we are in a position on the lower end of the cost curve here in the US, it can participate not only in the domestic markets, but in the global markets as well.

I appreciate that. And a direct follow-up on that. You mentioned the industries, a lot is below cash breakeven. You've streamlined your portfolio, just actually most recently, with another curtailment. With the mines that you have remaining, would you say that they are all cash flow positive?

That's correct.

The met coal mine specifically?

Yes, there's no question, Lucas. In the second quarter, our Appalachian segment, both our metallurgic and thermal mines were cash positive.

That's helpful. Thank you.

Thank you.

Brandon Blossman, Tudor, Pickering, Holt.

Good morning guys, Jennifer.

Good morning, Brandon.

Paul, this is to fill out a question already asked. But Leer continues to ramp. How many quarters until we get to optimal production at Leer and optimal cost structure? And then related, is Leer production ultimately constrained by its capacity, or by market demand, as the current market exists for its product?

Brandon, I've got to say, the guys have done a great job, and pretty well hit all our expectations to date. I've been there twice in the last couple of months celebrating, really, what the guys have gotten done. As you look at the ramp that we laid out, it was -- John may argue it was being conservative, but we laid it out as about a 12 month ramp up. And as I noted in my prepared comments, we are going through our first longwall move as we speak, and we are finishing it up.

And I have got to say that went well for the first time for these guys. So if you were to tie it all together, I would say we are slightly ahead of where we thought we would be, but I still feel good about things. As far as its cost, it is very cash positive, even in this market. So what you are seeing us do is, with our portfolio of mines, we are culling out or slowing down the lower -- or the higher cost ones and pushing the lower cost ones pretty well to capacity.

And marketing efforts for that coal successful to date?

No, no problems at all with that coal. It has been very widely accepted. And a side note, we've been pleasantly surprised with the as-shipped quality versus what we thought.

Next question, John, asset sales, was there any asset sales in the quarter? Asset monetizations?

No, we didn't have any asset sales during the quarter. We -- if you think about what we've done over the last 12 to 15 months, we've monetized about $475 million worth of assets. These are assets that were non-core to us executing our strategy. In addition to that, we eliminated capital requirements of over $200 million over the next couple of years.

So we have looked at our portfolio hard. We continue to do that. We are not we sellers of assets; we're buyers of assets. We are always looking at our portfolio to make sure that it is consistent with our strategy. And that's something that we will continue to do. But in our position, we don't feel like we are compelled to have to do anything, unless we get full value for those particular assets.

All right, thank you.

Thank you, Brandon.

Caleb Dorfman, Simmons and Company.

Good morning, gentlemen.

Good morning.

Paul, you had a nice job at Black Thunder this quarter. It seemed like the rest of the PRB struggled. Was that something specific with the mix of rails that you have at the operation? Or were you doing anything specific which allowed your PRB operations to actually increased their volumes quarter on quarter?

I will start off, I appreciate you saying they did well. I was pretty disappointed in what they'd done. I think actually, we've been a little more disproportionately affected by it. If you think about it, the majority of the issue has been with BNSF. And just the quirk of the sales this year, we are about 60% or 65% BNSF. So while it is been a tough road, as John said, we spent a lot of time talking to the railroad, a lot of time working on anything we can to improve service.

Normally, we have a pretty significant step-up in Q3 volumes from Q2 volumes. And you've talked about how you think that rail service would get gradually better. Do you think that we will be able to have the same magnitude of a step-up? Or is that just going to be a pretty minor step-up when you look forward?

Caleb, as I mentioned in my prepared comments, we didn't get off to a good start in July. So I'm a little concerned that Q3, probably, if you measure it versus Q2, which is, I think, a pretty low benchmark, I think you'll see a step up. But I don't think it is going to be the magnitude we've seen in the past.

Thank you.

John Bridges, JPMorgan.

Good morning, everybody. I just wondered, is there a problem with the Leer -- sorry, with the Mount Laurel reporting in MSHA, as well, that was a bit weak in the quarter?

No, John, I think we continue to see a gradual improvement at the operation. Honestly, I'm a little disappointed with where we are. I would say we are running about 85% or 95% of where I thought we would be. All that put together, though, I still think what I told you last quarter. And that is, I think we're going to be on par to be in that low 2 million to 2.2 million ton production level.

It is going to be a little bit lumpy. We have a longwall move that comes up this quarter. We are thinking this third panel in the district is going to be better conditions, from what we've seen on developments. So I'm sticking with the, as I say, the 2 million to 2.2 million ton range.

So this is geology?

This is all geology.

Okay. And then, you pointed out that you are having a lot of success with West Elk. Where is that going? What customer is getting excited about that [coal]?

It has been pretty well across the board, but surprisingly to us is, a lot of the coal is moving West. And the answer is pretty simple, is that we're -- we can beat the dispatch of the coal units in Nevada and Utah. So as we looked at our -- as you recall in the -- when we did the beginning of the year, we thought West Elk was going to run about 4 million tons. This is the second time we've raised our production target of the operation, and a lot of it has been driven by the gas story this year.

(multiple speakers) It is not only on utility side; it is on the industrial side, as well. And we might have had a slight benefit from the rail problems at PRB, but it is all demand, really, driven on where we've seen natural gas prices. So we're pretty encouraged by what we're seeing in the back half of this year, going into 2015. Real turnaround there.

Kuni Chen, UBS

Hi, good morning, folks.

Good morning.

Just to follow-up on the met market. You talk about the oversupply conditions up versus (inaudible) near-term. Others have commented on conference calls, how many more tons need to come out of the market to get back to balance. Would you care to weigh in on that? As far as how many more mines globally we need to see idled?

We've seen the 20 million, and I don't think we've seen the full impact of that until we get to 2015. It is been kind of sporadic out -- year to date. We do think, with 2.5% to 3% demand growth, that that will eat up some of it. But there are still some additional supply that needs to come off. I don't know that I would [put] a number to it. But I think it needs to be the US, Canada and Australia all looking at some of their higher-cost production and pulling it off. And I think given where the third quarter benchmark it is, where the spot market is, that you are going to see further cuts. I don't know that I have an exact number to put out there, but we need to see a little bit more in the back half of the year.

Right. Okay. Just as a follow-up, can you guys talk a bit about Illinois Basin? And just your thought process there? There's obviously a big block of reserves. Is that strategic longer-term? Is there a potential to use those preserves as an additional source of liquidity?

Let me start out, and Paul can jump in. Certainly, we've got a pretty sizable position in Illinois. It has been a position we are pretty proud of. The Viper mine continues to perform better each quarter, in terms of safety and cost control. We've been very pleased with our investment in Nighthawk. That continues to provide benefits to Arch Coal. And then we have our Lost Prairie reserve, which is a sizable reserve there that's fully permitted and ready to go. But given the volume that we see coming out of that market, we don't have any near-term plans to bring that on. It is -- certainly, Illinois could represent a core operating region for Arch Coal down the road.

It is something we continue to watch. We are proud of our reserve position there, but it is something that -- I don't see it in the near-term. We are always looking at opportunities with our assets. It is something that we continue to look at there. We want to try to get as much value out of that region as we can. And certainly pleased with where we are today, but always trying to enhance that value. So we are always looking at opportunities that may be out there. Paul, you got anything to add?

I'd simply add, we have a long history of operating in the Illinois Basin. That's where a lot of us started our careers with the Company. And I don't think people really appreciate the value of the assets we have in Illinois. Between Viper and Nighthawk, we do about 7 million or 7.5 million tons a year. And they are all very strong, and contributors to cash flow and EBITDA. So I think there's a good growth potential in Illinois. We're going to be careful, as John said, on opening up any of our other mines. But it is definitely an area where we've got a lot of growth potential.

Great. I will turn it over. Thanks.

Justine Fisher, Goldman Sachs.

Good morning.

Good morning.

I think the point about the rail issue is interesting out of the PRB. And it does seem that utilities, per your comments and your competitors' comments, at some point will want to replenish their inventories. But despite the low levels of absolute coal inventories that we've seen, they seem to be managing thus far pretty well. And so I was wondering if you would give us some color as to how they seem to be managing?

Are they just more comfortable with lower inventories, given that they were lucky and the summer has been mild? Or are they being better at running plants that don't burn PRB instead of their PRB plants? Or are they blending more [filomene]? How are utilities able to manage through this? And do you think that they would be able to do that in the future, instead of potentially building inventories?

I think it couple things, Justine, is going on. I think some of our customers have learned to conserve. They've probably been burning some natural gas in instances, which is certainly an impact to us. I do think that they've gotten somewhat of a break as we started the summer. We've had a very mild winter and mild summer. As I was coming in this morning, on my car, it was low 50s. So in St. Louis, Missouri in late July, that's not something we've seen a lot of. So that low natural gas prices have given our customers particularly, out of the PRB, a break. I do think that those inventories are some of the lowest inventories in the country.

I think when they get comfortable with the rail performance, that they will not only come out and take the tons that they've contracted for, but they will be out to replenish their inventories, as well. And we are seeing that for 2015, 2016 and 2017, with the amount of RFPs that we've got on the table currently. So I think these problems get fixed. I think the utilities probably are sitting on lower inventories than they would like under normalized weather conditions. But I think they have done a decent job in managing those through a pretty difficult period. Paul?

The only thing I'd add to that, Justine, is we look at these averages, and the averages can be deceiving. We know, in several instances where we have customers that -- they are not on the ground, but they are down 10, 15, 20 days of inventory. And they are in a really bad situation. So while the averages are there, I think when -- there's some sense that the railroads are -- have got their act back together. I think you will see a change in what's going on. But right now, it has created an implied market that's over-supplied and under-demand, simply because of the rails service.

And even with the mild summer that we have started out with, we still were forecasting inventories, by the end of the summer, somewhere between 115 million and 120 million tons. And then with normalized weather through the fall, end up somewhere between 123 million and 125 million tons by the end of the year. Still well below where we've been for many, many years.

Okay, thanks. And then just a quick question on those take-or-pay contracts with the ports. Can you remind us how many years those run for?

This is John Drexler. We talked about the liquidated damages that we did incur, and I think we've talked about this before. Those agreements, there's a variety of them. They do cross over multiple years. It is too early to discuss what our expected impact in 2015 will be, as we continue to look at opportunities and how we manage that and where markets will be as we move forward.

So I think we are comfortable in looking at the back half of the year. We are working very aggressively to mitigate the impact of those. I think if you look at what we did in 2013, we were very successful in minimizing those. And we have provided our expectation for the remainder of this year, but we will continue to work to manage those through the remainder of the year.

Brett Levy, Jefferies.

Hey, guys. In terms of your bank covenants and your senior secured note covenants, but if you wanted to raise additional cash or availability, what are the constraints right now? And how much could you raise in cash? How much could you increase your bank availability? And how hard would it be to get a waiver to take that number up to an even higher level?

This is John Drexler. We have worked very hard over the last several years to position the Company to manage through the challenges that we've seen in these markets. And we've been very successful in enhancing our liquidity, extending maturities, and converting our liquidity to that being primarily focused on cash. As we sit here today, if you look at financial maintenance covenants that we have, they really apply only to our undrawn revolving credit facility. It is a $250 million facility.

We have a relaxed senior secured leverage ratio that steps back in mid-next year. We will continue to watch markets, and see where those develop. But right now, we are comfortable, as we look forward, in where those are. I guess as we sit here today, and specific to your question, you are asking what additional opportunities are there? I guess first of all, we feel with $1.25 billion of liquidity, $1 billion of that in cash, coming out of what was expected to be our heaviest cash outflow quarter, with a reduction in improvement in that cash flow -- outflow as we move through the remainder of the year.

That primary restriction on secured additional capacity is a CNTA, a consolidated net tangible asset limitation, which is at 30%. And so if you look at our balance sheet and work through the mechanics, what you roughly come out to is there's $2.5 billion of secured borrowing capacity. Right now, $1.25 billion of that is -- I'm sorry, $2.25 billion of that is currently utilized in the secured borrowings that we have in our first and second lien debt. And then the remainder, just looking at in broad terms, is available on the undrawn revolving credit facility.

As we have been, we will continue to look and manage our liquidity proactively. Those are the current restrictions. I can't get into details on what is viable or not viable in the current markets, et cetera. But suffice it to say we feel very comfortable with our position, and with future opportunities, and continue to be able to manage our liquidity aggressively as we move forward, if the challenging markets persist.

Could you issue any more senior secured notes?

If you did, you'd probably be looking at a situation where you would be bringing down the size of the revolving credit facility.

And at this time, I would like to turn the call back over to John Eaves for closing remarks.

We certainly appreciate your interest in Arch Coal. We want to thank all the employees for their performance during the quarter on safety and environmental performance. As a management team, we will continue to focus on margin expansion, capital management and liquidity. We look forward to updating you on our third-quarter results in late October. Thank you very much.

And this concludes your teleconference. Thank you for your participation. You may now disconnect.