Arch Resources Inc (ARCH) 2015 Q2 法說會逐字稿

Good day and welcome to the Arch Coal, Inc., second quarter 2015 earnings release conference call. Today's conference is being recorded. At this time, I would like to turn the conference over to Mr. Charles Dayton, Investor Relations. Please go ahead, sir.

Thank you. Good morning from St. Louis, and thank you for joining us today. Before we begin, let me remind you that certain statements made during this call, including statements related 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 would also like to remind you that you can find a reconciliation of the non-GAAP financial measures that we plan to discuss this morning at the end of our press release, a copy of which we have have posted in the Investors section of our website at archcoal.com.

On the call this morning we have John Eaves, Arch's Chairman and CEO; Paul Lang, Arch's 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 an adjusted net loss of $0.73 a share and $45 million in EBITDA. These results reflect persistently weak coal markets driven by an over supplied global met market, the low cost of competing fuels domestically and the impact of the MATS implementation.

Despite these challenges, we remain sharply focused on taking steps to enhance our competitive and our financial position. We continue to believe in the long-term prospects for a well positioned US coal producer such as ours. Before I get any further into my prepared remarks, I would like to address our current activity in the capital marks.

As you are aware, we're in a marketplace with open private debt exchange offers. If successful, the exchanges will allow us to meaningfully de-lever the balance sheet and reduce (inaudible). John Drexler will discuss the status of these transactions in his prepared remarks. Now to the quarter results.

Among our key achievements so far this year, all our major operations remain cash flow positive through the first half of the year. In fact they generated enough cash in the first half of the year to cover our corporate SG&A as well our CapEx. We further reduced both our CapEx and our SG&A guidance for the year to a point that is over $35 million favorable to what we guided to at the beginning of the year.

A full half of our operations achieved perfect zeros in the first half of the year which is to say they recorded zero safety reportable injuries and zero environmental violations. We think this puts Arch in a unique position and reflects the impact of our strategic focus on operating large scale low cost operations.

As we've indicated last quarter, we expected the second quarter to be our heaviest cash outflow quarter of the year and it was. We anticipate cash outflows to moderate significantly during the back half of the year. In fact our current estimates show us building cash slightly between now and the end of the year. John Drexler will discuss our cash flows and liquidity in his prepared remarks.

While the summer's been a bit warmer than some may have expected, natural gas prices continue to trade in the $2.75 to [$2.85] range, a level low enough to displace even PRB coal in some regions. As we noted before, the MATS regulations are expected to drive the closures of around 20 gigawatts of coal-based generating capacity this year which will take a toll on coal consumption as well. As a result, Arch continues to expect domestic thermal coal demand to fall by around 80 million tons in 2015 when compared to 2014.

Of course as most of you know, the Supreme Court took exception to the MATS rule during the quarter, scolding the EPA for failing to consider the significant cost of the rule against its relatively modest benefits. However, the reality is that most generators forged their MATS compliance strategies long ago, so we don't expect a significant change of the course in terms of the coal plant retirements. In a broader sense, though, the ruling could have significant impact on the timing and structure of the coming clean power plant rules.

On a positive note and in a sign that low prices are bringing the market into better balance, supply rationalization is happening quicker than expected. Supply declined 40 million tons in the first half of the year with the majority of that reduction in the second quarter. We currently expect at least 90 million tons of production to come out of the market in 2015.

On the international side, the picture's mixed. Longer term we continue to see build-out of coal-based generation particularly in China, India and southeast Asia. Unfortunately, currency rates and oversupply have eroded US competitiveness in many markets with the upshot being the lower US exports during the first half.

Still we believe we have a quality advantage into several international markets and will continue to be a supplier into those markets as opportunities present themselves. Overall we now expect net exports from the US to drop to about 80 million tons with the majority of which will be metallurgical coals.

Met markets remain challenged internationally as well as over supply and weak Australian dollars continue to prop up the profitability of these producers. With that said, we continue to find a home for our metallurgical production in the overseas market, at prices we don't like but at levels that continue to generate cash from our low cost portfolio.

Domestically, the strengthening US economy has kept steel mill utilization reasonably strong. This near record levels of auto sales and a strong construction environment have helped compensate for a sharply lower demand from the drilling industry. Anchored by the Leer longwall mine our low cost metallurgical platform continues to generate meaningful levels of cash flow even at today's prices.

In summary, coal markets are as difficult as I've seen during my 30 years in the industry but we've embraced these challenges. We continue to focus on cost control, reduce capital spending levels and right-size large scale low cost operations as part of our effort to help us through these difficult times.

On that note, I will now turn the call over to Paul Lang, Arch's President and COO for a discussion on operating performance in the second quarter and an updated outlook. Paul?

Thanks, John. In the second quarter, our operations displayed significant flexibility in a rapidly changing market environment. In the powder river basin, our team did an excellent job managing the operations as the region experienced heavy precipitation during the quarter. While our mines themselves did not sustain any damage, rail service was disrupted to various degrees over a several week period. Primarily as a result of these rail service issues, we missed about 3 million tons of shipments which resulted in a 10% decline in sales quarter over quarter.

Even with these headwinds, the region was basically able to hold cash costs flat as compared to the first quarter and recognized a cash margin of $2.25 per ton and a positive operating margin of $0.58 per ton. For clarity, I would like to note that the cash costs we report are inclusive of all costs except for DD&A. The per ton amounts include the impact of reclamation costs, fuel costs, including the cost of any activity to protect fuel costs and the impact of brokerage activity incurred in the region.

While we believe we'll make up a majority of the shipment shortfall this year, we have reached an agreement with a customer to move approximately 1 million tons back about 12 months. Given the impact of the shipments during the quarter, and a more cautious outlook for the sales the balance of the year, we're lowering the midpoint of our overall thermal volume guidance by 3 million tons.

With this, we're going to raise the bottom end of our cash cost guidance for the region and are now forecasting a new range of $10.60 to $11.00 per ton for 2015, or an increase of $0.05 per ton over the previous midpoint.

In Q2, both of our bituminous thermal operations had an outstanding quarter reducing cash costs by almost 20% as compared to the first quarter and 3% better than 2014 on materially lower volumes compared to the prior year. With this performance, our cash margins in the region grew to $10.22 per ton which is almost 34% of net realization. We continue to see success in placing the higher quality coal produced from West Elk and still believe the operation will ship approximately 5 million tons during the year.

Along with this, Viper continues to deliver solid operating costs which have collectively allowed us to lower our expected cash costs for the full year to a range of $23 to $25 per ton. In Appalachia, as expected, we saw an increase in operating costs due to longwall moves in Mountain Laurel and Leer as well as idling for the start of the annual miner's vacation. Even with these anticipated events, the region is running a cash cost of $57.71 per ton year-to-date which is a 10% improvement over 2014.

Significantly, during the quarter we continue to see both of our thermal and metallurgical franchises in this region operate on a cash positive basis. This result highlights the success of the actions we have a taken over the last two years to optimize our portfolio of mines and reduce costs. Overall, we're comfortable with where the operations are at and are maintaining our previous cash cost guidance of $56.75 to $59.75 per ton for the full year.

Turning to marketing, overall thermal sales remain tempered as generally mild weather and industrial consumption have raised questions about domestic generation levels for 2015. Year-to-date, power generation has been slightly down compared to 2014. This reduced generation, along with displacement of coal by natural gas, is collectively adding to customer caution and forward buying.

With that background, we took a measured approach to any additional 2015 sales and in the Powder River Basin, placed approximately 1.5 million tons which was offset in part by working with customers to retime some shipments and by settling some volumes financially. In addition, we priced a portion of our index commitments and were able to take advantage of a period of low OTC prices and actually purchased some physical volumes that were delivered from other mines in the quarter.

For the year, we're now showing 107 million tons of committed sales of which 106 million are priced at $13.32 per ton. With this, we are and now 96% committed based on our 2014 run rate.

For 2016 shipments, we sold about six million tons and added the volume moved from 2015 as well as priced about 1.2 million tons of index volume. With these new sales, we now have 66.4 million tons committed of which 52 million are priced at $13.99 per ton. Based on the run rate of the first half of 2015, we're now over 60% committed for next year.

In the bituminous thermal region, we placed approximately 500,000 tons of sales, the vast majority of which was with domestic customers for West Elk. With our current outlook for production our sales book of 7 million tons puts us at a 97% commitment level.

We continue to field inquiries from international customers that desire West Elk's quality of coal for blending. As a result, we've been able to complete niche sales well above benchmark prices and have shipped almost a million tons from the operation, roughly 40% of the mine's sales, to international customers so far this year.

In Appalachia, we completed thermal sales of about 300,000 tons, of which 180,000 were a standard product while the balance was the mids byproduct from our metallurgical operations. Given this, we're effectively sold out for the year.

For 2016, we placed minimal volumes but also have limited exposure since essentially all of our ?- our only remaining thermal production in the region is at our Coal-Mac operation which we believe is on the lower end of the region's cost curve.

On the metallurgical side of the business, in Q2 we shipped 1.6 million tons at an average price of slightly more than $77 per ton. In the first half of the year, we have now shipped 3.1 million tons of which 1.9 million were export and 1.2 million were delivered to domestic customers. Differential pricing between domestic and international customers net of transportation is now running about $1 a ton.

During the quarter, we committed about 700,000 tons at an average price just over $70 a ton. About half of these new sales were low-vol and high-vol A, with the balance being high-vol B. As I mentioned last quarter, we continue to see reasonable demand for our coking coal, although with much softer pricing. Based on this, we're optimistic about placing the remaining open tons and are maintaining our previous metallurgical volume guidance of 6 million to 6.8 million tons for the year.

Briefly looking at our capital plans, we are now expecting a reduction of our 2015 capital spending by $10 million versus our previous guidance and are now looking at a range of $130 million to $140 million inclusive of land payments. We continue to focus on the variables that we can control and believe we'll be able to maintain capital discipline in the years to come.

Finally, I would like to recognize Arch's employees for another outstanding quarter related to our core values of safety and environmental stewardship. Through the first half of the year they're achieving world class results in both of these critical areas, even with the general distractions prevalent in the industry today.

With that, I'll turn the phone over to John Drexler, Arch's CFO, to provide an update on our financial results, liquidity and guidance. John?

Thanks, Paul. As John and Paul have described, the challenges in the marketplace continue but our focus remains steadfast. We continue to execute our plan to manage our costs and capital expenditures tightly while ensuring the Company is strategically positioned in important markets with large scale low-cost assets. That plan is designed to help us to manage through these difficult times. But more importantly, generate significant value when coal markets turn.

Throughout the down cycle, we have been proactive in managing our capital structure in a dynamic and changing environment. Those efforts continue. John mentioned that on July 2 we launched two simultaneous private debt exchange offers.

Based on the results to date from the offers, if the offers were consummated, we would issue 631 million of new secured debt with annual cash interest of $44 million and extinguish $1.5 billion of unsecured debt with annual cash interest of $112 million. As a result we would reduce debt by approximately $870 million and reduce annual cash interest expense by approximately $70 million. We also would incur approximately $60 million of cash costs including payments to holders and fees and expenses.

As you saw in our recent release, a group of term loan holders have filed certain assertions with regard to the offers. We believe these assertions are without merit. As you also know, since the exchanges are still active in the market, we are precluded from saying anything further.

Next I would like to address our cash flow and liquidity. As we discussed during the last quarter conference call, we expected the second quarter to have the largest cash outflow for the year due to the timing of interest payments for the majority of our unsecured bonds, along with making the fourth of five annual $60 million LBA payments.

However, in addition to those known events, we also saw an increase in collateral requests primarily associated with our surety bonds. We are working very closely with our surety providers and currently expect that our collateral expectations are manageable. We also saw some negative working capital impacts as the growth in our coal inventories that we discussed on our last call did not completely reverse during the quarter and we had other temporary negative adjustments in our receivables and payables. We expect these impacts to reverse over the course of the year.

With the LBA payment behind us and as we project out to the end of the year, we expect a significant moderation in cash outflows. In fact, we currently expect our cash to end the year flat or increase modestly from levels at which we ended quarter. At quarter end we had $812 million in liquidity of which $690 million was in cash.

As a reminder, with regard to our capital structure and covenants that apply, we currently have a senior secured leverage ratio covenant that is calculated net of cash of five times on our $250 million revolver. We are in compliance with the covenant at the end of the quarter.

In addition, we have a minimum liquidity covenant of $550 million. The leverage ratio and minimum liquidity requirements are tied only to any borrowings under the revolver and both covenants would cease to apply if the exchange offers were to succeed and we have no meaningful debt maturities until 2018.

Our liquidity, focus on cost control and CapEx spend, combined with the potential impact of our ongoing exchange transactions, are designed to help us achieve adequate liquidity as we manage through the ongoing challenging market cycle.

In addition to the success we have had managing costs across our operating platform, we have also been active in reducing overhead costs, even though we already had one of the lowest costs in the industry prior to these changes.

While painful to implement, but necessary as we right-size our Company, we reduced our overhead head count during the quarter by 20% and have reduced our guidance for SG&A from the beginning of the year by $18 million. In fact, between efforts to reduce our SG&A costs and ongoing capital expenditure efforts, we have improved our anticipated cash spend in these two areas alone by nearly $30 million in the past quarter.

These efforts will be ongoing and we believe across the entirety of the Company there will be additional opportunities to reduce costs and capital expenditures.

Turning now to our updated expectations for 2015, in the PRB, primarily as a result of reduced volume expectations, we have modestly increased the lower end of our cash costs to a range of $10.60 to $11.00 per ton, an increase of $0.05 per ton over the prior quarter. In Appalachia we continue to expect our costs for the year to be in the range of $56.75 to $59.75 per ton.

In the bituminous thermal region, as a result of solid operational performance to date and an expectation of maintaining that momentum for the rest of the year, we now expect cash costs in the range of $23 to $25 per ton, a decrease of $0.50 per ton from the prior quarter.

In other financial guidance we expect as follows: with our ongoing CapEx reduction efforts, our updated 2015 CapEx range is between $130 million and $140 million, a reduction of $12.5 million from the prior quarter. As a reminder, included in that range is the $60 million LBA payment that we just made this past quarter.

With reduced volume expectations, we now expect DD&A to be in the range of $400 million to $420 million.

Total interest expense is expected to be between $385 million and $395 million. Our cash interest expense will be between $360 million and $370 million for 2015. This guidance does not anticipate any reductions in the interest expense from our pending exchange transactions.

We now expect our SG&A expense to be between $95 million and $105 million, a reduction of $15 million from the prior quarter midpoint. We also expect a tax benefit for the year in the range of 0% to 10%.

Despite the ongoing challenges, Arch continues to weather the coal market storm. We have right-sized our operations with an unending focus on cost control and CapEx reduction while working to preserve liquidity.

Our resulting operational platform of large scale low cost complexes generated enough cash at the operations for the first half of the year to cover our SG&A costs and our CapEx. That platform will continue to be our foundation to help us continue to manage through the down cycle but more importantly to generate significant value as the market cycle turns.

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

Thank you. (Operator Instructions). Our first question comes from Pavan Hoskote with Goldman Sachs.

A macro question to start with. Given the stress in the US thermal coal markets, how do you think the rebalance process happens? It's probably a different process in the Powder River Basin versus Appalachia given the different shapes of cost curves and the costs of taking production off-line. It would be great to get your perspective on this.

Yes, this is John. You know, we certainly think that the way we position our portfolio with our thermal production, met production and our cost structure positions us very well to be able to respond to market changes.

I guess we see a lot of pressure continuing to be applied in Central App. We see a pretty significant step-off in production in Central App this year as well as Northern App. And we think one of the primary beneficiaries in that market as it starts to improve will be the Powder River Basin. We think their quality, their economics really position us well to take advantage of the market when it materializes.

So, you know, as we sit here today, we think there's a lot of pressure on higher cost production particularly in the east. And we think our position in the Powder River Basin places us very well for not only the domestic markets, but as we see improvements in the international markets with additional access off the West Coast, we do think that we're well placed to take advantage of both those markets. Paul, you got anything to add?

Yes. I think the only other color I would add, Pavan, is while we will think the PRB market in general will remain strong, I think you got a bifurcate that market. As you look at the PRB, the 8,400 mines continue to decline in production and frankly that's where the pressure's going to be. So the region's not going to escape the downturn or the reduction or the rationalization of production, but I think the higher quality mines like Black Thunder and the other southern mines that ship higher quality coals will do well in this period.

I think when you think about Arch, to follow on Paul's point, most of our uncommitted volumes in 2016 are the higher BTU coals. And we think that those will be the most desired in this marketplace. So, with our 8,900 plus BTU coal, we think we're probably as well or better positioned than most.

Great. And a follow up to that would be you've talked about production coming off-line across the different basins. Is this production coming off-line permanently or is it just waiting on the sidelines for improvement in pricing? And, is there a different answer, say, in the Powder River basin versus the Appalachia?

This is Paul. I think it's a little bit of a mixed bag. From what I've seen in Central App, a lot of these mines that are closing, particularly the smaller ones, I think are gone for good. And the cost to reopen them I think is going to be very difficult when you look at terms of regional natural gas pricing.

I think the issue at the other regions of the US is going to be more of when some of this coal comes off-line, it's not permanently but the cost to restart it is going to be very high. It's going to take a very strong market to bring some of this back.

We were little taken aback when we looked at the MSHA data through the first half of the year. And if you look at the 40 million tons that have come off, the biggest part of that was in second quarter. And we think as we move into third and fourth quarter, that's only going to accelerate.

We've got it at about 90 million tons of reduction for the year but I think that could be conservative. And if you think about the marketplace, that's the one thing that could accelerate this correction. I think supply's coming off much quicker than we ever anticipated, particularly in the eastern United States.

Got it. And then one last question on this topic, if I may. When you look at industrial restructuring and potential bankruptcies that happen over the next year or two, what role does that have on production? Because in the past we've not really seen a strong correlation between restructuring and production coming off-line. Do you think that still will remain the theme or would restructuring accelerate this process of taking production off-line?

I guess every situation is kind of unique but we would think as companies go through restructuring and they emerge from bankruptcy, that their supply would be a lot less. I mean what they would try to do is rationalize their portfolio, run just their efficient mines and close the others. And as Paul said, a lot of the mines, particularly in Central App, might be more permanent closures versus be able to come on when you see a market uptick.

Got it. And then the final question just to follow up to your point right now, you talked about taking some of this production off-line. But there are typically reclamation costs and other costs associated with taking production off-line. And in the absence of having cash, how do you take care of those costs?

Well, you know, I think, it's going to have to be a very general answer because everything is site specific. But mines or companies that remain in existence will reclaim these mines from cash flow. If the worst case scenario on the other end of the book end is the company is dissolved, the reclamation bonds would ultimately cover the price. I think a lot of what you're seeing is people are making that calculus on some of these mines. Frankly, there's a point where that can't continue and I think you're starting to see that.

And our next question comes from David Deterding with Wells Fargo.

Hey, guys, thanks for taking my question. Just wanted to follow up on -- you kind of mentioned the self-bonding or with the surety. Can you just elaborate on that anymore? Is that in relation to Wyoming and have they contacted you guys?

Hey, David, this is John Drexler. The self-bonding, for Arch Coal, we're self-bonded in the state of Wyoming as disclosed in our 10-K. We've got about $458 million of self-bonding with the state of Wyoming. As we've discussed previously, we continue to comply with the rules that exist for the self bonding requirements.

We do self-bond at a subsidiary level. We've been consistent in how we've applied for that self-bonding and expect to remain self-bonding as we move forward. Those results are under review but, as indicated, we would expect to continue to be self-bonded.

The overall surety market, as described in my prepared remarks, given what we've seen across the industry, we have been working very closely with our surety providers. One of the things I think that we make sure that we are indicating and that's come across over the course of our remarks here is really focused on the quality of assets, large scale cash flow positive operations.

I think as markets look at those, that's something that when they evaluate the opportunity to assure that risk it's something that's very much a positive for us here at Arch. So something we'll continue to watch closely. We'll continue to manage very actively. But where we stand today we feel good about where things are.

Okay. And then just the other one. I've been kind of surprised in I guess the liquidated damages that you guys are guiding to in your other operating line. It looks like it's smaller every quarter. So just wondering two questions. One, is something offsetting that in that line? And two, if not, are you expecting an increase in liquidated damages in the second half of the year?

David, I think we'll have to look at the detail of exactly what's flowing through that line. But we have been consistent with our guidance for liquidated damages for 2015 being between $50 million and $60 million. That's consistent with where we were last year and I think we have been essentially accruing that equally over the course of the year. So there may be a little bit of other noise flowing through that line item, but generally that's where we are on liquidated damages for 2015.

All right. Great. Thanks, guys.

There are no further questions in the queue at this time. I would like to turn the conference back to Mr. John Eaves, Chief Executive Officer, for any additional or closing remarks.

I want to thank you for your interest in Arch Coal today. We continue in this difficult market to focus on the things that we can control, our safety and environmental performance, our costs, our capital, our liquidity and we're being proactive on our capital structure.

I want to thank the employees for all their hard work and focus during the first half of 2015. We look forward to updating you on third quarter results in October. Thank you very much.

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