ARCH - Arch Resources Inc.'s (ARCH) CEO Paul Lang on Q2 2022 Results - Earnings Call Transcript

Arch Resources, Inc. (ARCH)

Q2 2022 Earnings Conference Call

July 28, 2022, 11:00 AM ET

Company Participants

Deck Slone - Senior Vice President, Strategy

Paul Lang - Chief Executive Officer

John Drexler - Chief Operating Officer

Matt Giljum - Chief Financial Officer

Conference Call Participants

Lucas Pipes - B. Riley Securities

David Gagliano - the BMO Capital Markets

Nathan Martin - The Benchmark Company

Michael Dudas - Vertical Research

Presentation

Operator

And ladies and gentlemen, please stand by. Good day. And welcome to the Arch Resources, Inc. Second Quarter 2022 Earnings Conference Call. Today’s conference is being recorded.

I would now like to turn the call over to Deck Slone, Senior Vice President of Strategy. Please go ahead.

Deck Slone

Good morning from St. Louis, and 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 have posted in the Investors section of our website at archrsc.com.

Also participating on this morning’s call will be Paul Lang, our CEO; John Drexler, our COO; and Matt Giljum, our CFO. After formal remarks, we will be happy to take your questions.

With that, I will now turn the call over to Paul.

Paul Lang

Thanks, Deck, and good morning, everyone. We appreciate your interest in Arch and are glad you could join us on the call this morning. I am pleased to report that the Arch team delivered record earnings for the third straight quarter in Q2, as well as record coking coal realizations and record coking coal margins. I view these strong results as a testament to the team’s excellent work in building out our premier metallurgical platform, and in the process, our exceptionally strong cash generating capabilities.

Even with these impressive accomplishments, it’s important to underscore that our Q2 results would have been stronger still, if not for two issues, the first being poor rail and logistical service, and the second related to the cash costs in our metallurgical segment.

As you know, inadequate rail service has been a persistent issue at all of our operations in recent quarters. And I am disappointed to report that the situation has extended itself into the first month of Q3. While we continue to engage with our rail carriers on more or less a continuous basis, the reality is there’s only so much we can do to rectify the situation.

In Q2, our Eastern operations saw an incremental improvement in rail service over Q1. While the Western Railroads performance actually declined. However, based on assurances from the railroads, we remain hopeful that their overall service will continue to recover as we move through the balance of the year. But progress remains painfully slow and the situation is extraordinarily frustrating for all of our customers.

The other item that acted to dampen our second quarter financial results was a localized geologic issue at Leer South. While that issue had no effect on our Q2 coking sales volumes, we actually built inventory during the quarter. It was a significant contributor in pushing up our metallurgical segments costs.

Obviously, some of the increase we saw in the quarter was attributable to higher material and supply costs in the current inflationary environment, as well as higher sales sensitive costs related to our record average selling price. However, the largest component of our cost increase for the segment stemmed from our tougher than anticipated cutting conditions we encountered Leer South.

Well, John will share some additional details, let me say that we fully expect those conditions to improve significantly in late August, which should lead to an improving cost performance in our metallurgical segment as the year proceed.

While we are pleased with the company’s strong financial results in Q2, we believe the progress we made on a range of other strategic initiatives are just as noteworthy, if not so more, given that they position the company for ongoing success and value creation well into the future.

Among the team significant accomplishments during the second quarter, Arch reduced total indebtedness by $136 million or 42%, ended the quarter in a net debt positive cash position of about $95 million, reached the targeted funding level for a recently established thermal mine reclamation fund of $130 million inclusive of the July payment and deployed more than $280 million via dividends and convertible security settlements under capital return program.

In short, we stay true to our clear, consistent and actionable strategy for long-term value creation by continuing to fortify our financial position, while simultaneously returning excess cash to shareholders through our recently re-launched capital return program. As we stated in the past, we view this program as the centerpiece of our value proposition and an excellent way to drive long-term value for our shareholders.

It’s important to add here that in addition to the $280 million of capital we returned in Q2, we also declared today a quarterly dividend of $190 million or $6 per share payable in September. I should note that this figure while significant would have been higher if not for $138 million build in our Q2 accounts receivable balance that was precipitated by heavy June shipping schedule to overseas customers.

Fortunately, the impact of this is simply a timing issue, which is to say, we expect those funds as the cash is received will be returned to shareholders via future dividends or other capital return mechanisms.

As you know, the amount of the dividend was driven by our recently implemented capital return formula, which envisions returning 50% of our discretionary cash flow we generate each quarter to shareholders as a dividend. As for the other 50% of our discretionary cash flow, we stated our intention of putting that cash to work in a variety of other value driving ways, including share buybacks.

While the Board is still evaluating the optimal use of the second 50%, if you will, it clearly views share buybacks as an effective means of returning capital to shareholders, and likewise, use large stock as an attractive investment option. To that end, the Board recently increased the company’s buyback authorization to $500 million.

Bringing this all together, I am particularly pleased to report that inclusive of the just declared September dividend, we will have deployed just over $400 million since the start of the year under our capital return program.

Simultaneously, we have taken a substantial steps towards lowering our overall risk profile by reducing our debt by over $417 million or 70% and finishing contributions to the thermal mine reclamation fund.

Before returning the call over to John, I’d like to spend a few minutes talking about dynamics we are currently seeing in the global coking coal markets. As you know, coking coal markets have softened markedly in recent weeks, with High-Vol coal off the U.S. East Coast now being assessed at $249 per metric ton.

While this is a considerable decrease from the 1st of April, when the assessed price was $480 per metric ton, it’s still a strong number from a historical context and remains at a highly profitable price level for Arch’s coking coal portfolio.

The principal driver behind the significant price pullback in our estimation is slowing economic growth that is having the predictable impact on global steel production. Year-to-date, hot metal production is down about 5.5%, which as you can imagine is slowing seaborne coking coal demand and at the same time pressuring prices.

However, we see other market dynamics, particularly in the supply arena, that should continue to supply or continue to support a healthy long-term supply and demand balance in the coking coal markets.

Of particular note, coking coal exports out of Australia, traditionally the source of more than 50% of the seaborne seaboard coking supply are undershooting the already depressed levels of 2021 by about 7% year-to-date.

Additionally, the war in Ukraine threatens to trim Russian coking coal export levels, particularly once the EU’s ban on Russian coal imports takes effect the second week of August. Elsewhere, U.S. and Canadian coking coal exports are up less than 2 million tons in aggregate year-to-date, despite exceptionally strong pricing levels for the first half of the year.

In summary, underinvestment in coking coal capacity in recent years continues to weigh heavily on the long-term outlook for global metallurgical coal supplies, which should bode well for the longer term pricing environment.

Finally, I’d like to highlight the strength in international thermal coal markets as potentially a significant support mechanism for coking coal prices. The current price for thermal coal out of Australia is around $415 per metric ton, and the price for thermal coal in the Northern Europe stands at roughly $390 per metric ton. It is nearly up precedented to have thermal coal trading at a premium to coking coal and we don’t expect that to last.

In fact, we anticipate that a fair amount of global coking coal supply is already crossing over into the much larger thermal coal marketplace, which should serve to support coking coal prices over time.

As you can imagine, we are exploring every opportunity to ship some of our own uncommitted coking coal volumes into the thermal markets, and have had success this week, with a fourth quarter cargo out of Mount Laurel into Europe.

In closing, let me reiterate that last several months have been a period of amazing success and progress for Arch. Even with logistical constraints and typical coal mine issues, our expanded and upgraded operating portfolio continues to allow us to capitalize on this market environment, while positioning the company for still greater success in the future.

While the recent pullback in pricing was inevitable and arguably even healthy, we still see a constructive and profitable coking coal market well into the future, recognize you, of course, that there’s certain to be numerous twists and turns along the way.

With that, I will now turn the call over to John Drexler for some further details in our operating results. John?

John Drexler

Thanks, Paul, and good morning. As Paul just discussed, the Arch’s team delivered another record setting earnings performance and drove tremendous progress on our key strategic priorities during the second quarter, even while navigating ongoing logistical challenges, mounting inflationary pressures and localized geologic issues.

More significant still, they accomplish this while maintaining the same sharp focus on what matters most working safely and responsibly. I am incredibly proud of the team’s ongoing pursuit of operational excellence in all areas and particularly in the ESG arena, and I feel fortunate to work with such a talented, diligent and professional group.

Let’s turn now to some of the key drivers behind our operating performance during Q2. As indicated, our core metallurgical segment delivered exceptional financial results, despite grappling with several issues that acted to suppress our sales volumes and drive up our operating costs.

As Paul indicated, one significant challenge we faced during Q2 was poor rail and logistical performance. To be fair, we did see improvement as the second quarter progressed, but even with this improvement, still received only 90% of the trains we require for the efficient operation of our minds.

As indicated, we estimate that this rail and logistical shortfall reduced our coking coal shipments by around 200,000 tons from previously communicated levels for the quarter, which as you well know had a -- had significant implications for our Q2 cash generation.

As a result of this shortfall, we built inventory levels again in Q2 ending the quarter with approximately 1.1 million tons of highly valuable coking coal on the ground at our minds and at the ports.

The third quarter is off to a slow start with July service levels retracing as compared to May in June, but much of that shortfall is attributable to the July 4th holiday week and miners vacations, and we expect performance to improve as the quarter progresses.

While rail service and logistical challenges acted to constrain our sales volumes during the second quarter, other pressures, including localized geologic issues acted to inflate our operating costs.

Of course, geology changes continuously and as miners were used to adjusting as required. But we experienced tough conditions that Leer South with the predictable impact on our operating costs given the minds relative size and significance within our portfolio.

After a successful ramp at Leer South, a great first longwall move in the middle of May, and a quick ramp to forecasted productivity levels at the outset of the second panel, we encountered isolated areas of tough sandstone in the mid -- in mid-June. These challenging conditions have persisted, but should be behind us by the end of August and we expect to see substantial improvements in productivity thereafter.

More importantly, we expect conditions to further improve as we progress through the balance of the five panel first district. We have already developed the vast majority of the third panel and initiated development in the fourth and the Leer South team is confident that both these panels offer superior cutting conditions.

I would also add that we are simultaneously beginning to develop the infrastructure for the second longwall district as well and conditions there appear exceptionally favorable. In short, while we have yet to see Leer South deliver the kinds of productivity levels that we know it will in time, we are very encouraged by what we are seeing and experiencing as we continue to develop out the reserve base.

Let’s transition now to our legacy thermal assets, where we continue to generate very healthy levels of cash from our significant book of contracted business, as well as from a highly attractive export market environment. As you know, the focus for this segment is the harvesting of cash and we continued to deliver on this objective in a very substantial way.

In Q2, the thermal segment generated around $93 million in segment level EBITDA, while expending just $4.6 million in CapEx. That means that since launching our harvest strategy five and a half years ago, we have generated an aggregate total of approximately $1.1 billion of segment level EBITDA from these assets, while expending just $119 million in capital. Or to put it another way, we have generated nine times more cash than we have expended and we expect more of the same as we progress through 2022 and beyond.

Moreover, as Paul noted, we have also put aside in our new thermal mine reclamation fund, the cash we will need for final mine reclamation of our Black Thunder asset, which means that we -- that the outlook for continued cash generation remains exceptionally strong. We view that as hugely value creating for our shareholders.

Before moving on, let me discuss a few other items that might prove useful. First, I would note that the -- that Western rail service continues to represent a significant drag on our legacy thermal segment as well and is not improving in the way Eastern service appears to be.

As a result, since the start of the year, we have reduced our expected shipment level by 5 million tons and expect those tons to now move into 2023. Well, that’s clearly not ideal given the time value of money, it does mean that our 2023 book already looks exceptionally healthy and that we are growing increasingly confident about the strong cash generating prospects for our thermal segment next year as well.

Second, I would remind you that while our costs increased substantially in Q2 that was due in large part to higher sales sensitive costs at our West Elk mine stemming from a substantial increase in our average selling price.

Finally, I’d like to spend a few minutes discussing several developments in the marketing arena before handing the call over to Matt. With the meaningful drop in metallurgical coal pricing, there has been a great deal of discussion about the opportunity to move metallurgical coal into thermal markets, which are currently in an almost unprecedented fashion enjoying a higher price than met coal.

We have very recently signed a fixed price agreement to move a fourth quarter vessel of High-Vol B quality coking coal into Europe as a thermal product with pricing that is substantially above current High-Vol B marks. Not only is this a value creating an opportunistic move, but it also should help to provide price support for High-Vol metallurgical coal. We also believe there will be additional opportunities for these types of transactions as the year progresses.

In our Western thermal portfolio, export pricing is also providing extremely attractive netbacks and enhancing our cash generating capabilities, although, as you will recall, the overall volume opportunity is limited due to rail constraints.

We currently anticipate moving a total of 2.5 million tons of our Western thermal coal into export markets during 2022, consisting of 1.5 million tons from West Elk and 1 million tons from Black Thunder.

Moreover, as part of our efforts to lock in strong pricing for these volumes, we recently concluded a multiyear fixed price transaction for our West Elk coal beginning in 2023 into Europe, at extremely attractive netbacks.

While the volumes are modest given logistical constraints, the additional cash flows are significant and further strengthened the outlook for another robust year of cash flows from our thermal segment in 2023.

In closing, let me reiterate that we remain sharply focused on engaging the railroads in every way possible in an effort to drive performance improvement and we are equally focused on restoring strong advanced rates and productivity levels at Leer South. Even with these drags on our overall results, it should be increasingly evident that the cash generating capability of our core coking and legacy thermal portfolio is impressive.

With that, I will turn the call over to Matt for thoughts on our financial performance. Matt?

Matt Giljum

Thanks, John. Good morning, everyone. From a financial perspective, Arch’s second quarter was exceptional, setting new records for quarterly earnings and generating robust cash flows. Well, Paul touched on the earnings already, I wanted to provide some additional detail around the quarterly cash flows.

Cash from operating activities totaled $268 million in the quarter, despite growth in working capital of $124 million and a $60 million contribution into the thermal reclamation fund. The working capital change was the result of increases in both accounts receivable and inventories, with the vast majority due to growth in our receivables.

Rail service was weakest in April and improved later in the quarter, resulting in metallurgical segment revenues heavily weighted to the back half of the quarter. While the timing is disappointing, we will clearly benefit from those collections in Q3.

Turning to the investing and financing cash flows, we spent $31 million for capital expenditures in the quarter, while utilizing over $280 million in our capital return program, with nearly $130 million used to reduce dilution in the settlement of the convertible notes and more than $150 million in dividend payments.

We ended the quarter with cash on hand of $282 million and total liquidity of $350 million, including availability under our credit facilities. Discretionary cash flow for the quarter was $237 million and under our capital return program, the Board has declared a dividend of 50% of that amount or $6 per share. That dividend will be paid on September 15th to stockholders of record on August 31st.

Over the last several quarters, we have prioritized derisking the balance sheet, reducing debt, pre-funding reclamation and enhancing liquidity. As we sit here today, we have largely addressed those priorities.

Our debt totaled just $187 million at the end of June, and is largely made up of tax exempt bonds, which are not callable until 2025, and equipment leases, which will continue to amortize on a monthly basis.

Regarding reclamation funding, including amounts funded in July, we now have $130 million in place, roughly equivalent to the current ARO obligation for Black Thunder. As a reminder going forward, we expect to keep the fund at the level of the Black Thunder ARO, increasing with the ongoing accretion of the liability, but offset by reclamation work as completed. In any event, we would expect additional contributions after this quarter to be no more than $5 million quarterly for the foreseeable future.

Finally, we expect to begin to draw money from the fund as we commence significant final reclamation work at Black Thunder several years from now.

Given the significant steps we have taken over the last several quarters, we now expect to maintain minimum liquidity levels of approximately $250 million to $300 million, with most of that held in cash. In addition, we would expect to hold additional cash at the end of each quarter in an amount that represents a substantial portion of the following quarter’s dividend.

We plan to execute the second 50% of the capital return program over the course of the third quarter, maintaining a clear line of sight on these liquidity targets. Given the settlement of a significant portion of the convertible notes in the second quarter, we have narrowed down the uses for that portion of the program. And as Paul mentioned, our Board has recently increased the outstanding authorization for share buybacks to $500 million.

Before turning the call over for questions, I wanted to address a topic that we haven’t spent much time discussing previously income taxes. We have historically benefited and continue to benefit from significant net operating loss carry-forwards, resulting in effectively zero income tax payments in recent years.

With the strength of our earnings over the last several quarters, we have accelerated the utilization of these carry-forwards in a substantial way. Based on current market conditions, we continue to expect to pay no income taxes in 2022 and will likely carry substantial NOLs into next year. However, if market pricing for our products remains above historical averages, we would expect to begin to pay cash taxes in 2023 with an effective rate of up to 5% of pre-tax earnings.

Beyond 2023 assuming we have utilized substantially all of the NOL carry-forwards, we would expect our annual income tax payments to be between 10% and 15% of pre-tax earnings in most market environments.

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

Question-and-Answer Session

Operator

Thank you. [Operator Instructions] And we will begin with Lucas Pipes with B. Riley Securities.

Lucas Pipes

Thank you very much, Operator. Good morning, everyone. Lots of…

Paul Lang

Good morning, Lucas.

Lucas Pipes

Lots of moving pieces here, I will try to keep my questions short. The first is on the rail side, obviously, disappointing that they continued to struggle. But for the remainder of the year, what do you expect the cadence of met coal shipments going to be and in terms of rail rates, have you seen movement there or as we look into next year, can we kind of keep them flat down price dependent, I would appreciate your color on those two points? Thank you very much.

Paul Lang

Yeah. Lucas, good questions. Look, we continue to work closely with the rails. It’s been very public, the challenges that they have had. In the recent earnings calls, they are all working to address their issues, primarily, labor related and getting additional employees into the network.

We are encouraged that we have continued to see ongoing improvement. It’s beginning to approach levels that we are going to need ongoing. July, as we indicated, was off to a slow start. There are a few reasons for that. But we expect things to continue to improve there.

So with our current guidance at 8.4 million tons, you look at kind of how the ramp has been with the 1.5 million tons shipped in the first quarter, 2.1 million tons shipped in the second quarter. We are indicating modest improvements in Q3. I’d say, probably use 10% increase from where we were at this quarter. So now you are at 2.3 million tons, that would put you on a pace of approaching an above 2.5 million tons, 2.6 million tons for Q4 to get us to the midpoint of the guidance that we currently have out there. So, that’s kind of what we are looking at as we move forward.

In regards to the rates, we -- we are kind of -- we have got an agreement with the rail provider to that -- kind of flexes, we have indicated this before with pricing. It is capped. We have indicated before that, it kind of at that $55 level is capped.

What also incrementally comes into that for maybe a few dollars, depending on where pricing is for fuel, so there’s some fuel surcharges that can push that several dollars higher as well. But once again, that’s kind of the max we are going to see it, especially at the levels of pricing that we saw during the second quarter as well.

Deck Slone

And Lucas, remember -- it is Deck. And the rates are determined in arrears. So, basically this quarter’s rate is reflective of last quarter’s pricing. So in Q4 prices continue to sort of stay in the current range, there would be a meaningful step down and we won’t get into the details there. But it would obviously be meaningful, you sort of know how much we are seeing, how much the market has pulled back and that’s probably the right way to think about it, think about commensurate with that pullback.

Lucas Pipes

And that would also hold for 2023.

Deck Slone

Correct.

Lucas Pipes

And the cap…

Deck Slone

Yeah.

Lucas Pipes

And the cap as well.

Deck Slone

Yes.

Paul Lang

I think that is correct, Lucas.

Lucas Pipes

Very helpful. Thank you. Quick anecdote, I learned yesterday that the person who did my home appraisal for my refinancing last year is because business is so bad and real estate is switching into long-haul trucking, I am going to encourage them to give CSX a call.

Paul Lang

We would appreciate that Lucas and any other railroad as well.

John Drexler

Lucas, I got to give CSX credit. They have done a better job the last two months or three months. Like I said, I -- the first quarter was a disaster. They got their act together better in the second quarter. We started off slow. But I am more hopeful of CSX than any of the other four railroads and the frustration level with the Western Railroads is only increasing.

Lucas Pipes

That’s good and bad to hear. Good, obviously, that the CSX, that you most helpful -- most helpful there. And my second question for today is on this switching met into the thermal coal market opportunity. When you, like, I am modeling 1 million tons of met coal over the next couple of years in that ballpark? Theoretically, given where prices are today, how much could you or what you want to switch over into the thermal coal market going into next year? Thank you very much.

Paul Lang

Yeah. No. Lucas, it’s another good question. Look, the opportunity is a significant, given the price that we are seeing in the thermal markets now. The interest is extremely high. We are in a position now where we are going to evaluate the opportunities. We think this -- over time if this situation persists, although we do think it is unprecedented and if the view is over a matter of time, it will reverse and correct itself.

We plan to take advantage of what we are seeing right now in the marketplace. So, we were successful here recently in booking a vessel into Europe and now we continue to have some additional interesting discussions as we move forward.

Don’t get us wrong, we are not changing into a thermal coal producer. But we are -- in our met segment, we do plan on taking advantage of what we see with the dislocation currently, which we think over time could put more pressure into the met markets. Clearly, we will continue to work closely with our metallurgical customers, but right now with where we see the opportunity, we are going to optimize value here as we go forward.

Deck Slone

Lucas, it’s Deck. And so, look, I would say that, the order in which the coking coal should clear, metallurgical coal should clear into the thermal market would be PCI, but really not Low-Vol PCI, more sort of U.S. PCI, followed by High-Vol B and then High-Vol A, and it’s going to take a little while as we engage with the customer base. These -- certain parameters are different than what they are used to, but already, we are seeing and understanding that the certain of these coals can easily be blended into their overall mix and be a good fit.

So we feel really good about the conversations we are having. We think there are good opportunities out there and while, look, our steel making customers are always going to get the preference. The fact is that if thermal customers right now have a higher value, higher reserve price for how they view the product and we are certainly going to take advantage of that, and as John said, that has the added benefit of rebalancing the market.

So, we remain quite interested in those transactions. We do think that this is unusual and sort of anomalous that you would have thermal coal trading at a higher level than metallurgical coal, and we are very focused on bringing those things back into balance.

Lucas Pipes

Very helpful. Thank you. I will squeeze one last one in. You alluded to a preference for share buybacks on the other 50%. Theoretically, if you were to use that full other 50% for buybacks, how quickly, would you deploy it? Is it is it kind of over the coming quarter 120 million-ish to be deployed or would factor into the largest share buyback authorization that you have just trying to get a sense of cadence of buybacks -- that’s the path you decide to go down?

Matt Giljum

Yes. Lucas, it’s -- this is Matt. Obviously, we ended last quarter with maybe a little less cash than we envisioned, and certainly didn’t have excess cash at that point in time. But with the receivables that we had, at the end of the quarter, we have seen some very strong collections here in July. And frankly, you know, feel like from a cash perspective, we are in a position that should that decision be made, we can start that program up fairly quickly after we exit the blackout period.

The one thing in terms of the cadence to keep in mind, as I mentioned, the liquidity levels that we are targeting, call it $250 million to $300 million have sort of a base liquidity, but then as we look at what we are going to pay as a dividend next quarter, we would like to have most of that on the balance sheet at the end of this quarter as well.

So really, we will be looking to manage the cash to be in a position to have enough cash to have our minimum liquidity set aside to have most of that, that dividends set aside and the rest really could be used for the other 50%.

Lucas Pipes

Understood. I appreciate all the all the color and detail, best of luck. Thank you.

Matt Giljum

Thanks, Lucas.

Operator

Now we will move to a question from David Gagliano with the BMO Capital Markets.

David Gagliano

All right. Thanks for taking my questions. I have a few different topics. I am trying to get through them all here, capital allocation. Just to follow-up on Lucas’s question there. And in the commentary mentioned, the Board is evaluating options for the other 50% that includes buybacks, and it’s narrowed down the uses for that other 50%. What are the other uses aside from buybacks that are under consideration?

Matt Giljum

Yes. David, this is Matt. We have talked in the past about the, the other dilutive securities there are still some of the convertibles outstanding. We talked also about the potential for basically holding back some cash on the balance sheet, some capital preservation. So really those would be the other two that we would consider.

Obviously, as the Board goes through their evaluation, they are going to look at where the stock price is and weigh the benefits of being in the market versus doing those other things. And look, I think if you look at where we sit today, I think the value in sort of the narrowing down to the other options might lead you to a particular direction, but certainly don’t want to presuppose how that that will ultimately be decided.

David Gagliano

Okay. Thank you. Just wanted to check the box on that one. On the Leer South issues Sandstone is never a good thing, obviously from a long wall mining perspective or at least in my view it isn’t, but what gives Arch the confidence that these Sandstone issues will improve after August?

Paul Lang

Yeah. Dave…

David Gagliano

And also along what’s the reasonable assumption for 3Q met cash costs given the expectations at Leer South?

Paul Lang

Yeah. So, Dave, you know we will talk a little bit about Leer South and the recap. We started longwall Panel 1. We ramped over the course of that panel got two levels of productivity that we expected. In mid May, we finished mining, in that first longwall panel had a great longwall move congratulate the team on a safe and very efficient move along scheduled timing. Then we started in panel number two in late May and quickly ramped up to expected levels of productivity.

So we were very encouraged with how we were moving through that panel, we then encountered large sandstone. It it’s not that we don’t encounter sandstone I mean we cut sandstone all the time and a lot of our mines it was how hard this sandstone was. To some extent we kind of expected we would see it but just not how hard it is and the challenges that we have going through it. So to remind you the panel, that we mined, we mined at 1200 foot panel.

It’s only in certain sections of the panel, really the back half of the panel, we are encountering this and we are working to get through it. And -- we expect to be through it by the end of August and to see productivity levels improve substantially there. But more importantly in to your question is what gives us confidence as we move forward that we are going to see things improve. Generally with where this mine had to start kind of given that was built out of Sentinel.

We expected some of the sandstone in the first couple of panels. But as we continue to move into panels, three, four and five in the first district, all of our mapping and geology shows that that sandstone reduces. More importantly, we have got continuous miners that are developing the head gate in panel three, and have just started developing the head gate and panel four.

And they are reporting favorable cutting conditions, which gives us further confidence that all of the geology and mapping and drilling that we have done, you know, will be supported with what we are actually seeing. Equally, and if not even more important, we are now developing districts two, three and beyond

With many more longwall panels well into the future, which once again, all of our mapping in geology should indicate that we have got reduced sandstone issues in those areas. We have good cutting conditions with the continuous miners that are developing those out as well. So hope that gives you a little insight and additional perspective into what we are dealing with.

David Gagliano

That’s helpful. Thanks. And then just on the third quarter met cash costs, given?

Matt Giljum

We are continuing to work through this -- and over the course of the third quarter. We have guided to an $89 midpoint cash costs for the met segment. Clearly Q3 is going to be challenging. I would indicate though, or at least how we currently see it is it should be less than we are seeing in Q2 or we saw in Q2 and but probably higher than we had in a little bit higher than we had in Q1. And then should see meaningful improvement in Q4 as we as we get a full quarter of favorable productivity across our platform.

David Gagliano

Okay. Thank you. Okay. Switching gears working capital $130 million accounts receivable in the second quarter, do you expect that to swing to a working capital benefit in the fourth quarter?

Matt Giljum

Yes. David, it’s Matt. I would say in the third quarter, we are expecting a lot of that to swing back to our benefit. We are still going to have some of the same issues here in Q3 as we saw in Q2 with the timing of shipments likely to be weighted more toward the back half of the quarter given the production issues that we are wrestling with now.

So we are going to see probably still an elevated level of receivables, but as we look at the difference in pricing between the June timeframe and where we sit today, we would anticipate that most of that build that we saw in Q2 reverses in Q3.

David Gagliano

Okay. Right. And if we do the math, just assume it goes to zero. Any reason not to do the math or you know, half of that $55 million is free cash flow that works out through a $2.85 cent per share special dividend this upcoming quarter without any other cash and generation is there any reason not to do that math?

Matt Giljum

I don’t see any reason and why that wouldn’t be the case, Dave.

David Gagliano

Okay. And then for -- switching gears to the Powder River Basin for 2023, what is the 2023 PRB price position on terms of volumes at this point? And what is the average price for those volumes?

John Drexler

Dave that’s a good question as you know, we have not provided guidance related to that. But a couple of things that I think continue to come across in what we are representing. We are building out a very good book of business in the thermal portfolio with how we have positioned both the -- all of the thermal assets. I think what we are willing to share is, we are at a position now with at least the expectation of 2022 shipment levels.

We are approaching levels of commitments for next year that are probably around 80%, give or take where we are. So we feel very good about how we built that book of business. Second, at least give you some color on pricing. We are clearly in negotiations all the time working to build out the rest of that book. But, I think we can shade this to the expectation that from what we are seeing the market out right now is above long-term historical averages for the PRB.

Probably not to the levels we saw during 2022, when we were able to achieve some very significant and outstanding contracts over the course of 2022. But we feel real good about where it’s getting booked at and the opportunity to really lock in some good strong cash generation from the portfolio going forward.

Deck Slone

Hey, David. It’s Deck. And I would add to this that, look during this year, we are going to be -- and already have, put aside about $110 million into the thermal mine reclamation fund. So, those are funds not available to shareholders in the capital return program. Next year, we would envision that being very modest, and potentially not making any contributions. But if we do, they would be very modest indeed.

And so that means that there’s an additional $110 million of cash that will be available to shareholders from the thermal assets. And so the other thing would be that look and we continue to see that average price that we have got committed for 2023 and the PRB, marching up, so we continue to realize, improved pricing relative to the base.

And so, we are seeing that march up. And so while as John said, we might not be there yet, in terms of what our average selling price was in the PRB or has been in the PRB to date this year, we certainly are looking at moving in that direction steadily with ongoing transactions.

John Drexler

And Dave is to add to that further, we are seeing a lot of utilities come into the market for multiyear volumes. So not only are we building out next year, we are also, really focused on learning beyond 2023, once again, all giving us more confidence on the cash generating capability of this portfolio as Deck indicated.

The final point, I would say that -- on the domestic side of West Elk, we have already layered in business, and they are to a meaningful step up relative to where we have been for domestic business and are pretty much sold out. Obviously, we are going to be reserving some volumes, for the export market, since it is so attractive.

The small amount of export business we have done at a fixed price was done at a very attractive price so again already seeing good visibility from West Elk, and a very significant contribution from West Elk with all the upside that comes with, the export potential for that month.

Paul Lang

David, this is Paul. I think in the end, I think what’s really changed in my mind with the PRB is, with the implementation of this reclamation fund, you know, we have got this, what I would call, we have created a great option in the PRB. And frankly, we are not going to spend a lot of money out there, we are going to keep it going so long as we get good returns.

But frankly, we have got a huge amount of freedom now, with that closure cost already in the bank effectively. And look, we are not going to do anything to screw up this cash generating capability we got out there, and we are just going to try and play it smart and do the right thing by the employees and the other stakeholders, but we are not going to be chasing a lot of prices.

David Gagliano

Okay. There’s a lot in those answers. I appreciate it. So I just want to -- just ask a few follow-ups here on that. So first of all on the range, above historic average, but not you know the future, that’s a pretty wide range. I mean that’s like, I think like 10 to 20 bucks or something like that. So it’s reasonable to be -- is it reasonable to say maybe $15 to $16 a ton for contracts have been signed for 2023 something in that zone now?

Paul Lang

Look, David, you know that 15 is the expectation I think is pretty solid.

John Drexler

And wouldn’t be unreasonable.

David Gagliano

Okay. Thank you. And then you mentioned selling into 2024 to, how much of the 2024 is booked at this point? And on a related note, what’s the denominator are we assuming? Is it fair to assume that volumes are going to be flat year-over-year in the PRB in 2023 and 2024? Is there any -- is there capital being spent for growth? Doesn’t sound like it conversely, is there plans to continue to fade the volumes at some point?

Paul Lang

Look, David, I’d say on the out years sales were on a typical, step down year-over-year, year-over-year. Although as I said, we are starting to hear more people talk about longer term prod contracts. Relative to your question on expansion capital that’s a really easy answer no.

Matt Giljum

The 80%, that John mentioned, is predicated on this year’s run rate. So that gives you a sense of the denominator. And while we don’t know exactly what that’s going to be, I think you have got a pretty good sense from the guidance. So that was the 80% suggesting that, you know, that’s certainly within sort of, you know, that that’s certainly possible that we would reach the same levels next year as this year.

But as Paul indicated, we are not going to chase. And then in 2024 I mean look, it is interesting that after the pendulum has swung back so much, to the extent where power generators, were buying an awful lot of volume, maybe 35% to 40% of their volume, on a prompt basis, they are now swinging back, as far as we can tell, to wanting to lock that business longer term because of concerns around the availability of coal so to the extent that there are concerns about scarcity, that’s clearly going to be good for sort of long-term pricing.

David Gagliano

Okay. Thank you. My last question, I promise is the press release had indicated that there’s plans to sell incremental 600,000 of West Elk incremental 500,000 of Black Thunder into the international thermal markets for the second half of this year. What are the prices for those tons and is that included in your 2022 thermal realized price expectation of $18.57 a ton?

Matt Giljum

Yes. David, the expectation is built in to the guidance, there is some of that though, well that is floating with the market, I don’t have that split here unnecessarily right in front of me, but we can get that. But once again, you look where the market is currently, in, you look at it the opportunity for operation like West Elk specifically, you know, netback opportunities is in excess of $200 a ton.

So we plan to take full advantage of that, I think I indicated in my prepared remarks, the total exports for both West Elk and Black Thunder, are approaching 2.5 million tons for the year, 1.5 of that West Elk 1 million tons Black Thunder. If you go back to our prior quarters’ discussion, we have that at 3.5 million tons. But because of logistical issues primarily, as we have indicated, problems with the Western railroads that don’t seem to be getting better, we have dropped that expectation.

So we are working very, very closely with the rails, there’s, there’s opportunity there, we were going to take full advantage of the opportunity that is presented, and we think it significantly increases our opportunity to generate cash.

Paul Lang

David, the frustration here is the obvious one on the rails. As John said West Elk debt backs, if we could get more coal out, its triple digits. And probably more importantly, Black Thunder, even though the volumes aren’t huge, a couple of million tons, the net backs on that coal or the mine are three or four times what the domestic pricing is. So look, they are not huge volumes, but they are extraordinarily leveraging.

You stand back, there’s a bigger picture here where you know, some of this coal needs to go help our European allies. And that’s really what we are focused on is trying to, this isn’t going to be a huge business, how long it’s going to last, but we clearly think, there’s a good incremental benefit next year and some of these exports.

John Drexler

So, Dave, I would say on that one other piece on the 1857 [ph], look, that’s on the committed business. So there certainly is upside there, you know, we are not fully a lot of the those times do float with the market, those export tons we are discussing. So meaningful upside of 1857 depending on where that price is and, you know, more than 50% and probably 70% or so of that is still floating with the market. So, we could definitely see some lift to that 1857.

Matt Giljum

And just to circle back, back on what Paul was talking about, with opportunities into Europe. It was a significant development for West Elk to lock in a multiyear deal at fixed prices that are very attractive because of the demand that we are seeing out of Europe, given the current situation and there’s other discussions ongoing with additional utilities as well. So, we will really be focused on optimizing the value and the cash generating potential of the thermal portfolio.

David Gagliano

Okay. Thank you very much. Very helpful. Thank you for taking all of my questions.

Paul Lang

Thank you, David.

John Drexler

Thanks, David.

Operator

We will now hear from Nathan Martin with The Benchmark Company.

Nathan Martin

Hey. Good morning, guys. Thanks for taking my question.

Paul Lang

Good morning, Nate.

John Drexler

Hi, Nate.

Nathan Martin

Very robust discussion so far. So I think most of my questions on my list have probably been checked off at this point. Maybe drilling down on thermal just a little more. Given the rail issues, the likelihood of a chunk of 2022 tons in the PRB getting deferred to 2023? Could we actually see shipments higher year-over-year in 2023 out of the PRB? And then maybe looking at West Elk shipments, could those be flat to up as well, especially given, I think, John, you call out a multiyear fixed price contract?

John Drexler

Yeah. Nate, I guess, on the first question, so much of its going to be dependent on where, ultimately, the market the markets go. But from our perspective, right, we moved out of our committed position, 5 million tons that we expect to carry over now. That’s part of the 80% kind of level that we see. We are at a much higher position from a commitment perspective than we have been historically. So could you see an increase year-over-year, once again, the rails are incredibly challenged right now, but a lot of that just going to be where the market plays out.

On the West Elk question, West Elk was producing a lot lower volume here, not all that long ago. And so this has been a tremendous opportunity for West Elk to lock in multiyear volume at very healthy pricing. And so, we are very focused there on making sure we are putting the mine in a position to be able to achieve the levels that we are committing to and our expectation for West Elk, given the export opportunity is, we are going to be at healthy levels of production, from a historical perspective, for the next several years.

Deck Slone

You know, Nate. It’s Deck. While there clearly is a limit to how much we can produce in the PRB now. Obviously, with the guidance we provided, previously we think we could do 5 million tons or so more than we are actually going to ship, so there -- but again, there is a physical limit there as to how much we can produce and so we will see where that goes.

I will also say that look, over the longer term we do still believe that thermal coal consumption in the U.S. is going to be drifting down. And so, it does seem like right now with gas prices where they are, we could see good robust demand in 2023 and even into 2024. But that is -- that day is still coming that you are going to see continued coal plant closures.

Nathan Martin

Got it. Very helpful color guys. And then maybe just kind of shifting over a topic that nobody’s touched on yet, any commentary so far on the domestic met contracting season, any thoughts on timing there, especially given the decline we have seen in met prices as of late? Just appreciate your thoughts.

John Drexler

Yeah. Nate, I think, it’s still it’s still pretty early and I don’t know if there’s -- and others can weigh in an expectation of when this will begin. But it’s an interesting dynamic with what we have going on right now and we touched on it a little bit earlier. You have got a weakening met market. You have got a thermal market that’s beginning to pull volume away from the met market into the thermal market. We are seeing opportunities into next year for that type of thing. We haven’t done anything yet.

But if that’s happening for others, as well, if things start to improve on the economy and there’s a lot of question marks around that, when those negotiation starters we look into next year, you may have removed somewhat would have been available volumes into the met market, put them into the thermal market, right, as those negotiations are ongoing. So hard to say, but we will see how that continues to play out.

Paul Lang

Nate, I think, we answered this question last year, and I think the answer is about the same. I wouldn’t be surprised if we effectively sell zero coal into the North or into the U.S. market. We may sell a little bit into Canada, but our presence in the U.S. domestic met coal market is pretty small and I don’t think it’s going to change.

Nathan Martin

Perfect. Very helpful, guys. I will leave it there and best of luck in the second half.

Paul Lang

Thank you, Nate.

John Drexler

Thanks, Nate.

Operator

Looks like we have time for one more question today and that will come from Michael Dudas with Vertical Research.

Michael Dudas

Well, I better hope I can keep it to one here.

Paul Lang

Okay. Good morning, Mike.

John Drexler

Good morning, Michael. How are you?

Michael Dudas

You know, we have some…

Paul Lang

You know…

Michael Dudas

I am great. Yeah. I just -- my observation is, you guys first off talking about all these thermal export and crossovers, they are going to think you can be a thermal coal company again. So be careful, guys. So remind us on labor contracts or profit sharing or how increases might occur here as you move through this inflation and the tightness in the marketplace and like turnover and what you are seeing in the marketplace around you. I assume you are feel fairly comfortable with the productivity levels of synthetic improve and keep the labor force intact to drive that?

John Drexler

Yeah. Michael, as we all know, for the broader economy, labor is an issue. We see it discussed everywhere we see issues and concerns within our industry as well. I will give you an additional color kind of on our views.

While our turnover, on a relative basis from a historical perspective for our operations is higher, we have historically had very, very low turnover rates. The reason for that, just foundationally, is we have got Tier 1 low cost, very safe, long lived mines. So that’s kind of just foundational to, that attracts a workforce that wants to be there, one, we then treat the employees incredibly fairly. And so, I think they feel a part of the team and taking the company forward.

More recent pressures here as we come out of the pandemic and things have gotten tight, and labor’s gotten tight, once again, has droven -- driven our turnover rates up modestly. But we have been working real hard to make sure we are keeping our employees satisfied.

We are addressing those in a variety of ways, and we will continue to do so and be responsive to where we see the market to see our success moving forward and working closely to make sure that they continue to feel part of that team and moving forward. But it is an inflationary pressure on us as it is on everybody else. But once, again, we think we are able to manage that and manage our employee levels well.

Michael Dudas

Overall costs and ben -- like, payroll benefit year-over-year changes mid-single digits -- low-to-mid is -- does that could changes as you move forward?

Matt Giljum

Yeah. I -- it’s probably mid-single digits, maybe a little bit above that on an annual basis with some of the things that we are doing moving forward.

Michael Dudas

Great. Thanks, guys.

Paul Lang

Thank you, Michael.

John Drexler

Thanks, Michael.

Operator

And that does conclude our question-and-answer session. I will turn the call back to your host for closing remarks.

Paul Lang

I’d like to thank you again for your interest in Arch. In my view, the company is approaching the maturation of our long-term strategy for value creation and growth. We have completed the build out of our premier coking coal portfolio and believe we will need minimal capital on a relative basis going forward.

We are back to a net debt positive cash position and we have seized our principal long-term liability with our new thermal mine reclamation fund and we have rolled out a new capital return program that has already driven significant value.

In short, we are now in a position to rightfully reward our shareholders for their trust and patience over the last several years. As I have said many times, Arch’s story is by design and increasingly simple one.

There will always be commodity cycles and there’s always going to be mine issues to some degree. We have, however, completed the hard work and take the necessary steps to build a compelling cash generating model that has prepared not only for the strong markets, but the inevitable trough periods that are sure to come.

With that, Operator, will conclude the call and we look forward to reporting to the group in October. Stay safe and healthy everyone.

Operator

Once, again, ladies and gentlemen, this does conclude your conference for today. We do thank you for your participation and you may now disconnect.

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Arch Resources, Inc.'s (ARCH) CEO Paul Lang on Q2 2022 Results - Earnings Call Transcript