Arch Resources Inc

NYSE:ARCH

Earnings Call Transcript 2020-Q1

[Operator]

Ladies and gentlemen good day, and welcome to the Arch Coal First Quarter 2020 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, Senior Vice President of Strategy]

Good morning from St. Louis and thanks for joining us today. While, we are conducting this morning’s call from Arch’s Board room. I want to assure you that the team is widely spaced and following CDC guidelines closely.

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 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 posted in the Investors section of our website at archcoal.com.

As you know John Eaves will be retiring as CEO and transitioning to the Executive Chair role next week. He plans to say a few words at start this morning’s call before turning to proceedings over to Paul Lang, our incoming CEO and the rest of the team. Also participating in this morning’s call will be John Drexler, our incoming COO and Matt Giljum, our incoming CFO. After our formal remarks, we will be happy to take your questions.

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

[John Eaves, Chief Executive Officer]

Thanks, Deck and good morning everyone, I hope you and your families are staying healthy and safe during this unique and challenging time. As you are aware, I will be transitioning to a new role as Arch’s Executive Chair at the Company’s annual meeting next week.

I want to take a few minutes here at the outset of this morning’s call to say a few words about my time as CEO to talk about the leadership team and the workforce as a whole and to express my great confidence in Arch’s future.

Let me start though by saying thanks to all of you for your interest, your support, your friendship during my eight years as CEO, I have enjoyed the frequent and close interactions with so many of you over the years and had benefited greatly from our exchanges. I look forward to continuing the relationship into the future.

Second, I want to ensure that the Company could not be in better hands. As you know, we have been planning the succession process for several years now. And there is simply no one better equipped than Paul to lead the Arch team forward into the future. He has played a critical role here at Arch for many years and brings tremendous experience and expertise in every aspect of our business.

In addition, he is supported by an outstanding Senior Officer Team. One that is contributed significantly to the Company’s growth and success over the years, and one that is well equipped to carry it to even greater success in the future. In fact, the entire Arch workforce is world-class in my opinion, and represents the Company’s single most compelling competitive advantage.

Finally, I want to say how excited I am about the Company’s outlook as I transition into this new role with our premier metallurgical franchise, high potential growth prospects, industry leading safety and environmental stewardship credentials and tremendous human assets, I firmly believe that Arch is positioned for great things.

While I’m passing the time as CEO, I’m excited about the prospects of continuing to work with the Board, with Paul and the entire management team and leading the companies forward. In fact, I wouldn’t miss it for the world.

Again, many thanks for all your great support in the past, and thanks in advance for all your ongoing interest going forward.

With that, I will now turn the call over to Arch’s incoming CEO, Paul Lang. Paul.

[Paul Lang, President and Chief Operating Officer]

Thank you, John. And good morning, everyone. We certainly appreciate you taking time this morning -. Given the broader issues we are all facing personally. I too hope that you and your families are navigating through the crisis in a positive fashion that can be expected.

I would like to start by thanking the entire Arch workforce to the tremendous job they are doing there in this challenging time. As you know, the Federal Government and each of the states in which we operate have designated resource companies as essential service providers.

The Arch is proud of the role it is playing in keeping the country safe and functioning during this difficult period. At the same time, our people are balancing increasingly complex personal lives, even as they deliver on the work front in their every day, exemplary fashion. We applaud them for their resilience, their professionalism and their dedication.

Turning now to our first quarter results, I’m pleased to report that to-date, while continuing to manage through the current crisis in a successful and effective fashion with a keen focus on the things we can control.

Our core coking coal portfolio continues to demonstrate operational excellence, while making significant progress in the build out of Leer South and we have taken steps to further fortify our liquidity.

While our thermal segments struggle in the first quarter due to low natural gas prices and historically weak power markets, we are moving quickly to adjust our cost structure to match the softening thermal demand. In short, we are executing effectively and driving forward on numerous fronts as we adapt to the current market reality.

In Q1, our core metallurgical segment delivered another strong cost performance. While, John Drexler will provide some additional commentary shortly. I would like to highlight the fact that our average cash cost last quarter was on the low end of the guidance range, and solidifies Arch’s first quartile cost position. Leading the way, once again, was our -, which underscores the reason why we are so eager to get its sister mine Leer South up in running as soon as possible.

Turning to our legacy thermal operations, market conditions have come under intense pressure recently, in the face of exceptionally low natural gas prices, in a rolling shut down to the U.S. economy that commenced in mid March.

As a result, we reported the negative margin in both of our thermal segments in the first quarter. Anticipating that those challenges are likely to persist at least through Q2. We are moving quickly to adjust our production plans and costs structure to be prepared to the potential of lower sales for the balance of the year.

We are cautiously optimistic that these efforts will deliver improved results in the second half of 2020. Recognizing of course, that the unknown duration of the economic shutdown makes forecasting exceptionally difficult.

As we maintain our sharp focus on executing in our existing mines, we are also working to ensure that our plans for long-term value creation and growth remain on-track. Most significantly, we will continue to push forward with the development of the world-class Leer South mine at a rapid pace.

At quarter end, we had spent nearly 45% of the projected capital required for the project and we are now only five quarters away from the expected longwall start. It was difficult to predict the market turn and even harder in the current macro environment. We believe that Leer South could be ramping up production into a recovery market.

In addition, we’ve taken steps to align our corporate support structure with our changing operating profile and strategic direction. In late February, we initiated a voluntary separation program that resulted in a 30% reduction in our corporate staff.

Obviously it is always hard to say goodbye to friends and colleagues, particularly those who contributed greatly to the organization success over the years. Given that, we are please be able to go through this process in a way that works for both their personal interests and the Company’s long-term needs.

We see this adjustment is appropriate and healthy given our ongoing pivot to those metallurgical markets, as well as our progressively smaller thermal footprint. We also continue to pursue our joint venture with Peabody compiling our thermal operations in the Powder River Basin in Colorado.

We remain confident that the business combination will prove beneficial to all stakeholders, including our customers, employees and shareholders by creating a long-term, efficient, stable and cost competitive supply platform in an increasingly difficult energy marketplace.

The Federal Trade Commission has challenged the proposed joint venture at Federal Court in St. Louis. We respectfully disagree with the FTC’s position and along with Peabody we will be vigorously defending the transaction.

The court has set the date to commenced the proceedings in mid-June and we expect to have a decision by late this summer. Give the processes now in litigation, we will not be able to answer any questions related to the proceedings.

Finally, we are taking the necessary steps to ensure that we maintain ample liquidity through the full extent of the crisis. However long that may prove to be. We completed long time and attractive equipment financing effort in the first quarter.

We trimmed $20 million for our capital spending plans for the year, primarily at our thermal operations and we just announced the Board’s decision to temporary suspend our quarterly driven.

Longer term, the Board continues the view a sustainable recurring dividend as an important components to Arch’s value propositions. In short, the current environment have served to validate our longstanding commitment of maintaining exceptionally strong balance sheet and recent moves will serve to bolster that position further.

Looking ahead, we expect challenging market environment through the balance of the year on both the metallurgical and thermal fronts. After holding up reasonably well for much of the first quarter, steel markets have weakened considerably in recent weeks.

Major steel producers in most regions have announced plans to curtail output and idled blast furnace capacity. Those developments are starting to take a toll on global metallurgical markets. While few markets should improve as the economy stabilizes and then begin to recover. We expect all of this to take some time. Fortunately we believe we are well positioned to weather such a period.

In summary, we are navigating through the current environment in a precise and careful way, while working diligently to protect our people doing our part to limit the spread of the virus and we are executing in every aspect of the business over which we have control.

With our low cost assets, fortified balance sheets, solid book of business and skilled workforce. We believe, we are well equipped for the protracted period of market weakness. At the same time, we plan to be ready to respond to improving market conditions as the global economy stabilizes and ultimately recovers.

With that, I will turn the call over to John Drexler for further thoughts on our operational performance and outlook. John.

[John Drexler]

Thanks Paul and good morning everyone. It is a pleasure to be reporting to you in my new role is incoming Chief Operating Officer and it is exciting to me personally to be working even more closely with the operations and marketing teams. They are doing an outstanding job in the current environment and it is an honor to be a small part of that equation.

I would like to start my remarks by addressing our response to the current COVID-19 crisis. Across our operations, we could not be more proud of our men and women who have embraced the challenge of this pandemic head on.

We have instituted policies and procedures across our organization to protect our employees during the outbreak, including staggering shift times to limit the number of people in common areas at any one time. Limiting meetings and meeting sizes, continual cleaning and disinfecting of high touch and high traffic areas, limiting contractor access to our properties, eliminating business travel and instituting work from home for most of our employees in the corporate office.

We plan to keep the policies and procedures in place for as long as necessary and to continually evaluate enhancements. We recognize that the COVID-19 outbreak and reactions too, it will also impact both our customers and suppliers.

To-date, we have not had any significant issues with critical suppliers, but we continue to communicate with them and closely monitor their situations to ensure that we have access to the goods and services required to maintain our operations. In short, we are doing everything we can to protect our employees, and I commend them for making the difference as you manage through these difficult times.

As Paul noted, our core metallurgical franchise continues to perform at a very high level, even as our people take every precaution to ensure that we are maintaining the safest and healthiest work environment possible. During the quarter we shipped 1.5 million tons of metallurgical coal, which was generally in-line with expectations considering the typical seasonal closure of the Great Lakes shipping channels.

The team also delivered an impressive cost performance, particularly in light of the many additional precautions related to the virus. The segment’s average cash cost was $58.42 per ton, which is as Paul noted positions us well for the left on the U.S. cost curve, and arguably $20 to $25 per ton below the median for U.S. coking coal mines. The Leer mine continue to set the pace for the portfolio with another mid $40 per ton cash cost performance.

Perhaps most importantly, we again demonstrated strong and consistent progress at Leer South. We achieved excellent rates of advance in the development of the first longwall panel, and we remain well on-track for the longwall startup in the third quarter of 2021. It is worth noting that the first longwall panel is more than two miles long, which serves to underscore the highly advantageous nature of the Lear reserve base.

Importantly, the Leer South team is also doing an outstanding job of maintaining tight capital discipline during the development process. As you will recall, we had projected a total price tag of $360 million to $390 million when the project was first announced, and we remain very comfortable with that estimate.

We had invested a total of $165 million in the project at quarter end, which as indicated previously takes us to roughly 45% of the projected capital spend at the midpoint of the guidance. It is exciting to be approaching the halfway point of the development, and more exciting still to be just five quarters or so from the longwalls anticipated startup.

To reiterate, we view Leer South as the industry’s premier growth project, and we expect it to be transformational for our metallurgical segment and for the Company as a whole. With its startup, we expect to increase our High-vol A output to eight million tons annually to enhance our already advantageous position on the U.S. cost curve.

To strengthen our coking coal profit margins across a wide range of market conditions. And to cement our position as the leading supplier of High-vol A coal globally. Let me say again, we are making excellent headway and we remain intensely focused on staying on schedule and on budget.

Before moving on to our other segments, let me comment briefly on our metallurgical sales position. At present, we have a meaningful book of business in place for 2020 with a total of 5.9 million tons committed as of March 31st and we are working closely with customers to ensure those volumes move as planned. As we sit here today, we anticipate shipping the same amount of coking coal calling Q2 as we did in Q1.

While we are preparing for the possibility of only limited incremental sales for the remainder of the year. We continue to engage constructively with customers and potential customers, including some that have struggled to secure previously contracted tons from other suppliers.

Given the lack of visibility to near-term forward demand as the world manages through the global pandemic, we are suspending sales volume guidance regarding the placement of any incremental tons.

Correspondingly, we will no longer provide cost guidance either. Additionally, we are reducing our CapEx guidance for 2020 by $20 million predominantly to reflect reductions in the expected capital spend at our thermal operations.

Let’s turn now to our legacy thermal segments, which experienced lower volume levels in the first quarter in the face of very low natural gas prices and historically weak power markets. As a result of these difficult market conditions, both the Powder River Basin and other Thermal segments reported negative cash margins, a situation we are seeking to rectify.

As we have demonstrated repeatedly in recent years, we are fully capable overtime of adjusting our operating structure and our operating costs to align with lower demand levels. Given the sudden nature of the market decline, we anticipate significant margin compression again in Q2. However, we currently expect our cost control efforts to deliver a stronger performance in the year second half recognizing again, the difficulties of forecasting in the current environment.

As reported in the guidance table this morning, we have commitments totaling just over 58 million tons in the Powder River Basin and 3.8 million tons in the other Thermal segment. Again, the goal is to restore both our legacy thermal segments to profitability even if incremental sales prove thin to non-existent for the balance of the year.

In closing, we would be remiss if we didn’t take a moment to celebrate several significant successes on the safety front. During the first quarter, a time when concerns about the current health crisis were on the rise are Beckley, West Elk and Coal Creek mines all operated injury free. That is an impressive accomplishment and one we strive to replicate at every one of our minds every quarter.

With that, I will now turn the call over to our incoming CFO, Matt Giljum. Matt.

[Matt Giljum, Vice President Finance and Treasurer]

Thanks John and good morning everyone. Before we begin, let me say that I too am enthusiastic about the opportunity to serve Arch and its shareholders in this new capacity. Like the rest of the team, I believe Arch is exceptionally well positioned for long-term growth and success and I look forward to playing a part in helping the Company realize its great potential and deliver on its promising value proposition in the days ahead.

Moving now to the financials, I will be focusing my remarks on cash flows and liquidity. For the first quarter, cash from operating activities was an outflow of $12 million, which was primarily the result of negative changes in working capital of nearly $35 million.

This is somewhat typical for the first quarter as inventories built in advance of the opening of the Great Lakes shipping channels and payables historically are at their lowest point of the year. Capital spending for the quarter totaled $87 million with $62 million of that related to Leer South.

Both of those amounts are expected to be the highest of the year. Another item to highlight during the quarter was the execution of our four year $54 million equipment financing, which carries an average interest rate of 6.3%.

We believe our ability to get this done at favorable terms differentiates us from many in our industry, and is a reflection of and testament to our strong balance sheets and highly competitive operating profile. As we have discussed, this financing bolsters our liquidity, while we manage through the current environment, while only modestly increasing leverage on our strong balance sheet.

As we look at the remainder of 2020, while it is clearly a challenging time to try to forecast, we expect to see improved cash flows for the back three quarters of the year. As noted in our release, we will realize approximately $100 million of cash flow benefits over the remainder of the year.

This includes the refund of the remainder of our alternative minimum tax credits, benefits from the previously disclosed federal land settlement, additional insurance proceeds and the deferral of Social Security Tax from the Cares Act.

From a timing perspective, we expect more than 80% of this benefit to be realized by the end of the third quarter. Looked at one way we expect the supplemental cash flows to be nearly equivalent to the capital spending requirements for Leer South over the next two quarters.

Additionally, Management and the Board have taken actions that will benefit cash flows and preserve liquidity. As Paul mentioned, Arch’s Board has temporarily suspended the recurring quarterly dividend, a savings of more than $7.5 million per quarter. Combined with the reduced capital spending levels, these actions result in more than $40 million of savings for the remainder of 2020.

Lastly, we expect savings of $6 million in our SG&A expense in the back half of the year, offsetting the severance charges from the voluntary separation plan. Beginning in 2021, we expect the annual savings from this program to be in the range of $12 million to $15 million. As a reminder $18 million of our annual SG&A expenses in the form of non-cash stock compensation.

Before moving on, I would stress that the actions taken to-date are responsive to the market conditions that we see today. Clearly, these are uncertain times and we are ready and well equipped to take additional actions to preserve cash should they become necessary.

Turning now to our liquidity position, we ended the quarter with $323 million of total liquidity with $234 million of that in cash. While this is below the range we have historically targeted for liquidity given the cash flow benefits we will realize over the remainder of the year and the other actions we have taken, we believe this is ample liquidity to run the business and continue the development of Leer South. With that said, we continue to explore opportunities to raise additional modest levels of capital to bolster liquidity and help facilitate the construction of the project.

Before taking the questions, I would like to underscore the Company’s positive long-term outlook when it comes to test generation. While facing today’s challenges, it is easy to lose sight of the fact that we are just over a year away from a significant transformation for Arch.

When the Leer South longwall starts up Arch will meaningfully reduce its metallurgical cost profile and capital spending needs while boosting metallurgical volumes. In the process, we expect to greatly enhance the cash generating capabilities of our core metallurgical segment.

In the meantime, our already solid foundation of low cost operations and strong balance sheet combined with numerous liquidity management alternatives will allow us to manage through this uncertain time.

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

[Operator]

Thank you. [Operator Instructions] and we will take our first question from David Gagliano with BMO Capital Markets.

[David Gagliano, BMO Capital Markets]

Great, thanks for taking my questions. First of all, congratulations, John on the transition. It has been great working with you on various capacities over the last 20 plus years and I wish you the best of luck in terms of the next move on your side.

Just switch over the questions, I wanted to kind of drill down a bit more on the decision process with regards to capital allocation and liquidity. Clearly, I think a lot of us that look beyond 2020 see a big shift in cash generation positives. Obviously, as we go out to 2021, but at the same time given everything that is going on right now, all the uncertainty, obviously, we are seeing a big collapsing in fuel production and some of the forecasts we are seeing that John - consumption doesn’t get back to pre COVID-19 levels until 2023. Given all the uncertainty, and given the liquidity sort of squeeze a bit, why not just pause Leer South for a bit and preserve some of that liquidity, push it out, leave it in the ground until the world needs that met-coal a bit more?

[Paul Lang, President and Chief Operating Officer]

Hey David, this is Paul. I will start. Look, I think what you are asking is a fair question. You know frankly it is only talked about regularly. What I keep coming back to, this is a unique opportunity for the Company.

Arguably we will give Arch two of the top three coking coal mines in the United States, probably it will also be the top two marginalizing in the United States. It is going to lower our cost position, and we are going to be producing a high quality, high demand product.

So if when you look at the price tag of $360 million to $390 million. Look, when you look at that out of comparable or what is being bought and sold in the U.S. or internationally. You know I would say quickly, but it is a bargain.

More importantly, if you recall the analysis we did, even at today’s current pricing it is about 48 months payback on this project. Can you think about it, five quarters from now, which isn’t very long. We could be starting a longwall into an improving market. But you know as you say, this is and to be clear, this is not kind of a ban the torpedo, we are going to do this no matter what.

Right now we have the balance sheet and the liquidity to makes it happen as we see the market unfolding. But I would say if the current Black Swan event turns into nuclear winner or whatever analogy you want to use. We are going to have to be flexible in what we do. We have a very large lever here to pull if liquidity gets tight.

[John Drexler]

So David, this is John Drexler. I think the only other colors there is you know and Paul referenced it in the four year payback opportunity. Even at today’s pricing levels, when you look at the expected cost structure at Leer South and even with a very low price for High-Vol A products.

Our expectation on an annual run rate basis is we will be generating $90 million a year of cash flow of EBITDA from that operation. So, as Paul indicated, we are clearly evaluating everything. We have this as a very big lever, but as we sit here today. We think, actually the timing is rather interesting and we are going to continue to push forward with the opportunity.

[Deck Slone, Senior Vice President of Strategy]

Hey David, and a final point, it is Deck. I mean, the fact is, we are halfway there, right. So the fact is that, half the capital has been extended we only have about $200 million to extent, so really that changes the equation as well to get those $30 plus margins that John just referenced doesn’t require all that much more capital. Granted, these are unusual times as Paul said, we will continue to evaluate as we go forward, but right now that still feels like the smart way to go and the best value of our shareholders.

[David Gagliano, BMO Capital Markets]

Okay, I appreciate the additional color. Given the environment in a situation where things are the way they are or get worse over the next six months, for example, is Arch’s preference to tap at capital markets. Do you continue to push ahead with Leer South or would it be to park Leer South for a bit to preserve liquidity?

[Matt Giljum, Vice President Finance and Treasurer]

Hey David this is Matt Giljum. I would say in terms of tapping any capital markets, as we look at the more traditional high yield markets and where our loans trading today, I don’t think that is an option that we think is very attractive today. We do think we have access to I will call the more alternative areas of capital that we could tap and we are continuing to explore and if those things come at a cost that is more reasonable, I think that is our preferred path to continue to look at things like that to raise capital and continue the project.

[John Eaves, Chief Executive Officer]

You know David, I guess kind of finishing this up, look we have got a very sober view about what is going on and if the world gets worse, we will react and we have other things we can do. And we will probably do before we slow Leer South. Leer South is out there if we have to.

[David Gagliano, BMO Capital Markets]

Okay, just last one. What are those alternatives? Just roughly like what do you mean when you say alternatives?

[John Eaves, Chief Executive Officer]

Yes, there is continue reduction our CapEx at the thermal operations and there is a host of variety of things that we can do to cut costs further.

[David Gagliano, BMO Capital Markets]

Okay, I appreciate that. Thanks. So Paul was actually mentored towards the comment about alternative financing options as well -.

[Paul Lang, President and Chief Operating Officer]

That is okay. So clearly, with the equipment financing we just completed, we didn’t use up the entirety of our equipment, we still have equipment at other locations that could be used in a similar manner and have capacity for that in the agreements that we have. We have other avenues in terms of other markets that we are exploring today that haven’t traditionally been ones that the coal industry has been able to utilize. But hopefully we will be able to do that as we look at some of the unique spending aspects of Leer South and how those might qualify for other markets.

[David Gagliano, BMO Capital Markets]

Okay. I will just leave it at that for now. Thanks very much.

[John Eaves, Chief Executive Officer]

Thank you David.

[Operator]

We will take our next question from Michael Dudas with Vertical Capital Research.

[Michael Dudas, Vertical Capital Research]

I will echo David Gagliano’s comments John and congrats to all and John as well.

[John Eaves, Chief Executive Officer]

Thank you Michael.

[Michael Dudas, Vertical Capital Research]

Two things, first, with regard to COVID and the safety and what you have changed here, given their CDC guidelines, et cetera. How has that changed operations, productivity, has it been most impact, has there been some help, because of what you are doing and is that something as you move forward that this is kind of being factored into some of your operating thoughts in the plants moving forward.?

[John Drexler]

Hey Michael it is John Drexler. I think I have referenced it in some of my prepared remarks. We have taken aggressive actions across our portfolio to be responsive to the CDC guidelines and make sure we are adhering to them in every way possible.

Just given, all of those actions that we take. I’m very proud of the way that the operations have continued to perform and continue to operate. So when you are staggering start times, when you are reducing the number of people that are coming in and out of the mine at any point in time. There is some impact to productivity.

But from our perspective, what we have seen so far and as reflected in the cost performance turned in by the met segment, we are performing as expected and so very proud of them in the way that they are managing through this and through all of the challenges, but we are seeing minimal impacts at operational performance as result of COVID-19.

We have had an issue at our West Elk operation. We did have a small group of employees, four on the same crew test positive. That crew has been idled for an appropriate amount of time away from the operation and quarantined. The four gentlemen that have tested positive are doing well. So we are hopeful and confident that that crew will be able to come back here in relatively short order.

But that is really the only impact that we have had directly in positive cases, and we have taken appropriate actions there and even there the impact operationally is being managed very well by the management team at our West Elk operations.

[John Eaves, Chief Executive Officer]

You know Michael the only other color I would give it is you know I think we tried to be aggressive early in this, even in early March about the precautions we were taking. And I think clearly it paid off, the four people at West Elk obviously was a great concern, but in the end, we were able to limit it to a very small group. As John said I give nothing, but applause to our people and the way they have handled this. Frankly, keeping them back as hard as puling them to be more cautious.

[Michael Dudas, Vertical Capital Research]

No, I understand, that is a great news and it is good to hear from your end. Secondly, intrigued about your comments, I think you made it Paul. Paul, Matt and John, regarding inquiries from customers, because of concerns about other suppliers. And maybe you can elaborate a little more on that. Certainly, if the markets can be as hard in the near-term as most people believe. Is that something that you are prepared to deal with? Is that something that customers are not really focused on right now, because there is other issues but could that emerge would be something that they actually starts benefit Arch and associated all capitalized mines like yourself, as this thing eventually recovers?

[John Drexler]

So, Michael yes, as Paul indicated, as we have said throughout the course of all of our comments, we are taking a very sober view and clearly seeing a very large impact industry wide is to the steel producers. So we are very cognizant with that. But we have had inquiries that have come in.

Maybe we can share some anecdotal kind of observations as well. But as this whole COVID-19 issue has played out as other operators have shutdown, whether in response to COVID-19, or demand concerns or inventory concerns that they have had. We have had a lot of inbound calls from several of our customers wanting to know what our status was and concern that were we going to have any type of issues like that.\

So we took that as a positive sign. We have actually had a few inquiries for volumes as well and I think it does speak to what you alluded to, the consumers are looking at us is someone that is well capitalized has a good portfolio of great quality operations with great quality products.

So, with all that said, I think once again, very cognizant, we have had other customers call and want to discuss pushing out some volumes. Right now all of those discussions are very modest, kind of within weeks or one month to another, but in small volumes to-date.

And so, as we sit here today, our shipment booked for Q2 remains robust, we believe we are going to be able to manage it very well. We have got low inventory levels at our operations and at the ports, so we are continuing to need to run the mines in a good healthy levels. So from that perspective, we do feel good about things especially in the near-term here.

[Paul Lang, President and Chief Operating Officer]

So Mike just to add to that, we are really quite clear eyed about the demand side and we understand the pressures there, but of last week, we still think that more than 50% of U.S. coking coal production was shut down. As John said, for a range of reasons I talked how low commitment levels perhaps in some instances, but liquidity concerns.

And our view is that while some of that is starting to come back, there is some things we can operate in this price environment. So with a High-Vol A price today of $123, let’s say a blended price across products, let us say $120, that suggest a net back of maybe $80 to $85 at the mine, that is what we think the midpoint or sort of costs would be for the average coking coal mines in the U.S.

So you have got half of mines in U.S. today arguably operating in a cash negative position, commitments or notes commitments, they are simply not going to be able to do that for long given the liquidity crunch. So, as a result, we have been called to step into the breach even in this environment and fulfill obligations that others haven’t been able to deliver on.

So certainly, that is a positive offset to again what we recognize is a very substantial step down in demand. But, we are operating in a manner that allows us to be cash positive. I think our customers certainly understand we are going to be there. Those who need to fill in gaps know that we can step up, so that has certainly been advantageous.

[Michael Dudas, Vertical Capital Research]

Yes, low cost in liquidity is a great strategy guys. Everybody stay healthy. Thanks for your thoughts.

[John Eaves, Chief Executive Officer]

Thank you Michael.

[Paul Lang, President and Chief Operating Officer]

Thanks Michael.

[Operator]

We will take our next question from Lucas Pipes with B. Riley FBR.

[Lucas Pipes, B. Riley FBR]

So good morning, and congratulations to the team and respective chapters results. They are all very well deserved. I wanted two follow-up in some of the earlier questions regarding kind of capital structure and kind of what is your optimal capital structures? Is this maybe here a way to get to a higher net level? What do you think is just the right level for Arch? And then what amount of liquidity are you comfortable with as you kind of navigate this environment build out yourself?

[Matt Giljum, Vice President Finance and Treasurer]

Lucas this is Matt Giljum. In terms of a capital structure, as we look forward and see the Leer South project coming on, and the cash flows that we see coming from that clearly feel like we can support a little bit more debt than what we have had on the balance sheet historically. At the same time, we recognize what the strength of our balance sheet has allowed us to do both recently and as we continue to explore other avenues for additional financing.

So clearly do not want to take on excessive debt. But as we looked and as we have talked over the last several quarters, something in the neighborhood of an additional 100 million to 150 million of debt, some of which we have taken with the equipment financing. Makes sense, given what we see for cash flows, post Leer South.

In terms of liquidity. Obviously, we are kind of a little bit below here, the target liquidity levels that we have set before. We think it is manageable within the parameters we see today. And some of the things that have kind of pinched liquidity here we don’t think are necessarily permanent. Some of the working capital items I mentioned in my prepared remarks are things that really we don’t expect to see continue throughout the remainder of the year.

So as we look at it, liquidity today is something that we can feel we can manage very well. We don’t think we need to try and build a backup immediately. But as we whether through this, we will see maybe some fluctuations, but something in the level we are at today is clearly comfortable with how we are running the business.

[John Drexler]

And Lucas, this is John Drexler. Matt absolutely covered that very well, but from the old CFO here talking also. With the leverage that we are taking on by design and I think we have indicated this in the past. Once we get the time to healthier cash flows, this debt, whether it is the equipment financing, which is a four year amortizing time period, or a lot of our debt is pre-payable.

Once the cash flows are healthier, we can be in a position once again, if we choose to strengthen our balance sheet and we think there is great power in having a strong balance sheet in this industry. We can see a lot of volatility into it, it has benefited us, it will continue to benefit us, and we expect this will continue to benefit from it moving forward also.

[Lucas Pipes, B. Riley FBR]

I appreciate that. That is very helpful and then good job on the cost side on the met-coal segment, I know you haven’t given guidance. But what is the big range for this year in terms of just the cadence over the coming quarters? What do you think met-coal costs could shake out? Thank you very much.

[Paul Lang, President and Chief Operating Officer]

So Lucas, we were clearly guiding from $58 or $62 a ton on the last call. We have suspended volume guidance obviously, the volume component can have a big impact on what the unit costs are. However, as we look at the portfolio of the metallurgical assets, we think no matter where we go from the volume level, we are going to be able to continue to manage those costs very aggressively on the lowest end of the cost curves in the industry to allow us to continue to generate cash through the entirety of the market cycle.

Since we suspended guidance, it doesn’t mean that there won’t be more tons that won’t move, we do continue to expect we are going to be able to move more tons. Once again, we believe we can still be within the range of the expectation, as we said previously. So kind of at that level of high $50 a ton low $60 a ton cash costs, kind of wherever this market cycle continues to play out.

[Lucas Pipes, B. Riley FBR]

That is very helpful color. Again congratulations to each one of you and best of luck.

[John Eaves, Chief Executive Officer]

Thank you Lucas.

[Paul Lang, President and Chief Operating Officer]

Thanks Lucas.

[Operator]

We will take our next question from Mark Levin with Benchmark Company.

[Mark Levin, Benchmark Company]

Thank you. Great congratulations to everyone as well. John, very much enjoyed working with you over the years and congratulations to Paul and Matt and I wish everyone the best. Just a few questions real quickly. So on the met market itself, maybe you guys can comment on price and then Deck referenced price is a second ago in a High-Vol A market and just sort of across the U.S. Are you seeing, discounts to these prices or these prices good prices to use? How is the pricing environment relative to what we are seeing in the industries right now?

[Paul Lang, President and Chief Operating Officer]

I will start it and look the others kick in their thoughts Mark. I think what you are seeing in the market right now is a lot of noise. While I think we believe the index prices are relatively close. We are seeing kind of some odd sales here and there that have pushed the indexes down a little bit.

But as you look at our Q1 numbers, if you let back to Wale you know it is basically inline about where we should have been. So look I don’t know that that pressure won’t continue until some of this settles out. But right now I think the indexes are close to what we are seeing in the actual physical market.

[John Eaves, Chief Executive Officer]

Well Mark I was just going to jump in and say, I completely - I think the markets right now are so wild, it is hard to say precisely, obviously as we know, you have these quotes that is just an assessment not an index. Certainly if you see much pressure from here below the assessed prices, you are going to see a lot of carnage.

Already these quota prices, you are looking at lots of U.S. - the U.S. states simply can’t compete and can’t produce on a cash deposit basis. So, as Paul said, while there are interesting trades out there, it is hard to envision much discounting below the current level, simply because that just doesn’t work for so many of our competitors.

[Mark Levin, Benchmark Company]

Now it makes sense. And just given where praises are, has there been any discussions or conversation about let say Mount Laurel or anything where it might be somewhat lower quality coal and I guess no longer a longwall operation. There could be any discussion about maybe idling some tons or just not necessary?

[John Drexler]

Mark as we sit here today, and as we just reported with the first quarter called, the portfolio is operating well, right and every one of the complexes is continuing to perform. At Mount Laurel, as we have indicated, it is transitioning from the longwall operation to the continuous miner operation. And that transition continues.

We over the course of the first quarter got to fifth unit operating there, we are working to get them kind of in sequence, creating opportunities for them to be in their most productive environment.

So, every one of our operations we look at closely and how they are performing where the market is, as we have always demonstrated in the past Arch Coal is not afraid of idling operations that aren’t performing that aren’t contributing to the portfolio.

But as we sit here today the portfolio is operating, we will continue to monitor all of the operations when the market goes. And we will keep everyone updated as we continue to manage through this market environment.

[Mark Levin, Benchmark Company]

That is helpful John and then final question, and I know you guys aren’t giving any guidance, so I will try to be respectful with that. But when we are just kind of thinking about Q2, you alluded to coal sales being similar - met-coal sales, I’m sorry, being similar in Q2 to Q4 and I think you mentioned, we should probably expect negative margin environment on PRB and Other Thermal, at least through the second quarter.

So I’m just trying to get my hands around like why, or what would be the factors that would cause the Q2 EBITDA earnings to look materially different than Q1? Am I missing anything or should it have sort of a similar tenor and maybe with just the exception of how met prices roll through?

[Paul Lang, President and Chief Operating Officer]

Mark, I think as we look here today, I think that is essentially the direction we are somewhat setting here. We will work to see improvement in the thermal operation. Some of that does take a little bit of time, we will benefit from other things that we are seeing roll trough the market right now as well, such as diesel pricing.

So some of those will have impacts, we are going to work through improve, but essentially, kind of the tenor of what we are indicating here is the first quarter will kind of roll into the second quarter at somewhat similar levels at least from a base.

[John Eaves, Chief Executive Officer]

Yes Mark, I think, we typically see particularly on the coking coal side, pick up in Q2. As I said earlier, we are just trying to be sober about what we see coming. So I think we are trying to be very careful on what we are saying on the coking coal side. And you also have to remember in context, Q2 is historically the weakest on the thermal base side. So that is kind of the overall background of that discussion.

[Mark Levin, Benchmark Company]

And could volumes actually be like on the thermal side, just kind of continue - obviously, we know where gas prices are, we appreciate how much inventory there is on the ground and how difficult it probably used to do incremental tons. But is there any reason why the Q2, I mean, because I look at the PRB Q1 number, obviously, that is a very low number. I mean would that get worse for the seasonal reasons or and then just we expected much bigger pick up in the second half of the year or it will kind of follow this in sort of seasonal pattern and get weaker in Q2?

[John Drexler]

Mark, I think, our expectation is we will see some form of a seasonal pattern here. It is hard to predict kind of where that goes. It is one of the reasons why we suspended volume guidance. But we do feel good about the commitment level that we do have, it is a 58 million tons. We are creating operating plans and scenarios that will be very responsive.

If that ends up being kind of that level. But that will kind of project forward into a very low shipment levels. And once again, there likely we think continue to be some seasonality. So improvement after the Q2 as we roll into the summer months.

[Paul Lang, President and Chief Operating Officer]

John talked a little bit about pushback or very little pushback we have seen on the coking coal side. The same comments hold true on the thermal side. And it is really to our comments why we think, if we sit here at about 58 million tons sold, it may not be perfect, but that is kind of the zip code of what we could be seeing this year?

[Mark Levin, Benchmark Company]

Okay. Now, that is helpful. So it sounds like no delays or meaningful deferrals yet. Exactly ion inference.

[Paul Lang, President and Chief Operating Officer]

Mark, we are really not seeing any meaningful deferrals, particularly in the Powder River Basin.

[Mark Levin, Benchmark Company]

Okay. Great. Well congratulations to all of you in your new roles and best of luck. Stay safe.

[John Eaves, Chief Executive Officer]

Mark thank you.

[Operator]

We will take our next question from Scott Schier with Clarksons.

[Scott Schier, Clarksons Platou Securities]

Good morning everyone.

[John Eaves, Chief Executive Officer]

Good morning Scott.

[Scott Schier, Clarksons Platou Securities]

Following up on Lucas’ question on costs. Could you maybe bridge the main factors behind the big increase, we saw quarter-on-quarter, is that mainly attributable to Leer and the [indiscernible]? And secondly, what impacted any of the expects COVID-19 in the associated precautionary measures, taking that all cost inflation in the second quarter?

[Paul Lang, President and Chief Operating Officer]

Yes. Scott, so the big step down in costs in the fourth quarter as we report in the fourth quarter were just some of the difficulties and challenges as we were having at Mountain Laurel as we were continuing to transition from the longwall mine to a continuous miner operation.

So we did have some expectations for a meaningful step down. But yes, you are correct. Leer did, get into the new panel that is beginning to get into that thicker coal. We expect that actually to continue to improve over the remainder of this panel.

Not discussed on this call, in the first quarter, Leer actually had a longwall move. It completed that in great timing, very efficiently and effectively, and still were able to achieve the cost that we were able to achieve even with the longwall move.

So, as we move forward, we continue to feel very good about the opportunities to execute from a cost perspective very well and while we have confidence in the met portfolio and what it is doing.

For the COVID-19 perspective, I don’t think there is anything right now that we can specifically identify as increased expenses directly related to the COVID-19 kind of pandemic. And once again, as I discussed earlier, any impacts on productivity, operating performance to-date, we believe have been somewhat minimal and managed very well at the operational level.

[Scott Schier, Clarksons Platou Securities]

I appreciate that that is very helpful. Switching gears a little bit, can you talk about the dividend suspension and any conditions you think would be necessary that you would be looking for to warrant that assumption. Obviously, it is very early and there is a lot of uncertainty, but any color you could provided on that would be great?

[Matt Giljum, Vice President Finance and Treasurer]

Yes, Scott, this is Matt Giljum. I will start, I think the keywords you have there was the uncertainty, obviously, given the outlook, and really the difficulty in understanding when things might get back to normal is what drove that decision.

Obviously, the dividend when we first set it, we talked quite a bit about how it was something we would envision being able to support through the entirety of the market cycle and as we look today, or just in conditions that it is hard to predict.

And so really, this is an action that was taken really to make sure we were being very cautious with what could transpire. And as I look at it, what would be the things we would want to see before reinstituting that, really some certainty around demand and volumes.

And then, depending on where liquidity levels, if there is a need to kind of balance the liquidity versus the capital returns at that point in time, potentially build back some liquidity before doing it, but really the primary factor is going to be seeing some certainty around demand in our end markets.

[Paul Lang, President and Chief Operating Officer]

Scott, I would just kind of follow on that philosophically, you can stand back and look at our capital return program, you know I think from my perspective, it has been a great success. We have given almost a billion dollars back to the shareholders. We have continued to invest in the Company, and we check the balance sheet pristine.

So, look I think we have got a good balance here, clearly, as Matt pointed out, this is a unusual time or very unique time for all of us. But clearly philosophically, we haven’t changed anything in what we believe long-term.

[Deck Slone, Senior Vice President of Strategy]

Scott, this is Deck. I would just add, the fact is right now we are focused on building our Leer South as we discussed really building a bigger cash generating engine here by adding the second big horse to the stable. And so you know our expectation is longer term and as we believe the Board has this strong view that the capital returns are going to be an important part of the equation for us.

But as we take this pause right now, and as we focus on building this bigger engine with Leer South, we think it is prudent and again, given all the reasons we know in terms of current environment, but also this idea of just sort of pulling back on the capital return program at a time when we are making this significant investment in Leer South.

[Scott Schier, Clarksons Platou Securities]

That makes sense. Very helpful. Thank you for your time and good luck on the Board.

[John Eaves, Chief Executive Officer]

Thank you Scott.

[Paul Lang, President and Chief Operating Officer]

Thanks Scott.

[Operator]

Ladies and gentlemen, at this time, I would like to turn the conference back to Paul Lang for any additional or closing remarks.

[Paul Lang, President and Chief Operating Officer]

I would like to thank everyone again for your interest in Arch and for taking the time today to participate in our quarterly call. It is truly humbling for me to step into John Eaves’ shoes as Arch’s new CEO. John has been an amazing and positive force not only within the Company but in the industry as a whole. More importantly, he has been a good friend and mentor to me as well as many others in the Company. I’m looking forward to working with John in his new role as Executive Chairman.

I’m also excited about the long-term prospects that Arch offers our investors. We have a talented workforce, unparalleled set of assets and a strong balance sheet. While things are likely to remain challenging in the short-term. I feel that we are well positioned and agile enough to weather the storm and thrive in the current crisis seasons.

With that operator, we will conclude the call and I look forward to reporting to the group in late July.

[Operator]

Ladies and gentlemen, this concludes today’s call and we thank you for your participation. You may now disconnect.