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Edited Transcript of ARLP earnings conference call or presentation 30-Jan-17 3:00pm GMT

Thomson Reuters StreetEvents

Q4 2016 Alliance Resource Partners LP and Alliance Holdings GP LP Earnings Call

Tulsa Jan 30, 2017 (Thomson StreetEvents) -- Edited Transcript of Alliance Resource Partners LP earnings conference call or presentation Monday, January 30, 2017 at 3:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Brian Cantrell

Alliance Resource Partners, L.P. - SVP, CFO

* Joe Craft

Alliance Resource Partners, L.P. - President, CEO, Director

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Conference Call Participants

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* John Bridges

JPMorgan - Analyst

* Mark Levin

Seaport Global Securities - Analyst

* Paul Forward

Stifel Nicolaus - Analyst

* Lucas Pipes

FBR Capital Markets & Co. - Analyst

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Presentation

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Operator [1]

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Good day, ladies and gentlemen, and thank you for standing by. Welcome to the Alliance Resource Partners and Alliance Holdings Group fourth-quarter 2016 conference. At this time, all participants are in a listen-only mode to prevent background noise. (Operator Instructions). As a reminder, this conference is being recorded.

Now I would like to welcome and turn the call to the Senior Vice President and Chief Financial Officer, Mr. Brian Cantrell. Please go ahead.

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Brian Cantrell, Alliance Resource Partners, L.P. - SVP, CFO [2]

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Thank you Carmen, and welcome, everyone.

Earlier this morning, we released 2016 fourth-quarter earnings for both of Alliance Resource Partners, or ARLP, and Alliance Holdings GP, or AHGP, and will now discuss these 2016 results as well as our outlook for 2017. Following our prepared remarks, we will open the call to your questions.

Before we begin, a reminder that some of our remarks today may include forward-looking statements that are subject to a variety of risks, uncertainties and assumptions which are contained in our filings from time to time with the Securities and Exchange Commission and are also reflected in this morning's press releases. While these forward-looking statements are based on information currently available to us, if one or more of these risks or uncertainties materialize, or if our underlying assumptions prove incorrect, actual results may vary materially from those we projected or expected. In providing these remarks, neither partnership has any obligation to publicly update or revise any forward-looking statement whether as a result of new information, future events or otherwise.

Finally, we will also be discussing certain non-GAAP financial measures. We have provided definitions and reconciliations of the differences between these non-GAAP measures and the most directly comparable GAAP financial measure at the end of the ARLP press release. And we refer you to ARLP's website and Form 8-K for a copy of the release filed this morning.

Now that we are through the required preliminaries, I'll turn the call over to Joe Craft, our President and Chief Executive Officer. Joe?

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Joe Craft, Alliance Resource Partners, L.P. - President, CEO, Director [3]

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Thank you Brian. Good morning everyone.

As noted in our release this morning, ARLP finished 2016 in impressive fashion. Our strong performance in the 2016 third quarter continued into the fourth quarter as further reductions in operating expenses and near-record coal shipments led to sequential increases to net income and EBITDA. Solid performance throughout the second half of 2016 also drove year-over-year increases to net income and EBITDA for the full year 2016. While results like these are impressive under any circumstances, I trust that you would agree they are remarkable in light of the market conditions we faced at the beginning of the year.

As you may recall, conditions in the US thermal markets have deteriorated sharply coming into 2016 and continued to weaken during the first third of the year. The warm winter and low natural gas prices led to anemic coal demand, prompting utilities to defer deliveries, build inventories, and delay contracting decisions. ARLP responded by curtailing coal volumes to meet reduced demand levels and, in the process, shifted production to our lowest-cost mines to improve efficiencies, reduce costs, and minimize capital requirements. These initiatives enabled our operating team to effectively manage our coal production volumes through a period of extreme market weakness and positioned our marketing team to capitalize on opportunities as conditions began to improve.

For the year, ARLP produced 35.2 million tons and sold 36.7 million tons, approximately 15% and 9% below our 2015 record levels, respectfully. We finished the year with less than 1 million tons of coal inventory.

While ARLP's final 2016 sales volume, average coal sales price, and total revenues were all within our initial guidance at the beginning of the year, our cost containment efforts far exceeded expectations as operating expenses improved significantly, decreasing 17.3% compared to 2015. The strategic move to shift production to our lowest-cost mines helped drive segment adjusted EBITDA expense per ton down by 9.2% to $31.07 in the 2016 year compared to $34.20 in the 2015 year. Due to the better-than-expected reduction in expenses and improved productivity from our Tunnel Ridge and Gibson South mines, ARLP's actual results for the 2016 year were well above our early expectations with net income of approximately $73.9 million above the midpoint of our official guidance, and EBITDA higher by approximately $112.7 million.

ARLP also took steps in 2016 to strengthen our balance sheet. Capital expenditures came in approximately $50 million less than our budget. We took the difficult step to adjust distributions, not because of our performance, our outlook or our balance sheet, but to preserve liquidity to help ARLP maintain access to the debt capital markets during a period of uncertainty caused by the financial struggles faced by many of our competitors.

As a result of our strong cash flow, ARLP paid down $269.4 million of debt during 2016 as our distribution coverage ratio increased to a robust 2.9 times at the end of the 2016 quarter and nearly 2 times for the full year.

As Brian will discuss in a moment, ARLP was also able to successfully complete an amendment and extension of its revolving credit facility, providing sufficient liquidity to execute our plans going forward.

As we enter 2017, supply-demand fundamentals have improved meaningfully compared to this time last year and are pointing to a cyclical recovery in the domestic thermal markets. The extent of which will be dependent on electricity demand and natural gas prices staying at or above current levels.

Our initial guidance for the upcoming year, which Brian will discuss in more detail in a few minutes, anticipates 2017 coal sales volume will increase approximately 2 million tons, or 5% about 2016 levels at the midpoint of our guidance range. Export sales make up most of this increase as we have already contracted 1.5 million tons more export sales in 2017 than 2016.

Included in 2017 export sales are 167,000 tons of metallurgical coal. ARLP is expecting year-over-year coal production to increase approximately 3 million tons, or 9%, in 2017 to meet anticipated sales volumes and maintain current inventory levels. ARLP has secured price commitments for approximately 34.9 million tons in 2017, or 90% of anticipated sales volumes, at the midpoint of our 2017 guidance. Our sales team has also secured coal sales and price commitments for approximately 18.9 million tons in 2018.

As we assess the open positions of utilities later this year and into 2018, there is the possibility that market demand could improve further as the year progresses. Should the market signal a sustained need for additional tons, ARLP is positioned to increase coal production above current planned volumes with minimal incremental capital and attractive per-ton costs by deploying additional units at any of our Illinois Basin operations.

Longer-term, we are hopeful that the Trump administration will work to reduce the overreaching regulatory burden that has plagued the coal industry for the last eight years and protect the existing fleet of coal-fired generating power plants. The return to more rational environmental and energy policies should provide clarity and stability to coal markets and potentially set the stage for growing coal demand in the future. With our low-cost, strategically located operations, strong market presence, robust distribution coverage and conservative balance sheet, ARLP is well-positioned to deliver industry-leading performance and value for our unit holders for the foreseeable future.

I'll now turn the call over to Brian for a more detailed review of our 2016 financial results and 2017 guidance. Brian?

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Brian Cantrell, Alliance Resource Partners, L.P. - SVP, CFO [4]

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Thank you Joe. As Joe just highlighted and as outlined in our release this morning, ARLP delivered strong performance in both the 2016 quarter and year.

Turning first to our results for the 2016 quarter compared to the 2015 quarter, increased coal sales volume and lower operating expenses more than offset lower average sales prices to significantly drive higher net income at $119.6 million, or $1.30 per EPU, and EBITDA of $208.9 million, which increased 74.1% compared to the 2015 quarter. Adjusting for the $66.9 million of net non-cash charges incurred in the 2015 quarter, ARLP's adjusted net income and adjusted EBITDA also increased in the 2016 quarter by 35.3% and 11.8% respectively. Total revenues declined 2.7% quarter-over-quarter to $527.4 million as coal price realizations fell 8.9% to $48.01 per ton sold.

On the cost side, lower operating expenses drove a 16.5% improvement to segment adjusted EBITDA expense per ton, which declined by $5.47 to $27.72 per ton sold. Sequentially, increased coal sales in the Illinois Basin led ARLP's coal sales volumes in the 2016 quarter to nearly match the record total coal shipments achieved in the sequential quarter. Primarily due to increased volumes from the Hamilton longwall mine, segment adjusted EBITDA expense per ton declined by 19.3% sequentially in the Illinois Basin and contributed to a consolidated reduction of $4.72 per ton sold in the 2016 quarter. Strong coal sales and cost improvements led to a 33.2% sequential increase to net income while EBITDA jumped 17%.

Year-over-year, net income increased 10.8% to $339.4 million and EBITDA rose 3.5% to $692.7 million. Adjusted for the $77.6 million of net non-cash charges in the 2015 year, adjusted net income and adjusted EBITDA were lower by 11.6% and 7.3% respectively.

As anticipated, recent weak market conditions drove ARLP's average price realizations down 5.3% in 2016 to an average $50.76 per ton sold. Lower coal sales prices and planned reductions and sales in production margins drove 2016 coal sales -- coal revenues lower to $1.86 billion compared to $2.16 million for the 2015 year.

Operating expenses improved 17.3% compared to 2015, contributing to a 9.2% improvement in segment adjusted EBITDA expense of $31.07 per ton sold.

Let's turn now to our initial guidance for 2017. Looking first at capital expenditures and investments, ARLP is estimating 2017 capital expenditures in a range of $145 million to $165 million, including $9 million to $10 million of expansion capital expenditures or currently planned production increases. As noted in our release, total capital expenditures in 2017 are primarily related to maintenance capital, including equipment rebuilds and replacements of mine extension and other infrastructure projects in various operations.

Maintenance capital continues to reflect the benefit of used equipment previously acquired from others and the redeployment of equipment from ARLP's idled operations to our other mines. And we are currently estimating actual maintenance capital expenditures of approximately $3.80 per ton produced in 2017. Reflecting these anticipated savings and consistent with our approach of estimating maintenance capital over a long-term horizon due to the inherently cyclical nature of these expenditures, for our distribution planning purposes, ARLP is currently estimating total average maintenance capital expenditures of approximately $4.25 per ton produced over the next five years, which is down from our most recent estimate of $4.75 per ton.

Regarding our acquisitions of oil and gas mineral interests, Leanyer LP Initially launched this effort in late 2014. We intended to commit approximately $40 million to $50 million annually. Favorable conditions in the oil and gas markets provided opportunities to make attractive investments at a faster pace in 2015 and for much of 2016, and, as a result, ARLP had invested $135.4 million of its previous $144 million total commitment to this activity as of the end of last year. We recently committed an additional $30 million toward this effort, and currently expect to fund $20 million to $30 million for this activity in 2017.

Through the end of 2016, we had received cash distributions of $4.5 million related to our mineral acquisition and, as oil and gas operators prosecute development of our acreage, we anticipate these distributions will continue to grow, providing a sustainable source of cash flow over time. For 2017, we currently anticipate these investments will contribute approximately $9 million to $10 million to ARLP's estimated net income and EBITDA.

Based on the current market conditions Joe discussed earlier, ARLP is anticipating 2017 coal production in a range of 37.9 million to 38.9 million tons, and coal sales volumes in a range of 37.9 million to 39.2 million tons. ARLP has secured price commitments for approximately 34.9 million tons to be delivered in 2017 and has also secured coal sales and price commitments for approximately 18.9 million tons, 9 million tons, and 4.3 million tons in 2018, 2019 and 2020 respectively. Based on these existing commitments and expectations for filling its current open position, ARLP anticipates its average coal sales price per ton will be approximately 12% to 13% lower in 2017 compared to 2016, primarily due to recent weakness in the coal markets and the expiration of higher-priced legacy contracts.

We currently anticipate lower total revenues, excluding transportation revenues for 2017, in a range of $1.71 billion to $1.78 billion as the lower prices I just described are expected to offset increased coal sales volumes. Reflecting this guidance, ARLP expects to remain solidly profitable in 2017, generating net income in a range of $250 million to $315 million and EBITDA in a range of $550 million to $615 million.

In addition, our efforts to enhance operational efficiency and reduce costs are continuing to provide benefits, and we currently anticipate total segment adjusted EBITDA expense per ton at the 2017 midpoint will be 6% to 8% lower than 2016 levels. Based on ARLP's current price and cost estimates, total segment adjusted EBITDA per ton sold at the 2017 midpoint is currently expected to be approximately 17% to 22% below the prior year. ARLP is currently estimating 2017 distributable cash flow of approximately $379.3 million at the midpoint of our EBITDA guidance range, providing a robust distribution coverage of approximately 1.8 times on distributions at the current level.

Turning now to ARLP's balance sheet, we exited 2016 with total liquidity at a healthy $575.2 million and a very conservative leverage ratio of 0.9 times net debt to trailing EBITDA. We recently completed an amendment and extension of our revolving credit facility which provides for approximately $480 million of senior secured financing maturing in May 2019. Despite challenging debt markets facing the coal industry, ARLP was able to obtain this financing at a modest increase in pricing across the leverage grid with borrowings under the revolver bearing interest at an attractive rate of LIBOR plus 235 basis points at ARLP's current leverage of less than one times.

As part of our debt reduction efforts, we have significantly reduced borrowings under our revolver and have paid down our existing term loan to a remaining balance of $50 million, which will be paid in full at the expiration of its primary term in May of this year. With the completion of this amended credit facility and our strong balance sheet, ARLP maintains sufficient liquidity and financial flexibility to take advantage of opportunities that may develop as we execute our strategy.

This concludes our prepared comments. We appreciate your continued support and interest in both ARLP and AHGP. And now, with Carmen's assistance, we will open the call to your questions and then wrap up with closing comments. Carmen?

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Questions and Answers

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Operator [1]

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(Operator Instructions). John Bridges, JPMorgan.

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John Bridges, JPMorgan - Analyst [2]

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Thank you. Good morning Joe, Brian. Congratulations on the great results and the great outlook for 2017. I was just wondering. You're putting some more money into oil and gas. How are you sort of thinking when you think about where to put investments, the split between putting more money into oil and gas and putting money into coal?

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Joe Craft, Alliance Resource Partners, L.P. - President, CEO, Director [3]

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I think we are really not making a choice between the two. I think we are looking at opportunities as they present themselves, so we have the opportunity to continue the oil and gas investments, which we feel good about, so we're going to continue to do that.

And as we look at the coal space, we will continue to make investments as the demand outlook requires. So, it's not really a choice between the two. It's just really taking advantage of opportunities that present themselves to us.

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John Bridges, JPMorgan - Analyst [4]

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Are you happy with the yield you're getting so far from the money you've put in oil and gas?

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Joe Craft, Alliance Resource Partners, L.P. - President, CEO, Director [5]

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We believe we are still a little early but, with the strong production expectations in the Permian where a large part of our reserves are as well as stack scoop in Oklahoma, that we will start to see more cash flow rolling in. And yes, we believe the returns are going to be very attractive.

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John Bridges, JPMorgan - Analyst [6]

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Okay, great. And then just as a follow-up, you mentioned your hopes for the new administration. You also talk about demand for coal going up. I can see stability. I'm just wondering what might lead to a recovery in coal production if your expectations for shale gas, shale oil, are delivered on, and there's an awful lot of gas that sloshing around in the system.

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Joe Craft, Alliance Resource Partners, L.P. - President, CEO, Director [7]

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I think, on the gas side, we still believe that, to make a prudent return on investment as you deploy capital on the oil and gas side, really, that the producers need $3.25, $3.50 gas to make attractive returns. We think a lot of the drilling activity is more focused on oil than it is on natural gas.

And as you look at the Trump policies, I think we will start seeing more emphasis on allowing for the oil and gas producers to export their product. That will allow gas to receive more of a global price instead of just a US price. So, when you look at the export potential to Mexico and overseas with LNG, as well as some industrial increases in demand for natural gas, we think there can be a potential to see gas in the $3.25 plus area on a sustainable basis. And if we have gas in that range, we think that there's a potential for increased demand. So we are not talking about going back to 2008 levels, but we are looking at 2017 as sort of a floor on demand, or really 2016 as a floor on demand for gas, and that, for the next four to five years, we have the opportunity to see more stability as well as more upside for growth than downside as we try to evaluate where the gas price is going to be.

Another factor that I think will be an emphasis by the Trump administration is to try to allow for existing fleets to expand their capacity, and that's something that I know we will be working hard to see if we can make that happen.

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John Bridges, JPMorgan - Analyst [8]

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Great. Thanks again. Congratulations on the results and thanks again for your wisdom, Joe. Good luck.

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Operator [9]

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Mark Levin, Seaport Global.

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Mark Levin, Seaport Global Securities - Analyst [10]

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Good morning gentlemen. Congrats on another great quarter. A couple of quick questions. First is around distribution growth. And I think you'd mentioned, Brian, that, assuming flat distributions, you'd be looking at a 1.8 times coverage growth. Is there a thought process or a plan where, all things being equal, you would resume distribution growth this year?

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Brian Cantrell, Alliance Resource Partners, L.P. - SVP, CFO [11]

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I think the capital markets continue to remain a little bit challenged right now, and as we just went through this financing effort, given some of the stress that our competitors have experienced, the banks, to some degree, are still looking to runs, if you will. So, we are being cautious around that. Clearly, with the robust distribution coverage we have, we think we have a foundation to be able to grow distributions into the future, and I anticipate that we will. The timing of that will be dependent upon other factors that may be outside of our control a little bit.

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Joe Craft, Alliance Resource Partners, L.P. - President, CEO, Director [12]

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Just to reiterate -- this is Joe. And Brian mentioned a lot depends on having a normal lending market. And so the reason we made our reduction in 2016 was really driven by the lending markets and not our performance. So, we are sort of in that same position. If you look forward, we've got private notes that are due to be paid in May of 2018, so we will be looking at whether we need to just pay those down, which we could do, looking at our -- if we do not raise the distribution with the DCF that were projected in the current level, or we can go try to replace those. And so we will be evaluating that market, and we will see whether the attitudes change. We are seeing positive signs. I think the Trump victory made a positive indication in the lending markets. I think we are seeing more access to some of the markets opening up really on the enthusiasm around metallurgical coal. But that should also, in my view, translate to be very enthusiastic to the domestic side as well given the stable demand that we've got and the improved pricing that comes along with the increased switch from steam coal to metallurgical coal with some of the supply that's been in the domestic system. So we are hopeful that the lending markets will improve, and if we can get some clarity there, that gives us a little bit more confidence to get back to more normal coverage ratios.

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Brian Cantrell, Alliance Resource Partners, L.P. - SVP, CFO [13]

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Just to be clear, we believe we continue to have access specifically into which markets we may choose to go and the requirements of those markets may be looking for. We just need to let that play out a little bit before we start taking action.

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Mark Levin, Seaport Global Securities - Analyst [14]

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Got it. My other question is somewhat related to Donald Trump's victory. But you mentioned also, Brian, the balance sheet, 0.9 times debt to trailing 12 months EBITDA. Obviously, that's pretty dag gone good.

From an M&A perspective, you guys would, I would think would be sitting pretty with that balance sheet with certainly better access to capital than many of your peers, I would believe. Does the change in the White House have any or play any role in increasing the likelihood that you guys would do a deal this year or next?

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Brian Cantrell, Alliance Resource Partners, L.P. - SVP, CFO [15]

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I think our approach will be consistent with what it has been historically. We are always aware of what potential deal flow looks like, and in making our decisions as to whether we participate or not, it will be based on whether we can obtain assets at a reasonable price that allow us to show accretion to our cash flow and results. There could be opportunities there. It's always challenging to take those opportunities and turn them into execution, but we will continue to be evaluating all of those that present themselves.

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Mark Levin, Seaport Global Securities - Analyst [16]

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Hey Brian, related to that question, do you think seller expectations have come down, specifically on the thermal side, or is it still kind of -- is it still as challenging as can be to get something done that would make sense?

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Brian Cantrell, Alliance Resource Partners, L.P. - SVP, CFO [17]

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There always seems to be a bit of a spread between the bid and the ask. It ebbs and flows, narrows and widens, over time. I don't know that I would look at the current environment that we are in and say it's substantially better than it has been historically. And unfortunately, at times, there's a lot that might be available, but it's not something we would necessarily have an interest in. So, we will continue to be focused and disciplined, and execute transactions that add to our longer-term value.

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Mark Levin, Seaport Global Securities - Analyst [18]

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Last question has to do with 2018. I assume you'll punt the question but I'm going to ask it anyway. Is there any way to get an idea -- is there any way to get an idea of -- I think you mentioned 18.9 million tons priced in 2018, but just directionally where that kind of -- what kind of prices you guys have been getting. So, for people who are thinking about the distribution beyond 2017 and 2018 and trying to figure out what the cash flows could look like, anything you could maybe help us with with regard to 2018?

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Joe Craft, Alliance Resource Partners, L.P. - President, CEO, Director [19]

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I think that, when you look at our drop in average sales price from 2016 to 2017, one of the factors in that is we had some higher-priced contracts that expired at the end of 2016. So, we are replacing legacy contracts with sales that were made during the last half of 2016. The markets have definitely improved, most recently in the November, December, January time frame compared to six months ago. As we project supply and demand, because there will be some supply that will be depleting and some higher-priced contracts that some of our competitors have that will expire in 2017 that are supporting some production that is high-cost, we think there will be opportunity for uplift in pricing continuing beyond where we are today going into 2018. That's coal-on-coal competitive analysis. And we will get into what will be the buying strategy of our utilities. Will they continue to be short and go month-to-month, quarter-to-quarter in some cases? Not all of them are doing that but enough are doing it that it has made our book shorter. And then also of course the price of natural gas. I gave my view on that earlier. So, if you combine our view with natural gas prices staying in the $3.25 plus ranges as well as what we see on supply and demand for utilities, we are assuming in our plan that the prices will in fact be higher in the 2018 and really the five-year plan that we look at. It's a little bit too early to talk about at what level that will be, but we do anticipate growth in both the tonnage and price as we look forward to 2018 assuming the assumptions that I laid out come to play.

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Brian Cantrell, Alliance Resource Partners, L.P. - SVP, CFO [20]

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If you recall a few quarters ago, we talked about in contracts that we had recently entered into, we tended to see some contango in the out years. I think that supports what Joe just articulated as well.

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Mark Levin, Seaport Global Securities - Analyst [21]

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Got it. That's perfect. Thanks guys. Congrats on another terrific quarter.

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Operator [22]

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Paul Forward, Stifel.

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Paul Forward, Stifel Nicolaus - Analyst [23]

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Good morning and, again, congratulations on the quarter and a good year in 2016. Just thinking about -- I guess you've got about 10% of your tonnage uncommitted for 2017. I was just wondering if you could say right now if you've had an uptick in your export commitments. Just wondering, on that 10%, how does it look as far as could you anticipate one market or the other, domestic or export, is going to claim most of that 10%?

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Joe Craft, Alliance Resource Partners, L.P. - President, CEO, Director [24]

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In our guidance, we are assuming essentially all of that is domestic, so our export shipments that we've committed to will be shipped primarily in the first quarter of 2017. So, the market in the back half is a little backwardated, going forwards backwardated off the prices we've been seeing in the fourth quarter through today. So, depending on how the prices through -- what that price curve looks like, or the export market, we are still following it daily, so there's opportunity to sell into that market. But our current guidance anticipates that 100% of the UI position will be placed in the domestic market. And as I mentioned in my prepared remarks, simply all of that is market share we had in 2016. So, we are really not anticipating any additional demand with our market share from 2016 in our current guidance. So, we feel very confident that those tons will be placed. The reason for their being open today is really just driven back to each of our customers that we have identified to take that tonnage are continuing to stick to a shorter-term buying practice instead of going ahead and committing at this moment.

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Paul Forward, Stifel Nicolaus - Analyst [25]

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Great. And looking against your planned production increase for 2017, I'm wondering if you could comment a little bit on the labor markets and whether there's any sort of, after years of not really thinking about increases, any sort of scarcity or any positions that you are having a harder time filling that you would've had a very easy time filling a year or two ago.

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Joe Craft, Alliance Resource Partners, L.P. - President, CEO, Director [26]

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If you look at our increase in production, it's largely driven by our production at Hamilton, and so we did have a temporary reduction in force last summer that we called people back to allow us to put ourselves in more of a full production mode. A lot of our increase in the fourth quarter and reduction in cost related to the improvement in productivity at Hamilton. So when you look at fourth quarter at Hamilton, we produced right at 1.3 million tons compared 500,000 tons in the third quarter, as an example. We really didn't start that ramp until November at Hamilton.

So, relative to finding people, that has not been a problem. We do not anticipate that being a problem.

We also, as you recall, in fact, we closed the Pattiki mine, so we were able to transfer employees from our Pattiki operation to help staff both Hamilton as well as Gibson County, which is our other operation where we are going to increase production in 2017. So, as we look at how many people that we in fact have to layoff because of the reduction in 2016 of production compared to 2015, we find that our ability to hire quality folks, that they are still available. And once we announce for example just recently adding back the unit at Gibson County, a lot of the folks that had really taken jobs in other industries were quick to come back and say they wanted to get back into the coal business because of the outlook and the expectation. And I give credit to the election for this.

I believe that the Trump administration does appreciate the value that coal-fired electricity brings to the nation, and that our men and women can expect careers in this industry that before, with the prior administration, they were concerned may not exist.

So, from our perspective, we are always looking for the best, the brightest, but we don't anticipate a challenge to be able to complete our roster with the quality of folks that we need to be able to get the results that we've historically gotten.

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Paul Forward, Stifel Nicolaus - Analyst [27]

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That's really good to hear. Kind of lastly, you had a -- I think reported just under $21 a ton of segment adjusted EBITDA across the Company in 2016. Guidance is for something in the midteens or a little better for 2017. And you described a potentially little longer-term contango in the market. I was just wondering if you can talk about this call it midteens segment adjusted EBITDA per ton. Is that enough to incentivize production growth, or is that really something that -- a level that you could say might encourage you to produce at the 2017 level but not really commit to growth, or is a midteens type segment adjusted EBITDA per ton, does that incentivize any expansion at those kind of realized margins?

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Joe Craft, Alliance Resource Partners, L.P. - President, CEO, Director [28]

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Well, the answer is it could. I can't give you a definite, because I think so much of it really depends on our customers' commitment to take tonnage at a level that we feel comfortable hiring people and giving them sustainable jobs. And a lot of the swing does get back to natural gas prices, so I gave my view on that earlier. Now, we will see what the industry does, what the oil and gas industry does, to see if they do in fact bring on more supply and bring those prices down. So, we're going to be cautious. I think I mentioned on the last call and we mentioned it again in this release and/or in our prepared comments that we would like to see a commitment from our customers, and it doesn't have to be a legal commitment, but we would really like to hear that, as they look at their planning cycles, that they can give us more clarity as to what their expected coal burn is going to be to where we know it's sustainable. And absent that, I think to try to -- part of the challenge is most of our customers want to add diversity of supply also, so that's another factor that weighs in it. But we constantly are asking what's the right level to be, and we would rather take that market through growth in the market as opposed to trying to just bring on tonnage and trying to prop the overall price. It doesn't seem to -- the math doesn't seem to work if you try to get into that situation given the size of our market right now.

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Paul Forward, Stifel Nicolaus - Analyst [29]

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Okay. Thanks for the comments, Joe. Congrats again on the quarter.

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Operator [30]

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(Operator Instructions). Lucas Pipes, FBR & Co.

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Lucas Pipes, FBR Capital Markets & Co. - Analyst [31]

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Good morning everybody, and yes, fantastic quarter. I want to add that as well. I wanted to ask a question on the cost side. So impressive year 2016 and you're guiding to another 6% to 8% reduction in EBITDA expense year-over-year 2017. What is driving that? Is that more mix shift expansion of lower cost mines, or are there -- kind of is there more to trim across the portfolio? I would appreciate your perspective on that. Thank you.

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Joe Craft, Alliance Resource Partners, L.P. - President, CEO, Director [32]

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Yes, I think it's primarily driven by the production mix. So, if we can get Hamilton to full production, we believe it will be our lowest cost mine. (technical difficulty) probably as that distinction today, we are adding production there. So we've got -- of our increased 3 million tons, it's essentially at our two lowest cost mines. So when you look at the production mix, you get the decrease in cost.

The other factor is we went through 2016 in trying to decide how to move from record production levels at 2015 to wherever the market was going to take us in 2016, there were inefficiencies. We had reduced production units. We had less over time. We had extra people that were in the system trying to sort out where we were going to end up. So, as we got a better picture on where we think our demand level is that we are going to try to produce to, we are a lot more efficient, or we hopefully -- we are planning to be a lot more efficient in 2017 than 2016 to where we won't have those disruptions that we had a year ago. So, when you combine the efficiencies of trying to not have to guess where your production levels are going to be, as well as part of that moving your preproduction to your lowest cost mines, the final result of that is to show continuing cost reductions that will fully be realized with full-year production in 2017.

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Lucas Pipes, FBR Capital Markets & Co. - Analyst [33]

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That's helpful. I appreciate that perspective.

Then, on the broader market, I've also been writing about the outlook for a gradual cyclical recovery. And I was wondering. How do you look at 2017? In my opinion, inventories are still fairly elevated. Do you see a reduction of inventories over the course of 2017? And if so, at what pace? So where would you expect inventories to end this year 2017.

And more broadly, we had a pretty major recovery in coal production in the second half of 2016. Do you see the market being able to continue to ramp up production and maybe drag out the cyclical recovery, or has that been a major negative as you think about supply-demand? I would appreciate your perspective. Thank you.

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Joe Craft, Alliance Resource Partners, L.P. - President, CEO, Director [34]

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On the latter point, we haven't really seen an increase in production in the second half relative to actual tons produced. We've seen increased shipments because there's been a lot of coal that was on the ground previously that had been shipped. So when you take it back to actual tons produced in the third and fourth quarter, they are pretty flat, and we project that to continue into 2017.

The only tons that we really have going up in production are our own. We see about 3 million tons from us. We (technical difficulty) from others right now when you count that there may be some that actually increase more but there had been people that dropped out of the market in 2016 that won't be there. So, net-net, as we looked at the overall increase in production for Illinois Basin in the northern half, we don't see it going up hardly at all.

On the question of inventory, I'm of the view, and this may be a minority view, but I am of the view that the inventories are at the level they are right now because of the utility mining strategies are going short. In other words, I believe they are increasing their inventory level to complement their strategy of trying to be short in the contract commitments. So, when you look historically, I don't think that's a good measurement to determine where we are from a supply-demand perspective. And I base that on the fact that there were quite a few entries into the marketplace in the fourth quarter that these utilities had what would appear to be sufficient stockpile capacity, but yet they were still buying tons in the fourth quarter to replace burn that they had in the summer that was a little higher than what they had expected. So, I may be wrong, but I am of the view that supply-demand is in balance, and I think the export -- increase in export demand the last quarter is actually combined with the natural gas prices. And it's the responsibility as to why the prices have been a little bit better in the November/December/January time period compared to six months ago. Personally, I think the inventories are going to be at these levels. Each utility, there may be some outliers, but as a general statement, I think you're going to see inventories hanging around the levels they are today as long as utilities continue to want to continue their buying practices of being short as opposed to committing longer-term. If they want to commit longer-term, then they can pull their inventories down. With the cost of money, they really haven't needed to do that.

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Lucas Pipes, FBR Capital Markets & Co. - Analyst [35]

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That is very interesting and very helpful. I appreciate that, Joe. Thank you.

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Operator [36]

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This concludes our Q&A session for today. I would like to turn the call back to Mr. Cantrell for final remarks.

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Brian Cantrell, Alliance Resource Partners, L.P. - SVP, CFO [37]

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Thank you Carmen. We provided a lot of information and covered a number of topics this morning. And in closing, we would again like to offer some perspective. In 2016, ARLP continued its history of industry-leading performance, and we believe we are poised again deliver solid results in 2017. With our financial strength and low-cost, strategically located operations, we remain confident in our ability to create long-term value for both ARLP and AHGP unitholders.

We appreciate everybody's time this morning and your continued support and interest. Our next quarterly earnings release is scheduled for late April, and we look forward to discussing our first-quarter results with you at that time.

This concludes our call for today. Thanks to everyone for your participation.

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Operator [38]

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Ladies and gentlemen, this concludes the program. You may all disconnect. Have a wonderful day.