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Edited Transcript of ARLP earnings conference call or presentation 28-Oct-19 2:00pm GMT

Q3 2019 Alliance Resource Partners LP Earnings Call

Tulsa Oct 31, 2019 (Thomson StreetEvents) -- Edited Transcript of Alliance Resource Partners LP earnings conference call or presentation Monday, October 28, 2019 at 2:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Brian L. Cantrell

Alliance Resource Partners, L.P. - Senior VP & CFO of Alliance Resource Management GP, LLC

* Joseph W. Craft

Alliance Resource Partners, L.P. - Chairman, President & CEO of Alliance Holdings GP LP

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Conference Call Participants

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* Daniel Walter Scott

Clarksons Platou Securities, Inc., Research Division - Analyst

* Lin Shen

Hite Hedge Asset Management LLC - Analyst

* Lucas Nathaniel Pipes

B. Riley FBR, Inc., Research Division - Senior VP & Equity Analyst

* Mark Andrew Levin

Seaport Global Securities LLC, Research Division - MD & Senior Analyst

* Matthew Wyatt Fields

BofA Merrill Lynch, Research Division - Director

* Nicholas Jarmoszuk

Stifel, Nicolaus & Company, Incorporated, Research Division - Analyst

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Presentation

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Operator [1]

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Good morning, and welcome to the Alliance Resource Partners, L.P. Third Quarter 2019 Earnings Conference Call. (Operator Instructions) Please note, this event is being recorded. I would now like to turn the conference over to Brian L. Cantrell, Senior VP and Chief Financial Officer. Please go ahead.

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Brian L. Cantrell, Alliance Resource Partners, L.P. - Senior VP & CFO of Alliance Resource Management GP, LLC [2]

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Thank you, Sarah, and welcome, everyone. Earlier this morning, Alliance Resource Partners released its third quarter 2019 earnings, and we will now discuss these results as well as our outlook for the remainder of the year. 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 that are contained in our filings from time to time with the Securities and Exchange Commission and are also reflected in this morning's press release. 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, the partnership has no obligation to publicly update or revise any forward-looking statement, whether as a result of new information, future events or otherwise, unless required by law to do so.

Finally, we will also be discussing certain non-GAAP financial measures. Definitions and reconciliations of the differences between these non-GAAP financial measures and the most directly comparable GAAP financial measures are contained at the end of ARLP's press release, which has been posted on our website and furnished to the SEC on Form 8-K.

With the required preliminaries out of the way, I'll begin with -- I'll turn the call over to Joe Craft, our Chairman, President and Chief Executive Officer for his perspective on the markets and the ARLP's outlook for the remainder of 2019. Joe?

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Joseph W. Craft, Alliance Resource Partners, L.P. - Chairman, President & CEO of Alliance Holdings GP LP [3]

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Thank you, Brian. Good morning, everyone. Following a year, where we enjoyed record coal sales volumes of 40.4 million tons, including a record 11.2 million tons sold in the export market, ARLP entered 2019 with expectations for another record-setting sales year relying on export shipment levels similar to if not slightly higher than last year.

For the first couple of months of 2019, the market was meeting our expectations. As the year progressed, however, the international coal markets deteriorated. In Europe, weak power demand, aggressive marketing by Russian producers and an oversupply of LNG have all contributed to a 30% drop in API 2 thermal coal prices since the beginning of the year, leading to what we believe will be a 20% year-over-year decline in Eastern thermal exports by U.S. producers in 2019.

For ARLP, we now expect a disappointing 7.4 million tons of export sales in 2019. As hedges fall off at the end of this year, we believe it may take a couple of quarters or more for international prices to return to a level where U.S. producers will again participate in the thermal export markets in a meaningful way. This international market downturn has not changed our belief in the long-term fundamentals for growth in coal demand globally, and we continue to believe ARLP will deliver 10% to 20% of our total coal sales volumes into the export market for years to come. A loss of export volumes as well as falling domestic demand due to low natural gas prices has caused a significant supply overhang in the United States, pressuring domestic coal prices to levels which we believe are unsustainable for most of ARLP's competitors. We currently anticipate these conditions will require the industry to rationalize production to stabilize the markets so fundamentals can improve. While some supply response has already occurred, more reductions are necessary to balance the market. We anticipate additional temporary and permanent mine closures are likely in the near future as other coal producers assess their options in this difficult environment.

ARLP has been proactive in responding to these uncertain markets, adjusting our production to meet customer demand, including the closure of our Dotiki mine and altering normal operating schedules at several of our operations. In this fluid market, ARLP continues to evaluate numerous operating scenarios and strategic opportunities that will help us mitigate the potential loss of export sales in 2020 and a likely drop in our average sales price per ton next year.

While it is too early to project what our production levels and revenue will be next year, we are more optimistic in our future cash flow potential than what our current unit price reflects. Based upon the updated 2019 full year guidance, outlined in our earnings release this morning, ARLP expects 2019 coal sales volume to decline only 2% off last year's record level. At the midpoint of the range, projected adjusted EBITDA for 2019 is close to $610 million, resulting in a 1.21 distribution coverage ratio for the year. Since our last earnings release, we have also continued to build our contract book and increase ARLP's domestic market share, securing additional commitments for the delivery of 11.2 million tons through 2023. We are fortunate that our low-cost operations have us better positioned than most to navigate today's challenging environment, and we continue to see the potential for strategic opportunities created by these challenges.

Looking to our oil and gas minerals segment, we continue to be pleased with this growing part of ARLP's business. Enhancing this growth, during the 2019 quarter, we completed the acquisition of Permian Basin mineral interest from Wing, adding approximately 9,000 net royalty acres in the Midland Basin and strengthening our position in this prolific liquids-rich area. This transaction gives ARLP exposure to more than 400,000 gross acres under active development by well-capitalized operators. And as Brian will discuss in more detail in a moment, it's adding to the growing contribution of this platform to ARLP's total financial performance. Regarding full year 2019 expectations for our oil and gas minerals segment, development and completion activity on our acreage remains as expected. Therefore, we are maintaining ARLP's existing guidance for the mineral segment.

After careful consideration of current year results and our forward outlook, ARLP elected to maintain its quarterly cash distribution at current levels for the 2019 quarter. I believe the combination of cash flow growth potential in minerals, positive global supply-demand fundamentals for coal and the consolidation of U.S. coal industry will strengthen long-term value creation for our unitholders.

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

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Brian L. Cantrell, Alliance Resource Partners, L.P. - Senior VP & CFO of Alliance Resource Management GP, LLC [4]

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Thank you, Joe. I'll cover the details behind our performance beginning with a review of our results of coal operations in the 2019 quarter.

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a build in ARLP's coal inventory impacted the performance of our coal segment during the 2019 quarter. Delayed shipments of contracted tons pushed ARLP's coal inventories higher to 2.5 million tons, an increase of 1 million tons over the sequential quarter. This inventory build contributed to reduced coal sales volumes in the 2019 quarter and in combination with lower coal price realizations, negatively impacted coal sales revenues by approximately $40.3 million compared to the 2018 quarter. Results for the 2019 quarter and 9 months were also impacted by the nonrecurring, noncash asset impairment charge of $15.2 million recognized by ARLP upon the closure of the Dotiki mine in August.

Segment adjusted EBITDA expense per ton in the 2019 quarter was comparable to the 2018 quarter. However, the lower revenue, I just mentioned, caused Segment Adjusted EBITDA from our coal operations to decline by $15.8 million following 9.9% to $144 million. Sequentially, although segment adjusted EBITDA expense per ton improved by 1.2%, lower coal sales volumes and revenues led segment adjusted EBITDA from coal to fall $10.2 million or 6.6%. Reflecting strong performance at the start of the year, results for ARLP's coal operations during the first 9 months of 2019 were generally comparable to the first 9 months of last year.

Turning now to our Minerals segment. Oil and gas royalties and lease bonuses contributed total revenues of $14.2 million during the 2019 quarter, an increase of 14.1% over the sequential quarter. Including equity income from our AllDale III limited partnership investment, segment adjusted EBITDA for minerals declined 9.9% sequentially to $12.2 million for the 2019 quarter. With the addition of the Wing assets in August and active development of our acreage during the 2019 quarter, production volumes increased to approximately 4,707 barrels of oil a day equivalent or 22.7% higher than the sequential quarter.

For the first 9 months of the year, our Minerals segment contributed total revenues of $37.3 million on average daily production of 4,040 barrels of oil equivalent per day. Segment adjusted EBITDA, excluding the gain related to our AllDale acquisition earlier this year, increased to $32.4 million for the 2019 period compared to $14 million during the 2018 period.

I'll close my comments with a look at ARLP's balance sheet. After funding the Wing Minerals acquisition in August, we ended the 2019 quarter with liquidity of approximately $340 million and with leverage ticking up to a still conservative 1.5x ARLP's total debt to trailing 12 months adjusted EBITDA.

Last quarter, we indicated that we were exploring options to expand our current revolving credit agreement as well as potentially accessing the debt capital markets to term finance ARLP's oil and gas mineral acquisition investments this year. We are now actively working with our lead banks to extend our existing revolving credit facility and currently anticipate completing that process before year-end.

Regarding potential term financing, recent activity by several competitors has caused near-term turmoil and the institutional turmoil in and on bond markets causing spreads to widen. Accordingly, we will wait for conditions to improve before accessing the debt capital markets. In the meantime, we expect to increase liquidity in the near term by completing a $50 million equipment lease within the next few weeks.

This concludes our prepared comments, and now with Sarah's assistance, we will open the call to your questions. Sarah?

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Questions and Answers

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Operator [1]

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(Operator Instructions)

Our first question comes from Mark Levin with Seaport Global.

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Mark Andrew Levin, Seaport Global Securities LLC, Research Division - MD & Senior Analyst [2]

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A couple of them. The first on the exports side, Joe. I think you referenced maybe doing 7 million tons this year. Any preliminary thoughts about what it could look like in 2020? I ask only because you mentioned in the release that you may ship some exports overseas even into a weaker market. So if 7 million tons is the baseline this year, what would you think is a reasonable expectation for 2020?

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Joseph W. Craft, Alliance Resource Partners, L.P. - Chairman, President & CEO of Alliance Holdings GP LP [3]

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It's very difficult to answer that question with everything that's going on in the consolidation of our industry. So if we look at the volume we picked up since the second quarter call, we picked up over 3 million tons of domestic sales from what I would call a consolidation of the industry. As I mentioned in the release and in my opening remarks, we believe there will continue to be some supply responses that I believe will create opportunities for us. So they may or may not happen. So depending on whether they will be opportunities for us to pick up more sales and more market share because of consolidation that will impact what we do in the export market. I mentioned in the release we can decide to -- our volume is the issue, do we want to participate in the export market or not with these price levels that we currently see? I would not rule it out, but there may be better opportunities domestically than the export markets. So it's really hard to predict. I do believe we will be involved in the export market in 2020, but it probably won't be in the first quarter because probably wait and see how the action of other producers may create opportunities. So I may want to wait a while before I commit some in the export market in the first part of the year. But we do believe in the fundamentals of the export market we want to participate in. I'm sure we will be selling into that market in 2020. Exactly how much? I just can't give you a guess right now.

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Mark Andrew Levin, Seaport Global Securities LLC, Research Division - MD & Senior Analyst [4]

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Got it. And as it relates to your distribution coverage, I think it was 1x today, and it looks like it's going to slip below 1x in Q4. How are you thinking about the dividend as we go into 2020? I think Brian referenced a second ago, the dislocation maybe in the capital markets, particularly as it relates to looking for term financing. I know that sometimes access to capital, sometimes has maybe weighed on that decision. But I'm just curious how you're thinking about the distribution headed into this type of market in 2020.

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Joseph W. Craft, Alliance Resource Partners, L.P. - Chairman, President & CEO of Alliance Holdings GP LP [5]

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I'll answer to this question similar to my last one with a lot of the opportunities that may present itself in the consolidation. As we look at the distribution going into 2020, first off, we think 2020 will definitely be -- it's going to be a correction year for the industry. And I think with that correction year we should be coming out of 2020 a lot stronger, and be in a position to have coverage ratios greater than 1x and closer to what we've experienced in the past. As we look at 2020 and we stress test the opportunities in front of us it really comes down to what kind of volume can we secure. And based on what we have targeted, if we can achieve our objectives, we believe that we can have a distribution at current levels at 1x coverage ratio.

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Mark Andrew Levin, Seaport Global Securities LLC, Research Division - MD & Senior Analyst [6]

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And Joe, -- I'm sorry, go ahead.

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Joseph W. Craft, Alliance Resource Partners, L.P. - Chairman, President & CEO of Alliance Holdings GP LP [7]

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Maybe a little bit more, maybe a little less, but we feel if we do our job then we can achieve the sales commitments that we have targeted, and we should be able to sustain this distribution.

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Mark Andrew Levin, Seaport Global Securities LLC, Research Division - MD & Senior Analyst [8]

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Got it. And last question, relates to that point, which is, what is a reasonable volume target for 2020 if things happen the way you hope? And then related to that point, I think on the last call you had mentioned $1.25 of margin maybe plus or minus depending upon the market, in terms of change in 2020. So just shipments and margin expectations for 2020 as you look at the world today?

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Joseph W. Craft, Alliance Resource Partners, L.P. - Chairman, President & CEO of Alliance Holdings GP LP [9]

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The margin will be dependent on the volume. If we maintain our volume at 2019 levels I would expect that margin reduction to go from $1.25 maybe another $0.50 or $0.75, it's hard -- again, we are not that far advanced in our planning to know, but there would be pressure because to maintain that volume, we would have to participate in the export markets at low prices. So if we elect not to participate in the export markets, then the productions would be 2 million to 3 million tons lower and margins would stay within that $1.25, maybe slip to $1.50 or so. When we closed Dotiki that was one of our higher cost operations, so we will be getting the benefit of having some of that market or some of that production coming from lower cost operations. So we do expect to see some cost reduction in 2020 to offset the revenue reduction that is anticipated because of the weak markets.

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Operator [10]

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Our next question comes from Daniel Scott with Clarksons.

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Daniel Walter Scott, Clarksons Platou Securities, Inc., Research Division - Analyst [11]

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So last quarter, Joe, you talked about the kind of M&A environment out there being the most active, I think you'd said in your career and certainly a number of years, and I assume that, that is the same today. If you could give a little update on that? And then more specifically, there is clearly 2 of your larger peers, 1 public, 1 private, that are -- the way their bonds are trading would indicate upcoming bankruptcies. Are those 2, in particular or maybe distressed operators in general are they pulling the usual scenario of overproducing to try to hang on? Is that one of the biggest overhangs here? And is that equal some potential opportunity for you, either directly or indirectly through M&A when that comes to fruition?

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Joseph W. Craft, Alliance Resource Partners, L.P. - Chairman, President & CEO of Alliance Holdings GP LP [12]

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The answer to your first question, the activity continues. So yes, it's the industry with these pricing. These prices are just not sustainable. So every participant is trying to evaluate what is their best decision. Is it to close or to partner or to sell? So there's a lot of conversations going on. Relative to who we are talking to and what may happen it's a little premature to talk about that. I think it's clear where we have our focus in the thermal business for low-cost operations or anything that's low cost that we can transact with. That's what we're going to be trying to position ourselves to achieve.

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Daniel Walter Scott, Clarksons Platou Securities, Inc., Research Division - Analyst [13]

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Okay. That's helpful. Now as far as back to the distribution policy and Mark's question a bit there. Having your yield up near 16% here, I understand the suspension of increases, I think you've illustrated your intention of maintaining and stress testing the ability to do that. But also given your current trading levels is -- when does unit repurchase or can it become part of the conversation as well?

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Joseph W. Craft, Alliance Resource Partners, L.P. - Chairman, President & CEO of Alliance Holdings GP LP [14]

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It can be. I think that, that capital is going to compete with what our opportunities are for investment, whether it be in the coal business and/or the minerals business. So whether we reduce -- if we -- the implication of your question, I think, is that, will we be better off taking $15 million out of our distributions and buying back units. And I'm of the view that using that $15 million for distributions provides more value to the shareholders than buying back $15 million worth of units.

If we didn't have all these opportunities, whether to grow and to sustain for the long term and buy at a time where hopefully we're at the low end of the market, then that would be a different answer, I believe. But I think everything for me gets back to how we allocate capital, and we've got some very interesting investment opportunities in front us that if we can complete then I think that's in the best interest for the long-term value to the company.

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Daniel Walter Scott, Clarksons Platou Securities, Inc., Research Division - Analyst [15]

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Okay. And just one last follow-up here. I'm sure I can predict the nonanswer, but so far the diversification into minerals has been pretty very well received and is performing nice and steady. When you talk about opportunities on the coal side due to the distressed nature of the markets and the competitors, is that kind of diversification plan stay intact? Or is it just up against the potential returns if the coal side is distressed enough?

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Joseph W. Craft, Alliance Resource Partners, L.P. - Chairman, President & CEO of Alliance Holdings GP LP [16]

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No, I think it does stay intact. I think as we look at the coal space we're trying to think creatively as to how we would finance that, to where it would not slow down our interest in growing the oil and gas side. So if the oil and gas -- the people -- so we're seeing a lot of opportunities on the oil and gas side also. And the only thing that would keep us from doing deals on the minerals side is if the sellers' expectations are unrealistic, which right now, I'd say, they probably are. But if there's more realistic valuation expectation on the oil and gas side, then I could see us participating in that as well in 2020.

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Operator [17]

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Our next question comes from Lucas Pipes with B. Riley FBR.

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Lucas Nathaniel Pipes, B. Riley FBR, Inc., Research Division - Senior VP & Equity Analyst [18]

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I wanted to follow up a little bit more on 2020 and appreciate the disclosure of the committed and priced sales tons. But I wanted if you can give us a flavor for the price level at which those tons are committed and priced? If one average would be great. If there is a way to maybe break it out between Illinois Basin and Northern App that would be extra appreciated.

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Joseph W. Craft, Alliance Resource Partners, L.P. - Chairman, President & CEO of Alliance Holdings GP LP [19]

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Most of the commitments have been in Illinois Basin. We've had some in Northern App. So most of the committed tons are Illinois Basin. And the pricing, I prefer not to get into that because we are right in the middle of several solicitations and negotiating those as we speak. So for competitive reasons, I feel like I can't really address that question. I can only give you the guidance that I gave earlier as to what I think would happen to margins. We're just trying to be helpful to be responsive to where you are headed, but I can't help you build the model right now because negotiations are going on.

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Lucas Nathaniel Pipes, B. Riley FBR, Inc., Research Division - Senior VP & Equity Analyst [20]

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That's helpful. I appreciate that. And maybe to hone in on that just a little bit. I think you said earlier you would be looking to maintain the distribution if the sales distribution -- I'm paraphrasing a little bit, if the sales distribution delivers according to plan. Can you share with investors and us what that plan is? Is it $40 Illinois Basin prices, $45, $35? What are you shooting for?

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Joseph W. Craft, Alliance Resource Partners, L.P. - Chairman, President & CEO of Alliance Holdings GP LP [21]

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I can't. I can't go there. Like I said, probably without consolidation, without us acquiring somebody, I don't see our volume increasing beyond where 2019 is. It could fall depending on what we decide to do in participating in the export market, whether we pick up any additional market share because other competitors close mines and we assume contracts or if we aren't successful on the bids that we have targeted -- not the bids, but if we are not successful in the targeted markets that we should acquire at prices that I think are competitive, then our volume could drop. But right now, based on my best judgment, we are looking at a range of anywhere from $37.5 million to $41 million in 2020. Factoring in all those considerations, I can't see that they would be much higher than that, if any, absent an acquisition. It's possible but it's probably not likely. Could it be lower? Yes. Do I expect it to be right now? I do not.

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Lucas Nathaniel Pipes, B. Riley FBR, Inc., Research Division - Senior VP & Equity Analyst [22]

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That's very helpful. Maybe one last one. You mentioned in the release and I think on the call as well that you see no catalyst for prices to rise. So is it kind of fair to conclude that you're baking in current comp quarter prices in all of your estimates for 2020, meaning, though, I think it's a $1.25 to $1.50 margin increase?

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Joseph W. Craft, Alliance Resource Partners, L.P. - Chairman, President & CEO of Alliance Holdings GP LP [23]

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That's decreased.

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Brian L. Cantrell, Alliance Resource Partners, L.P. - Senior VP & CFO of Alliance Resource Management GP, LLC [24]

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Not margin accretion.

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Lucas Nathaniel Pipes, B. Riley FBR, Inc., Research Division - Senior VP & Equity Analyst [25]

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Sorry, sorry, sorry, sorry, decrease. Sorry about that.

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Joseph W. Craft, Alliance Resource Partners, L.P. - Chairman, President & CEO of Alliance Holdings GP LP [26]

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So I would say that the first half of the year is going to -- we're going to build more pressure in the first half of the year. There's a couple of reasons for that. One is we're winding down in East Kentucky for our MC operation where we are transitioning to a new reserve base. And the timing of that is, I believe, May before we get into that reserve. So the wrapping up of the old reserve is higher cost than what the new reserve will be. So we could be a little pressured. It's only 1 million ton annual run rate. So there could be some pressure there. If we participate in the export market, the near-term export pricing is lower, so that could have some impact in the first quarter. So those are 2 factors. The third factor is, we are continuing to operate at reduce operating shifts at several of our operations that probably will continue into the first quarter. We believe that the way we're -- again, depending on what operating scenarios we pick, that should stabilize itself by the end of the first quarter or maybe the end of the second quarter to where we're hoping we can get back to a full capacity position for operations so we can be lower cost. So -- but I don't think it's going to be uniform across all 4 quarters to answer your question.

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Operator [27]

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Our next question comes from Matthew Fields with Bank of America Merrill Lynch.

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Matthew Wyatt Fields, BofA Merrill Lynch, Research Division - Director [28]

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A little bit on the comments you made about picking up 11 million tons under contracts since the last quarter. You said, I think, 3 million of that was from consolidations in the industry. Does that mean you won business from competitors that are in financial distress or have filed? Is that what that comment means?

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Joseph W. Craft, Alliance Resource Partners, L.P. - Chairman, President & CEO of Alliance Holdings GP LP [29]

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It means that we either bought some contracts or paid for some contracts and/or just assumed contracts for people that were closing operations. For most of that volume, and then there was another contract that we got where a competitor had shut its operations and the customer was not getting tons from that particular competitor, and we won a bid by bidding lower than others to secure that business. So that market would not had happened had that competitor not ceased production. So there were 3, at least 3, maybe 4, but there were at least 3 that I know off the top of my head, contracts that we got for 2020 production that were direct results of mines closing. The market share we picked up with minimal capital.

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Matthew Wyatt Fields, BofA Merrill Lynch, Research Division - Director [30]

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Okay. Great. But one of them you had to kind of bid very low for it? So is it...

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Joseph W. Craft, Alliance Resource Partners, L.P. - Chairman, President & CEO of Alliance Holdings GP LP [31]

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Right. So the customer came and said, "Listen, I need the supply. I need to cover this position. Do you want to bid on it?" And we did.

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Matthew Wyatt Fields, BofA Merrill Lynch, Research Division - Director [32]

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Okay. Great. And those were mainly tilted towards 2020 and not all the way out to 2023?

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Joseph W. Craft, Alliance Resource Partners, L.P. - Chairman, President & CEO of Alliance Holdings GP LP [33]

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No, 2 of the 3 go to 2023.

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Matthew Wyatt Fields, BofA Merrill Lynch, Research Division - Director [34]

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Okay. Great. And then a lot about the distribution on this call, but obviously, with EBITDA declining and your leverage ticking up for the oil and gas acquisitions, where do you feel comfortable with your balance sheet? And sort of what leverage level may you have to get to when you start to think about cutting the dividends?

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Brian L. Cantrell, Alliance Resource Partners, L.P. - Senior VP & CFO of Alliance Resource Management GP, LLC [35]

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It's really more of a question of making sure we have -- in terms of our distribution policy, making sure we have control over that and can access the capacity in those markets that we believe we need. We are not trying to say at a certain leverage level that, say, trigger in terms of a decision we make around distribution. We've long said and this hasn't really changed, that we'll be in a position to potentially see leverage increase up into the 1.5x range, if we felt like there was a path toward bringing it back down over a reasonable period of time, and that really hasn't changed. We exited the quarter with liquidity at about $340 million or so. Having liquidity in that $300 million to $350 million range is a level that we would be comfortable at. So it's really not a linear decision in terms of how we view the balance sheet on our distribution policy and leverage levels. That's really kind of multifaceted and what our outlook is in terms of where we're comfortable and going at any particular time.

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Joseph W. Craft, Alliance Resource Partners, L.P. - Chairman, President & CEO of Alliance Holdings GP LP [36]

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Yes. We are celebrating our 20th year of being a public company. I think one of the strengths of our company and one of our successes is, we have not overlevered. We believed in a strong balance sheet, and that hasn't changed. We are still very committed to maintaining a very strong balance sheet. And relative to distributions, we don't expect to borrow to pay distributions.

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Brian L. Cantrell, Alliance Resource Partners, L.P. - Senior VP & CFO of Alliance Resource Management GP, LLC [37]

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Right.

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Joseph W. Craft, Alliance Resource Partners, L.P. - Chairman, President & CEO of Alliance Holdings GP LP [38]

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And we believe we can generate sufficient cash flow to maintain our current rate now. We need to have 2020 be a correction year where we can get back in balance. So it may slide below a little bit in 2020? It might, but our expectation is that, going forward, we will be able to maintain this distribution and hopefully get back to the type of distribution coverage ratios that we have experienced over the last 15, 20 years.

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Brian L. Cantrell, Alliance Resource Partners, L.P. - Senior VP & CFO of Alliance Resource Management GP, LLC [39]

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And to leverage levels that are more in keeping with how we've been running the business in the recent past.

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Joseph W. Craft, Alliance Resource Partners, L.P. - Chairman, President & CEO of Alliance Holdings GP LP [40]

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Right.

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Operator [41]

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Our next question comes from Nick Jarmoszuk with Stifel.

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Nicholas Jarmoszuk, Stifel, Nicolaus & Company, Incorporated, Research Division - Analyst [42]

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A question on the distribution and the debt trading levels. The bonds are currently trading below par. How do you weigh the equation of cutting the distribution, delevering and reducing the balance sheet's reliance on the debt capital markets? Because with the 2020 being the correction year, it's difficult to envision a scenario where the market is going to want to refinance you or provide you capital for the Wing acquisition. So longer term, what if the debt capital markets don't want to be there for you? How do you adjust the balance sheet for that?

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Joseph W. Craft, Alliance Resource Partners, L.P. - Chairman, President & CEO of Alliance Holdings GP LP [43]

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Well, we believe that the trading in our bonds were a direct correlation to activity by others in the bond marketplace. They have nothing to do with our current and/or future prospects. We believe that it will be a correction year. If it's not a correction year, we will have to adapt to that. We know there is capital available, it's just high cost. It's higher cost than what we can get in the equipment financing market, as an example. So the reason in the second quarter, Brian made the comment of looking into bond markets, the bond market was very favorable and was wanting to trade where our existing bonds were at 102%, I believe, at that time.

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Brian L. Cantrell, Alliance Resource Partners, L.P. - Senior VP & CFO of Alliance Resource Management GP, LLC [44]

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Correct.

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Joseph W. Craft, Alliance Resource Partners, L.P. - Chairman, President & CEO of Alliance Holdings GP LP [45]

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And so when we were exploring it, if we could maintain or increase our capacity at levels that were comparable to where our existing bonds were, we were exploring that. But then Brian said in his comments that the spreads jumped 200 basis points or so, and -- so we've decided to pull back, believing they will get back to more normal level once we get clarity on how the shake out of the industry is going to occur in 2020. And if it doesn't, we'll have to adjust. We may have to do some of the things that you just suggested. But if we feel like that this is temporary and we can manage through it, then there's no reason, in my view, that we should overreact by taking a reduction that could send a signal that's a wrong signal.

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Nicholas Jarmoszuk, Stifel, Nicolaus & Company, Incorporated, Research Division - Analyst [46]

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Well, I think it's actually the right signal to send to bondholders to get the bond prices up because then it shows that defending balance sheet and paying down debt is a higher priority than distributing cash to shareholder or to unitholders which you can do that in perpetuity after principal is returned. That's just one analyst's opinion.

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Joseph W. Craft, Alliance Resource Partners, L.P. - Chairman, President & CEO of Alliance Holdings GP LP [47]

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Let me just answer you by that. We have shown the willingness to do that a couple years ago. So having this distribution, it's not a fixed charge. I mean we could definitely make the adjustment just what you said, and we've done it before. We will do it again under the scenario that you outlined if necessary, but I don't believe -- my future crystal ball is not like yours. I mean, I believe there will be increasing cash flow. I believe we will be able to show a customer demand that wants our product, that will allow us to grow once we get the higher-cost producers to face reality and get back to a supply-demand position that will stabilize the market. And then when the export market pops back up, we got even more opportunity, and we just need to get through this trough to be able to convert that story to reality. And the bondholders should feel like, with our coverage rate and with our debt -- our leverage levels that it's still a very, very safe investment for the bond market, which is trading at yields that are greater than a lot of other industries that have probably higher risk than what we did, in my opinion.

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Brian L. Cantrell, Alliance Resource Partners, L.P. - Senior VP & CFO of Alliance Resource Management GP, LLC [48]

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Historically, obviously, commodity businesses cycle, capital market cycle windows open and close. And unless or until the market tells us that, that typical pattern is no longer the case, we will wait until conditions improve and access the markets at the appropriate time. As Joe mentioned, if the market turn out to be different and are not there for us long term, we'll take the steps we need to take to make sure that we maintain the balance sheet in a manner that's consistent with how we've done in the past.

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Nicholas Jarmoszuk, Stifel, Nicolaus & Company, Incorporated, Research Division - Analyst [49]

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Okay. And then a follow-up on a comment that was made earlier regarding how you see the basins playing out and how you're looking to -- or how the industry is looking to close partner sell. In terms of partner opportunities that Alliance is looking at, do any of the opportunities that exist or that you're contemplating require Department of Justice antitrust review?

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Joseph W. Craft, Alliance Resource Partners, L.P. - Chairman, President & CEO of Alliance Holdings GP LP [50]

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They probably would. I mean they would I expect that we meet the threshold of Hart-Scott-Rodino. So they would have to be reviewed.

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Operator [51]

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Our next question comes from Lin Shen with Hite.

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Lin Shen, Hite Hedge Asset Management LLC - Analyst [52]

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When you negotiate with utility for 2020 price, I would think natural gas price assumption is going to be a key factor for both parties. So can you talk about the -- what are you expecting for natural gas prices next year? And also how big difference is your assumption versus utilities buyers?

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Joseph W. Craft, Alliance Resource Partners, L.P. - Chairman, President & CEO of Alliance Holdings GP LP [53]

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So I think that when we look at 2019, we've seen the volatility of natural gas. And the conversations that I've had with some utility executives is that, and it's more important what their forecast is instead of mine. They see the range being comparable in 2020 as it was in 2019. But the point they would make to me is with the commitment that they've made to the coal fleet, they want those plants to run, they believe in diversification. And they believe gas has done the damage that gas is going to do to coal. Now weather, if weather spikes, then gas maybe the winner instead of coal. But as far as the base low-type commitment to coal, we are expecting from the customer conversations we've had that we've taken our hit, 2019 compared to 2018 and then 2020. The expectation is gas will basically trade the way it did in '19 and then volumes for our customer region domestically should be comparable in 2020 as it was in 2019.

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Lin Shen, Hite Hedge Asset Management LLC - Analyst [54]

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Got it. And also when you talk about you expecting -- you're expecting more pressure reductions for some coal markets in U.S., it sounds like you think you already did what Alliance can do but expecting the peers cut more? Is any more production cut you can do on your mine for 2020?

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Brian L. Cantrell, Alliance Resource Partners, L.P. - Senior VP & CFO of Alliance Resource Management GP, LLC [55]

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I mean we've talked about that. Joe said, "Here's our view of what we expect in 2020. If our view doesn't play out, based on those current expectations, our volumes may need to drop further." And yes, we have the ability to adjust our volumes should that be necessary. You saw this play out in a similar way in the 2015, 2016 time frame. So yes, we are not dependent upon actions of others alone. We have the ability to modify our operating schedules and our total production levels as needed.

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Lin Shen, Hite Hedge Asset Management LLC - Analyst [56]

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Great. A last question, these days, we are hearing more and more positive news for U.S.-China trade talk. I remember, last year, there was some discussion that if China, U.S. kind of reach a deal, Chinese buyer can buy more U.S. coal. I think that's kind of a news last year. Have you guys heard any update on that for this round of trade discussion between U.S. and China?

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Joseph W. Craft, Alliance Resource Partners, L.P. - Chairman, President & CEO of Alliance Holdings GP LP [57]

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Not exactly sure I understood your question, but you're asking what is the impact of the U.S.-China trade talks?

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Lin Shen, Hite Hedge Asset Management LLC - Analyst [58]

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Yes. I mean, is that possible, like, a Chinese buyer can buy U.S. coal if there's success discussion?

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Joseph W. Craft, Alliance Resource Partners, L.P. - Chairman, President & CEO of Alliance Holdings GP LP [59]

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We don't really participate in that market. I think the bigger issue for the trade issue relates to the met market as to how that -- the global economy as to how the trade impact issues affect the global economy, number one. And number two, how much steel does China produce that then impacts other nations that buy U.S. metallurgical coal. So we've seen U.S. met coal also dropped 15% to 25% in price, which we participate smally. I mean, we shifted about 600,000 tons...

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Brian L. Cantrell, Alliance Resource Partners, L.P. - Senior VP & CFO of Alliance Resource Management GP, LLC [60]

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650,000 this year, somewhat.

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Joseph W. Craft, Alliance Resource Partners, L.P. - Chairman, President & CEO of Alliance Holdings GP LP [61]

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Yes, in 2019 into metallurgical markets. So it has some impact on us. But again, we believe that the overhang there is not as great as in the U.S. domestic thermal market. So I don't really think that trade talks are going to impact the U.S. thermal market any more than they already have, and I think it's really more of a met issue which we're not that exposed to.

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Operator [62]

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Our next question is a follow-up from Mark Levin with Seaport Global.

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Mark Andrew Levin, Seaport Global Securities LLC, Research Division - MD & Senior Analyst [63]

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Just 2 quick modeling questions. I'm not sure if you want to disclose it, but I'm going to ask anyway. Any idea on the 7 million tons of exports that you guys will do this year? What the EBITDA contribution might be?

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Brian L. Cantrell, Alliance Resource Partners, L.P. - Senior VP & CFO of Alliance Resource Management GP, LLC [64]

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I think you asked this question last quarter.

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Mark Andrew Levin, Seaport Global Securities LLC, Research Division - MD & Senior Analyst [65]

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I did, I did. I know they are kind of co-mingled, Brian, but I was just thought I'd give another run just to see if there is a way to just take those 7 million tons and apply some sort of margin to them. I mean the way I was thinking about is that you wouldn't -- you probably wouldn't have shipped them into the export market if you weren't getting better realizations than you were domestically, or least, is good. So is there anything faulty with that math of just taking 7 and using the floor domestic margin? Or is that not right?

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Joseph W. Craft, Alliance Resource Partners, L.P. - Chairman, President & CEO of Alliance Holdings GP LP [66]

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Well, I would start with 7.4 million instead of 7 million.

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Mark Andrew Levin, Seaport Global Securities LLC, Research Division - MD & Senior Analyst [67]

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Sure. I'm sorry. Yes.

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Joseph W. Craft, Alliance Resource Partners, L.P. - Chairman, President & CEO of Alliance Holdings GP LP [68]

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That's okay. And it also gets into the mix between thermal and met. As we just mentioned this year, I think we'll sell about 650,000 tons into the met market in '19 that compares to about 1 million tons last year. And so it really would get back to your expectations, Mark, on what the met market is going to look like and whether that would be something that could be attractive to us in 2020 as well. So it's overall volume issue and then a mix between met, if any, and thermal.

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Mark Andrew Levin, Seaport Global Securities LLC, Research Division - MD & Senior Analyst [69]

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Got it. Got it. No, that's perfect. And Brian, correct me if I'm wrong as I may have forgotten this. In terms of the pricing that you guys get on met, I vaguely recall you saying something like maybe 55% of the benchmark or 50% -- something to that affect. Is that still -- or what is the right way to think about how you price that met?

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Brian L. Cantrell, Alliance Resource Partners, L.P. - Senior VP & CFO of Alliance Resource Management GP, LLC [70]

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Yes. When they are -- that rule of thumb did apply for a while. It doesn't apply today. And what our sales are doing, it really depends on what market we go to. And so it's hard to project exactly what it is, but I think it's fair to say that our pricing is $15 below, at least going into '20 from '19.

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Mark Andrew Levin, Seaport Global Securities LLC, Research Division - MD & Senior Analyst [71]

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Is there a rule of thumb as how to think about modeling it now or there are just too many pieces?

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Brian L. Cantrell, Alliance Resource Partners, L.P. - Senior VP & CFO of Alliance Resource Management GP, LLC [72]

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There are just too many variables. It really depends on [the selling] market.

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Joseph W. Craft, Alliance Resource Partners, L.P. - Chairman, President & CEO of Alliance Holdings GP LP [73]

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And transportation.

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Operator [74]

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Our next question is also a follow-up from Lucas Pipes with B. Riley FBR.

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Lucas Nathaniel Pipes, B. Riley FBR, Inc., Research Division - Senior VP & Equity Analyst [75]

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Mark got most of it but I have one left, and that's the comment regarding electricity demand decline in the U.S. of 2% year-on-year. Do you have a rough sense for what proportion of that decline is driven by weather versus efficiency in the power sector of LED light bulbs, et cetera? Would appreciate your thoughts on that.

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Joseph W. Craft, Alliance Resource Partners, L.P. - Chairman, President & CEO of Alliance Holdings GP LP [76]

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I don't have that.

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Brian L. Cantrell, Alliance Resource Partners, L.P. - Senior VP & CFO of Alliance Resource Management GP, LLC [77]

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But I would think it's probably more weather-related than specifically related to efficiencies.

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Joseph W. Craft, Alliance Resource Partners, L.P. - Chairman, President & CEO of Alliance Holdings GP LP [78]

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And then you've got the increase in manufacturing and then there is some downward pressure recently. It's -- I don't really have it that precise, I'm sorry.

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Brian L. Cantrell, Alliance Resource Partners, L.P. - Senior VP & CFO of Alliance Resource Management GP, LLC [79]

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I'm not sure anybody does, quite frankly, but...

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Joseph W. Craft, Alliance Resource Partners, L.P. - Chairman, President & CEO of Alliance Holdings GP LP [80]

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Sorry, but we don't -- I don't have that. I'm sorry, I can't help you on that.

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Lucas Nathaniel Pipes, B. Riley FBR, Inc., Research Division - Senior VP & Equity Analyst [81]

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No. That's helpful. I will see if maybe there is something out there and...

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Joseph W. Craft, Alliance Resource Partners, L.P. - Chairman, President & CEO of Alliance Holdings GP LP [82]

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The only way I can respond to that is, again, talking to utilities based on the way they're looking at 2020. There is an expectation that right now that their volume in 2020 will be comparable to 2019.

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Lucas Nathaniel Pipes, B. Riley FBR, Inc., Research Division - Senior VP & Equity Analyst [83]

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Okay. Yes, it would be -- could be interesting, hopefully, it's really just weather and then we should see an increase in 2020, I would assume. Yes, good data point for sure. So maybe just a second follow-up since -- while I have you, in terms of -- sorry to go back to the distribution question, but -- so it seems like we're looking at a slightly weaker Q4 and then a weaker first half of 2020 and you mentioned a lot of attractive investment opportunities. So how do you square all of that? I assume you'll be below 1x coverage in the next few quarters and then that markets are tighter as you mentioned throughout the call. How does all of this factor into your thinking?

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Joseph W. Craft, Alliance Resource Partners, L.P. - Chairman, President & CEO of Alliance Holdings GP LP [84]

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All right. So over the distribution, we assume that there will be no transactions, and there will be no further benefit from the consolidation of us picking up any market share. So when we stress test our current operations, we look at domestic targets, we look at the international benchmarks and we make judgments on what we believe volume-wise we will produce, based on 95% probability we pick up the business that we're bidding at the prices that we're bidding. So that's looking strictly at what we control. And based on what we've done so far we're still in our planning to see that. But based on what we've done so far in trying to determine what's the right decision for our distribution, we believe that if we can achieve 95% probability of volume that we can achieve close to the 1x coverage ratio. Our goal is to beat an excess of 1x, but it may fall slightly short of that in 2020. But believing that the consolidation in 2020 that will occur, I think it has to occur, that we will roll out at 2020 and move to a better pricing environment that will allow us to get back to greater than 1x coverage ratio more likely to 1.2x. But it's really going to be dependent on how fast the export market returns and how fast the consolidation occurs. So that's the way we look at it. So we're not counting on any of the things outside our control. It will happen when we feel comfortable making a decision to maintain our distribution at current levels. So that's what we believe are sustainable.

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Lucas Nathaniel Pipes, B. Riley FBR, Inc., Research Division - Senior VP & Equity Analyst [85]

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Just another question occurred to me. Given the importance on the export side, is there something that the administration could do? So for example, when it comes to exports, is that something where the -- where increased investments, for example, could help and make a difference? Or do you think that's really all driven by LNG prices, power policy in Europe, et cetera? Would appreciate your thoughts if there is anything that the administration could do to make U.S. coal exports more competitive?

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Joseph W. Craft, Alliance Resource Partners, L.P. - Chairman, President & CEO of Alliance Holdings GP LP [86]

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I think we've got plenty of capacity, so that's not an issue for the coal side. I think the LNG side of the equation, the administration has been advocating for that and you could argue that, that's had an impact on us in a negative way because of the LNG it did impact flow to Europe this year. But I think longer term, those prices will price at levels that coal will be competitive. I think we're just in a short-term lull on LNG prices. I think those will go higher for the investments that are being made there, they have to meet the growing demand. So the good news about low prices is low prices tend to solve the problem.

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Brian L. Cantrell, Alliance Resource Partners, L.P. - Senior VP & CFO of Alliance Resource Management GP, LLC [87]

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Every time.

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Joseph W. Craft, Alliance Resource Partners, L.P. - Chairman, President & CEO of Alliance Holdings GP LP [88]

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Every time. So we believe that the administration is doing what they can to help the coal industry. The president is very much a strong support of our industry. He is doing everything he can to help us.

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Operator [89]

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Our next question is a follow-up from Matthew Fields with Bank of America Merrill Lynch.

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Matthew Wyatt Fields, BofA Merrill Lynch, Research Division - Director [90]

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I hate to beat the dead horse on this distribution, but you're talking about all this consolidation and strategic opportunities and whatnot. And where your bonds are trading right now it will be really, really hard to finance anything or really expensive to finance anything. You're kind of already in the middle of your comfort zone liquidity-wise that you previously stated. So anything major would sort of put you out of your comfort zone. All I'm saying is, I think, why not take like a 1-year holiday on your distribution if 2020 is going to be this correction year to take advantage of these great opportunities that you see in front of you? And not sort of jeopardize the balance sheet as a way of doing it?

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Joseph W. Craft, Alliance Resource Partners, L.P. - Chairman, President & CEO of Alliance Holdings GP LP [91]

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We don't plan to jeopardize the balance sheet. We plan to finance any participation in a way that it will not jeopardize our balance sheet. If the draconian view that you have plays out, then we may have to look at it differently. But I'm just more optimistic than you are as to what will happen in the industry and where the cash flows it will result once the industry goes through its consolidation. Now whether the lenders will be there or not, I'd like to believe once you present a clear picture on what the future cash flows are that those bondholders would want to invest similar to what they did a couple of years ago when we went out to show them what our cash flow projections were or what our future -- what our operating plans were. And we're still -- we're operating to achieve the goals that I've set out. And we feel comfortable that we can generate the cash flow necessary to discharge the operating plan that I've laid out for you this morning, I can't do it anymore clearly I don't think. Is there a risk? Yes, there is risk, but yes, we had just...

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Matthew Wyatt Fields, BofA Merrill Lynch, Research Division - Director [92]

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Like you mentioned earlier, you've shown willingness to cut the dividend, which you did in the spring of 2016. Can you just sort of walk us through maybe the parallels between then and now? And what might cause your -- what caused your thinking then to change? And what might cause your thinking to change now?

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Joseph W. Craft, Alliance Resource Partners, L.P. - Chairman, President & CEO of Alliance Holdings GP LP [93]

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What caused it then was our lenders basically said you needed to. They have capital at that time, so we did.

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Brian L. Cantrell, Alliance Resource Partners, L.P. - Senior VP & CFO of Alliance Resource Management GP, LLC [94]

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Specifically, the commercial banks at that time with the issues that a number of our competitors were having and the risks that they saw on their balance sheets and their credit. As a result, folks were looking for covenant structures, et cetera, that would have essentially taken away our ability to control our distribution policy, and we were unwilling to do that. So we took the steps necessary to make certain that, that capacity and that market was there for us in a way that allowed us to maintain control over how we want to manage the company and plan for our distributions long term. That's what drove it at that point in time. As we've said several times this morning, we will do what we need to in order to preserve the integrity of our balance sheet and gain access to the capacity that we need. We've laid out what we believe we'll be able to accomplish. You can paint draconian pictures that assume debt capital markets aren't here today, and they'll never be here. If that happens, we'll need to adjust our thinking. We just don't expect that to be the case long term.

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Operator [95]

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This concludes the question-and-answer session. I would like to turn the conference back over to Brian L. Cantrell for any closing remarks.

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Brian L. Cantrell, Alliance Resource Partners, L.P. - Senior VP & CFO of Alliance Resource Management GP, LLC [96]

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Thank you, Sarah. A good call this morning, and thank you everybody for your participation. We look forward to our next call in late January of 2020, at which time we'll review our fourth quarter and 2019 full year results. And we will have completed our planning process that we've talked about several times today, and we'll be offering our initial guidance for 2020. That concludes our call today. Thanks to everyone for your participation and your continued support in ARLP.

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Operator [97]

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The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.