Alpha Metallurgical Resources Inc

NYSE:AMR

Earnings Call Transcript 2018-Q4

[Operator]

Good morning. My name is Denise, and I'll be your conference operator today. At this time, I'd like to welcome everyone to the Contura Energy 2018 Fourth Quarter Earnings Conference Call. [Operator Instructions] Alex Rotonen, Vice President, Investor Relations, you may begin your conference.

[Alex Rotonen, executive]

Thanks, Denise, and good morning, everyone. Before we begin, let me remind you that during our prepared remarks and the Q&A period, our comments relating to expected business and financial performance contain forward-looking statements, and actual results may differ materially from those discussed. For more information regarding forward-looking statements and some of the factors that affect them, please refer to the company's fourth quarter 2018 earnings release issued on Monday, April 1 and the associated SEC filing.

Please also see those documents for information about our use of non-GAAP measures and their reconciliation to GAAP measures.

Participating on the call today are Contura's Chief Executive Officer, Kevin Crutchfield; and our Chief Financial Officer, Andy Eidson.

With that, I'll turn the call over to Kevin.

[Kevin Crutchfield, executive]

Thanks, Alex, and good morning, everyone. Before I begin my prepared remarks, I want to comment on the reason we allotted 2 days between the release of our financials and this earnings call. For those of you who've actually read our 10-K understand, it's a very long and complex document with many moving parts due to the merger and refinancing activity in the fourth quarter. Our preference was to give the investment community ample time to parse through the details of the document before we conducted the call. But rest assured in the future, we plan to follow a more conventional timing for conducting earnings calls.

We're pleased with what we accomplished in 2018 as it was an important year for Contura. We made great strides becoming the largest domestic met coal producer with a broad offering of met qualities complemented by cost-competitive thermal portfolio, allowing us to better serve our customers spanning 23 countries on 5 continents.

During 2018, we recorded full year revenues totaling just over $2 billion and generated net income from continuing operations of $303 million, including a tax benefit of $165 million. Our adjusted EBITDA for the year was $335 million, aided by strong met coal realizations of $124 per short ton. We shipped more than 11 million short tons of met coal during the year, including purchased coals sold through our Trading and Logistics segment. From basically every perspective, 2018 was an extremely successful year. We're also ahead of schedule in achieving the synergy targets that we've previously announced when the Alpha merger was finalized last November. Andy will provide further color on this synergy and financial details in his prepared remarks.

On our 2019 guidance call announcement in January, I covered the many accomplishments we have achieved since our formation in July of 2016, so I won't get into those at this time. Instead, I would like to spend a few moments on recent safety and environmental achievements by our operating affiliates in Central and Northern Appalachia, highlight key global met market dynamics and share with you a little more information related to our company's future strategic focus.

I'll start with safety, which has served as the cornerstone of our operating philosophy since our formation. It's really quite simple. We value our employees and believe we cannot run efficient productive mines without first focusing on our employees' safety. As evidence of that safety-first focus, we've garnered numerous safety awards across the industry. Among these awards, 7 of our West Virginia mines won the prestigious Mountaineer Guardian Safety Award in 2018. While recognition of our safety performance to date is of course appropriate, we're acutely aware that safety is not a onetime achievement. It's a continuous everyday process to get better and we're committed to that continuous improvement.

The same commitment extends to other areas and that's why we also pride ourselves on being good stewards of the environment. As with safety awards, we were recognized numerous times for our environmental stewardship in 2018. Among the many prestigious environmental awards we received last year were the following: The West Virginia Coal Association mine construction award for the load-out facility; the Republic Energy's working creek cohandling facility; West Virginia Coal Association Service Mine Reclamation Award awarded to Highland Mining, the company's Highland surface mine; Virginia Coal and Energy Alliance's Best Active Surface Mine Award awarded to Paramount Contura's 88-strip surface mine; and Virginia Coal and Energy Alliance's best active deep mine award awarded to Paramount Contura's deep mine 44. I'd like to compliment our operational teams for their steadfast focus on safety and environmental performance.

Shifting over to market trends now. The global met supply remains quite tight with demand holding steady. The market conditions have been in place for the better part of 2 years now, as indicated by continued strength in the pricing environment.

To illustrate this, I'll provide some brief price history. Over the last 6 months, prices for mid-Atlantic high vol have ranged from the high 190s to the low 200s, closing at $201.50 on March 28. In the Pacific region, Australia premium low vol prices have, by and large, remained above the $200 threshold since early October 2018, only dipping into the 190s for a very short period in January. The most recent Aussie low vol forward strip indicates December 2019 pricing around $189 a metric ton. But backward dated, this is indeed a positive indicator for future pricing trends.

On the met export front, after bottoming out in 2016 at 41 million tons, U.S. met exports in 2018 increased to 61.8 million tons, up 50% from the 2016 levels and up 13% from 2017. As a historical reference, U.S. met exports peaked in 2012 at 69.8 million tons. After a decent January this year, the East Coast port struggled in February due to weather-related issues, with met exports shipments declining nearly 20% compared to February 2018 and approximately 15% compared to January 2019.

Year-to-date, East Coast met shipments are down a modest 3.2%. On a side note, thermal exports also showed strong growth in 2018, increasing 19% to 53.9 million tons. However, now that the API 2 has declined meaningfully since the end of 2018, it appears that current year thermal exports might languish here in the near term.

Europe, our main export market, continues to be the most important destination for domestic producers, accounting for 44% of all U.S. met exports, followed by Asia and South America at 27% and 15%, respectively. India, now the second largest and fastest-growing steel producing country, continues to serve as an increasingly key market for us. In fact, according to World Steel Association, India surpassed Japan in 2018 and became the second largest producer of steel. And in 2019, it's likewise projected to surpass the United States in terms of steel consumption. Also according to the World Steel Association, India's steel demand is forecast to grow 7.3% in 2019, while the Central and South American region is expected to grow 4.3%. European steel demand growth expectations are a more moderate growth rate of 1.7%.

As an important input to that forecast, the German economy has recently exhibited slower growth, with its PMI declining to 51.5 with the manufacturing sub index dropping to 44.7, indicating manufacturing contraction in March.

China, after its crude steel production grew 6.6% in 2018, is currently expected to see flat steel demand growth in 2019. And given the increased focus on environmental and safety performance communicated by the Chinese government, it's difficult to assess the trajectory of that market with any reliability, whether looking at steel or met production.

Speaking of Chinese met coal production, the aforementioned regulatory factors have been curtailing domestic coal production in China, and it's hard to imagine that it can continue its reported limit on high-quality met coal imports from Australia amid its recently announced economic stimulus efforts. Notwithstanding these modest growth expectations in Europe and China, however, the supply-demand equation continues to suggest that the limited growth of new met mines, depletion of existing mines and challenged production at current mines will support a solid price environment going forward.

For example, while U.S. -- overall U.S. met production grew 5.6% in 2018, it in fact declined 3% in the fourth quarter compared to the third quarter and remained flat compared to the prior fourth quarter, with both Central App and Northern App met production specifically declining by more than 3% compared to the prior year period. Given the strong pricing environment and with very little supply growth coming from the U.S., these numbers are quite tailing.

I'll wrap up my met market comments with a couple of anecdotal thoughts. As many of you might know, Turkey has been a solid and important market for us over the years. In fact, we shipped approximately 0.75 million tons of met coal to Turkey in 2018. However, the increase in U.S. met coal tariffs from 5% to the current 13.7% that were instituted by Turkey in August 2018 has been difficult to overcome, with early 2019 shipments to Turkey trailing our expectations as a result.

The good news is that we're now making some headway in Turkey and expect to ship our first cargo in the second quarter time frame with additional bids for future shipments in the works. North American coal qualities are strongly preferred by the Turkish buyers. But given the tariffs, their current cost differential clearly favors coals from Russia, Colombia and Australia.

In another one of our key markets, South America, and especially Brazil, we've experienced very aggressive pricing competition in the early part of this year, which has impacted our sales volumes compared to the first quarter of last year. While certain other market participants have moved volumes at those reduced prices given the continued overall supply tightness, especially for higher grade met coals, we'd expect this to be a temporary phenomenon. We feel it's vitally important to remain disciplined and not chase pricing that undervalues our product. And while the first quarter will show lower sales volumes than we originally anticipated, we believe that this will best position us to continue commanding near index or premium pricing for our coals for the remainder of this year.

To summarize, the global met market remains quite well balanced and we expect near- to midterm pricing to remain attractive. While global macro drivers are important in any commodity business, our focus will continue to be on those things we can best control such as the successful merger integration, including achieving or exceeding both cost and operational synergy targets, continuing to engage with the investment community and most importantly, the safe and efficient execution of our day-to-day business.

On the investor front, we've increased our outreach and recently participated in the BMO Metals and Mining Conference and plan to actively participate at several upcoming conferences, host investors at our home office and conduct the nondeal roadshows over the remaining 3 quarters of 2019. And of course and as always, we're available to interact with our investor community over the phone.

And with that, I'll now turn the call over to Andy to go through our financial results.

[Charles Eidson, executive]

Thanks, Kevin, and thanks, everyone, for joining us today for the quarterly call. I'll begin with our fourth quarter results, and then we'll hit some color on our progress toward our synergies and also a couple of comments on what the first quarter is looking like. And then we can jump to some questions.

So before I get into the detail of our results, I want to remind everyone that our fourth quarter financials include legacy Alpha results from the November -- from November 9 moving forward. And actually, that was the date that the transaction closed.

As announced on Monday morning, the company reported a fourth quarter net income from continuing operations of $156 million or $9.85 per share on total revenues of $572 million. The fourth quarter net income benefited from an income tax benefit of $165 million, and that consisted primarily of action around deferred tax assets, NOL carryback benefit and finalization of our AMT credit calculations.

Also factoring in the net income were severance cost totaling around $22 million for the fourth quarter related to the transaction.

Adjusted EBITDA was $111 million in the fourth quarter, up from $44 million in the prior year fourth quarter. The increase was mainly driven by much stronger performance in our CAPP - Met and NAPP segments, which increased their EBITDA contributions by $56 million and $26 million, respectively.

Trading and Logistics EBITDA declined by $7 million for the quarter, as the legacy Alpha portion of the T&L segment became part of our captive CAPP - Met segment postmerger. Compared to our fourth quarter of 2017, the CAPP - Met results were bolstered by a $10 increase in average realization to $119 per ton as well as an increased volume attributable to a partial quarter of Alpha's T&L being included in our CAPP - Met volume, which grew from 0.8 million tons to nearly 2.1 million tons.

Our NAPP segment reported an EBITDA of $25 million compared to an EBITDA loss of $1 million in the year ago fourth quarter. Naturally, that quarter was impacted negatively by a roof fall that we discussed at the time. NAPP volume grew by nearly 600,000 tons to 1.97 million tons, resulting in a cost improvement of more than $13 down to $32.64. We're very pleased with the strong performance in our NAPP segment. It's also worth noting that our long wall move was successfully completed, and I would note in under 10 days, last month. Our next move is scheduled for September.

On the CAPP - Met side, our fourth quarter costs were $84.14 per ton, up from $74.68 in the fourth quarter of 2017. There were some -- a couple of different contributors to the increased costs. Their labor and benefits were up a bit, supply and maintenance costs. But also, there was an impact to the fourth quarter from the transaction and balance sheet allocation that I'll talk about in just a second. We also had higher sales-related costs due to improved pricing. That was probably about $1 per ton of impact. Just as a reminder, around 10% of our CAPP - Met selling prices are paid for royalties and severance taxes. So that will fluctuate as the market moves. Exclusive of idle costs, costs of purchased coal and fair value adjustments to the balance sheet due to the merger, CAPP - Met costs for the fourth quarter were $75.02.

I would note that the fair value adjustments, and that applied to all the inventory that was acquired from Alpha in the transaction, accounted for roughly $6 per ton of cost of CAPP - Met tons and nearly $9 a ton on CAPP - Thermal costs -- CAPP - Thermal ton of costs. This particular item will continue to flow through inventory during the first and second quarters of this year until all of the acquired inventory has been depleted. And to help visualize that reconcile, we added the cost reconciliation table to the financials. So hopefully, that presents that in an easier-to-understand fashion.

The company ended the year with $233 million in unrestricted cash as well as $244 million in restricted cash for a total of $477 million. Total liquidity, which would include unrestricted cash and availability under the ABL, was $430 million at year-end.

On the restricted cash balance, there was a reduction in that balance from previous disclosures, as you'll note. The main driver in that was reduction -- in that reduction was release of a significant portion of a surety collateral due to the finalization of the transfers of effectively all of the permits from Alpha to Lexington Coal as a result of that transaction, and that all happened prior to the closing of our merger. That said, this movement doesn't impact our target for release of restricted cash that we've previously communicated, which is still around $130 million in total.

Shifting to merger-related items. I'm very pleased to reiterate the comment that Kevin made earlier on synergies. We're ahead of schedule, and we expect to reach and potentially exceed the high end of our synergy estimate run rate at the end of this year. At current time or at least as the end of February, we were at about a $34 million run rate, and that's prior to some of the other items that will be experienced a little bit later in the year. We noted previously that we were effectively at full run rate on SG&A synergies at the closing of the transaction, which was approximately $20 million.

On the strategic sourcing front, we're tracking with our initial time line, which basically says that we see the majority of those benefits later in the year, which is more in the zip code of contract repricing and rollover. So that'll probably be third, fourth quarter issue.

Operational optimization is another focus, particularly employee turnover among hourly monitors. As folks in the industry know, there's a lot of competition for qualified experienced monitors in Central App, in particular. And so that's -- avoiding turnover there is very, very essential to continuing effective operations. So at this point, the legacy Alpha employee turnover has been reduced from the high teens or low 20s in certain months to around 12% to 13% currently.

Contura legacy has always been typically a single-digit turnover rate. So as we continue to close that gap, we'll be able to see a lot of savings related to that. Naturally, there are some nonfinancial savings there. Lower turnover leads to better monitor safety, improved productivity. And also financially, you save a lot of money by not having to retrain or track down new hires. And within operational optimization, we're also working on improving our prep plant yields, which will be highly accretive to earnings. And we'll provide more details on that particular topic at an appropriate time. One additional synergy we discussed at the time of the merger around coal blending and marketing optimization is making solid progress with the vast majority of the upside yet to be realized later in the year. But we'll continue to keep everyone updated on synergy tracking throughout the rest of the year.

Switching to our 2019 outlook and specifically first quarter, how we've seen things moving there. As Kevin mentioned in his prepared remarks, we saw some aggressive pricing in South America, tariffs impacts on Turkey and then also some weather-related issues in the first quarter. As a result of these primary factors, Q1 is trending a little bit softer from a sales perspective than we have initially expected.

Based on our ratable quarterly spread of the midpoint of our guidance on met sales, we're shipping approximately 300,000 tons less than we would have expected on that basis. And we do anticipate recovering those sales over the balance of the year. But it's also worth noting that our sales during the first quarter, and these are preliminary nonfinalized numbers yet, but those sales basically saw weighted average realizations of probably $4 to $6 a ton higher than the committed pricing we noted in our original guidance. And we feel this is further evidence that we can't continue to seek premium pricing for our product, and we plan to continue and expect to continue seeing that throughout the rest of the year.

Naturally, given lower volumes, there is a knock-on cost impact. And as such, we do anticipate our first quarter CAPP - Met costs will probably trend relatively high. But we fully anticipate those costs will come back in line with full year expectations through rest of the year.

Additionally, due to lower sales, an additional knock-on impact is the fact that those tons are still being produced. So you have a significant portion of cash pushed into working capital for inventory. But naturally, that's a timing issue and it will reverse as those tons flow through sales over the months.

We expect to report our first quarter results in the first half of May. In addition to our quarterly results, we plan to provide another update on our synergy performance at that time.

And again, we thank everyone for your participation and for being on the call today. Operator, I believe we're ready to take some questions.

[Operator]

[Operator Instructions] Your first question comes from Scott Schier with Clarksons.

[Scott Schier, analyst]

If I could start on capital allocation. We have you guys carrying a pretty sizable level of free cash flow this year. How should we think about the priorities of your plans for that cash?

[Kevin Crutchfield, executive]

Yes, it's a good question. I mean I think as we've always said, the first thing we want to do is keep our mines running well and allocate the appropriate amount of sustaining capital. But I will tell you that we'll announce something much more specific concurrent with the first quarter call. I can tell you that our board has spent a considerable amount of time evaluating the options, and we're now in a position to share what our intentions are in that regard. But naturally, until the plan is completely formalized, certain aspects could be considered preliminary and subject to change. But at the high level, we anticipate a biannual distribution of 50% available free cash flow, which will be paid in the second and fourth quarters and based on the prior 2 quarters of cash flow generation. This distribution can take the form -- 1 or 3 forms really: a special dividend, share repurchases or debt repurchases or any combination thereof based on the facts available to the board at that time. And moreover, I would add that the term available free cash flow, we'll define that specifically in the formal communication of the plan. But it'll be a typical free cash flow calculation beginning with the EBITDA and removing certain items that one would expect, capital, working capital interest, regular debt amortization, legacy liability or bankruptcy settlement payments, et cetera. So again, that's at a high level. But stay tuned for a more formal announcement concurrent with our first quarter discussion coming up here in probably a month or 1.5 months.

[Scott Schier, analyst]

And we're looking forward to hear on that announcement. As a quick follow-up, can you talk a little about your plans for the pinnacle reserves that you're supposedly slated to purchase?

[Kevin Crutchfield, executive]

Well, I would just say at a high level, it's been a little bit of a messy process, still not to the finish line yet. But the plan there for us was it was a simple reserve acquisition and will add to the reserve base of one of the mines that we picked up through the Alpha merger, adds a significant amount of reserve. It's a little better reserve than we otherwise would've mined in terms of its thickness. And we'll add probably circa a decade of life to that mine. So it'll just be incorporated into the long-term mine plan there at Road Fork 52, assuming that we can get to planned plant confirmation and get the deal finalized.

[Operator]

Your next question comes from Mark Levin with Seaport Global.

[Mark Levin, analyst]

So a quick question, Kevin. So obviously, you know Arch has announced a new 3 million ton a year mine. Warrior seems like they'll be shovel-ready in the first quarter. I'm just curious if you're thinking now, does this new West Virginia state law that allows for some return of your capital investment if you produce in Western Virginia, does any of that change your view in terms of what growth might look like for Contura over the next couple of years?

[Kevin Crutchfield, executive]

Honestly, Mark, I mean, we're still parsing through the language of that deal. I mean, there are a couple of parts there, one that involves tax benefit based on CapEx and the other is the severance tax reduction, which is based in over, I think, a 3-year period. On the second point, that's a modest help to us. But as we parse through the capital investments side, I mean, it could make -- it could change decisions. But I mean, I think we've got a pretty solid plan for West Virginia as we look ahead with the projects that we've already announced, a couple of more things that we're looking at that could induce us to move a little faster on them. But I think what we'd want to do is look at projects on their own merits. And yes, to the extent that West Virginia's plan that they'd put in place aids us, that's certainly a benefit. But we'd like to look at them kind of on a standalone basis and make those decisions accordingly. Andy's sitting here. He's kind of been looking at the West Virginia piece. He may have some additional color on it, but I think we're still kind of trying to understand it more completely.

[Charles Eidson, executive]

Yes, I agree with that, Kevin. As Kevin mentioned, it could be a driver for moving a little bit more quickly. But if you look at St. Leary South, a project that size definitely yields more benefit than the smaller projects that we would have on the table. So I don't know that it would make that much of an impact for us. But again, we're still evaluating that. I don't know that it's really going to change anything in the near term.

[Mark Levin, analyst]

Got it. And then the second question, Kevin, you referenced the API 2 price, which has obviously gotten hit pretty significantly in a pretty short period of time. Maybe you guys can remind us how much export steam you exported in -- or how much steam you exported in 2018? What you have under contract for '19, if you're willing to share that? And then what is a reasonable expectation based on sort of where the market is for your own export steam in '19?

[Kevin Crutchfield, executive]

Yes. I think, Mark, if my memory serves me correct, '18 was kind of circa 1 million tons to take advantage of where the API 2 or basically the seaborne and thermal markets were. We're nowhere close to that. This year, we're just a couple hundred thousand tons. Probably those are at fixed price. They don't move with the API 2. We booked a little bit of business in the first quarter domestically and they were with domestic customers. I think probably 400,000 tons, plus or minus, at something kind of low 7 handle on it. With the capitulation of the API 2 market in the net backs or I don't know, probably mid-30s or something, that's just a complete nonstarter at this point. So we're keeping an eye on it obviously. I mean, the worry that we would have there is that coal comes back into the U.S. trying to find homes, puts pressure on domestic markets and could even begin to put a little pressure on some of the inferior quality metallurgical side of the business, the low grade, high-vol Bs and whatnot. So it's something we will have to take a close eye on.

[Mark Levin, analyst]

Okay. The last question, so you mentioned -- I hadn't heard this before about Brazil. What's your sense of what's going on down there, Kevin? I mean just from what you're seeing and hearing, what's the dynamic that's causing that sort of pricing to go into that market?

[Kevin Crutchfield, executive]

Yes. I mean, I think it was just a move early in the year to try to take back some market share and pricing that I would consider kind of predatory levels, frankly. It was so -- such a significant discount that we chose to pass. And I think from our standpoint, the world is a big market and we have lots of other opportunities, and we didn't see any reason to take that bait early in the year. If you need to capitulate, you can capitulate later. But we chose to pass on that. We'll let the traders take those markets, and we'll hold our better quality coals out for better deals, frankly.

[Operator]

[Operator Instructions] Your next question comes from Lucas Pipes with B. Riley FBR.

[Matthew Key, analyst]

This is Matt Key asking a question on behalf of Lucas. Just wanted to confirm what you said in a prior comment. Did you say in the second and fourth quarter that you're planning to distribute around 50% of the trailing free cash flow?

[Kevin Crutchfield, executive]

Available free cash flow, yes.

[Matthew Key, analyst]

Available free cash flow? Got it.

[Kevin Crutchfield, executive]

Yes.

[Matthew Key, analyst]

And just one more quick one. I was wondering if you could provide any update on kind of your plans to divesture on the thermal coal operations.

[Kevin Crutchfield, executive]

I mean it's something that we've continued to think about. I mean, we believe our DNA is, at its heart, we're a met -- a very met-oriented company and would like to continue to be thought of in that way. And to the extent that there was something there that could be done on the thermal side that would make sense, we'd obviously be open because we're not romanticizing with any of our assets. But it's a function -- I mean, the first thing I'd say, too, is our thermal assets are doing just fine. And at current price decks, I think we'll continue to do just fine. But if somebody thinks they're worth more to them than they are to us, then there's certainly a conversation there to be had. So I'll just kind of leave it at that. And hopefully, that gives you what you need in terms of color.

[Matthew Key, analyst]

Yes, I know. That's very helpful. I appreciate your time and best of luck moving forward.

[Operator]

There are no more further questions queued up at this time. I'll turn the call back over to Mr. Kevin Crutchfield.

[Kevin Crutchfield, executive]

Again, many thanks for those who participated today, and we appreciate the support and will continue to keep you posted as we roll ahead. And we'll be back online probably here with the first quarter in circa middle of May, so look forward to talking to you then, if not before. Thank you again for participating today.

[Operator]

This concludes today's conference call. You may now disconnect.