Warrior Met Coal Inc

NYSE:HCC

Earnings Call Transcript 2018-Q2

[Operator]

Good afternoon, everyone. My name is Gary, and I will be your conference operator today. At this time, I would like to welcome everyone to the Warrior Met Coal Second Quarter 2018 Financial Results Conference Call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question-and-answer session. [Operator Instructions] Thank you.

Before we begin, I have been asked to note that today's discussion may contain forward-looking statements, and actual results may differ materially from those discussed. For more information regarding forward-looking statements, please refer to the Company's press release and SEC filings.

I have also been asked to note that the Company has posted reconciliations of the non-GAAP financial measures discussed during this call in the tables accompanying the Company's earnings release, located on the Investors section of the Company's website at www.warriormetcoal.com. In addition to the earnings release, the Company has posted a brief supplemental slide presentation to the Investors section of its website at www.warriormetcoal.com. Please note, this event is being recorded.

Here today to discuss the Company's results are Mr. Walt Scheller, Chief Executive Officer of Warrior Met Coal; and Mr. Dale Boyles, Chief Financial Officer.

Mr. Scheller, you may begin your remarks.

[Walter Scheller, Chief Executive Officer]

Thanks, operator. Hello, everyone, and thank you for taking the time to join us today to discuss our second quarter results. After my remarks, Dale will review our results and additional detail, and then you will have the opportunity to ask any questions you may have.

We had another solid performance in the second quarter continuing to leverage the strength of our operations and the healthy market demand for our premium product. While volumes moderated somewhat from the record highs we saw in the first quarter, our performance tracked in line with or better than our expectations.

Production volume for the quarter was $1.9 million short tons roughly equivalent to the amount produced in the same quarter in 2017. The actual production volume was better than expected given that we entered the second quarter with a scheduled shutdown for a week of maintenance at one of our mines. Our sales volumes were slightly lower than the prior year period. In the second quarter we saw market condition keeping prices elevated around $180 to $200 per metric ton that were all from the first quarter highs.

On the supply side issues out of Australia continued with heavy planned maintenance, weather delays related to Cyclone Iris, the Aurizon Rail dispute and specific Australian mine production issues all contributing to tighter global supply conditions.

Customer demand continued to be impacted by Chinese steel production policies. The global GDP growth and resilient global steel demand and production have continued to buoy the market. Restocking after the Chinese New Year is likely also to have had a positive impact. Our gross price realization for the second quarter was 100% of the Platts premium low-vol FOB Australian index price reflecting the premiums we achieved on our low-vol and mid-vol coals in a heightened pricing environment throughout the quarter.

Cost of sales per ton was 4.5% higher in the second quarter versus the first quarter of 2018 primarily due to higher maintenance cost and lower sales volume, but still in line with our full year guidance. As compared to last year's second quarter, our cash Platts per ton was higher due to the ramp in mining activities, including 133 more people, two more continuous mining units and higher maintenance expenses.

Looking at the big picture for our production we're continuing to make good progress through our Warrior's nameplate annual capacity of 8 million short tons. Halfway through the year the company produced and sold 4 million short tons of met coal without any longwall moves. We expect to have three longwall moves in the second half of 2018 with two moves in the third quarter. Given the strength of our results in the first and second quarters, ongoing global GDP growth, and strong demand for steel production we are raising our guidance for the balance of the year. Dale will cover the details in his remarks.

Our entire team pushed the business hard to deliver these excellent results and make the most of the pricing environment for our premium met coal product strong overall market conditions. I would like to thank all our employees for the work they have been doing to achieve the level of success we've had thus far in 2018. Our top priority remains working safely as of the first and most important step to working efficiently and ultimately achieving success in the marketplace.

Warrior's performance clearly demonstrates the unique value of a highly focused business strategy as a premium pure play met coal producer. Our goal is to operate profitably and efficiently in any pricing environment, not just in the extraordinarily favorable conditions we've experienced over the past year or so. To that end we've continued to invest in our operations in the second quarter devoting $33 million towards sustaining and discretionary capital expenditures.

Our second quarter capital spending included the completion of the new Mine 7 North portal that we previously discussed. This spending level remained above our average normal sustaining requirements reflecting our efforts to solidify our base operations in a manner that will significantly enhance our strength efficiency and reliability in the future.

Before I turn it over to Dale, I should point out that we successfully completed two secondary offerings and paid a special dividend during the quarter. We remain committed to returning excess cash to shareholders while maintaining the capital structure with an appropriate degree of leverage. We’re pleased with the company's excellent performance in the first half of 2018. Building on our strong operational and financial base we're committed to investing in the business to ensure our continued success. We expect to continue generating strong cash flows through the end the year that continue creating significant value for our shareholders.

I'll now ask Dale to address our second quarter results in greater detail.

[Dale Boyles, Chief Financial Officer]

Thanks Walt. For the second quarter of 2018 net income on a GAAP basis was $91 million or $1.72 per diluted share compared to net income of $130 million or $2.46 per diluted share in the second quarter of 2017. Excluding one-time transaction and other expenses for the secondary offerings and incremental non-cash stock compensation expense in the second quarter, non-GAAP adjusted net income was $96 million or $1.81 per diluted share.

Adjusted net income for the second quarter of 2017 was $2.52 per diluted share and excluded expenses associated with the IPO last year. And lower met coal price was the largest factor negatively impacting results quarter-over-quarter by approximately $27 million. Remember Cyclone Debbie occurred in the early part of Q2 last year.

Adjusted EBITDA was $129 million in the second quarter as compared to adjusted EBITDA of $188 million in the same period of 2017. The company's adjusted EBITDA margins which we calculate as adjusted EBITDA divided by total revenues and which we believe are some of the highest in the industry were 40% for the second quarter compared to 52% in the same period last year.

In summary, the current quarter results were lower than the prior year primarily due to lower realized pricing, higher costs associated with the weak shutdown of maintenance, the continued ramp up of mining activities from early 2017 and slightly lower sales volumes. These higher costs were already built into the company's original full-year 2018 guidance and are not expected to be incremental.

Total revenues for the second quarter of 2018 was $323 million which included met coal sales of 1.9 million short tons at an average net selling price of $167 per short ton. Total revenues in the quarter were $41 million lower than the second quarter of 2017 on a 3% decrease in met coal sales volume and 8% decrease in average net selling prices per short ton.

Our second quarter gross price realization was approximately 100% and whereas price realization represents a volume weighted average calculation of our daily realized price per ton based on gross sales, which excludes demurrage and other charges as a percentage of the Platts premium low-vol FOB Australia Index price. This result demonstrates the high quality characteristics of our premium, low and mid-vol of products.

As we have said before over the longer term we expect our gross price realizations to be nearly 100% of the index price. Our average net selling price per short ton decreased approximately 8% in the second quarter compared to the same quarter of 2017. Met coal prices were higher in the second quarter of 2017 primarily attributable to the impact on Australian supply due to Cyclone Debbie in the early April of last year.

Demurrage and other charges reduced our gross price realization to a net average selling price of a $167 per short ton in the second quarter of 2018. Mining cash cost of sales was $177 million or 56% of mining revenues in the second quarter compared to $160 million or 45% of mining revenues in the second quarter of 2017, driven primarily by lower sales volumes of 3% and higher costs associated with a week's shutdown of maintenance and the continued ramp up of mining activities from early 2017.

Cash cost of sales per short ton, FOB port was approximately $94 in the second quarter compared to $82 in the same period of 2017. While our cash cost per ton was higher than the second quarter last year, the quarterly fluctuation was within our expectations and in line with our full year guidance which has not changed. In addition, our year-to-date cash cost per short ton of $92 is tracking as expected.

SG&A expenses were about $14 million or 4% of total revenues in the second quarter and approximately $5 million higher than the same period last year. This included $3 million of incremental non-cash stock compensation expense associated with divesting of shares in connection with the May secondary offering that was not originally planned in our previous guidance. The remaining $2 million increase is primarily due to higher professional fees and other costs of being a publicly traded company.

For example, the company is required to be SOX compliant under the SEC rules and regulations for the calendar year ended 2018. Depreciation and depletion expenses for the second quarter of 2018 were $21 million or approximately 6% of total revenues compared to $20 million in 2017. The increase in the second quarter depreciation and depletion expenses was primarily attributable to the high rate of capital spending over the last year and a half. Transaction and other expenses were about $1 million and related to the completion of the two secondary offerings in the second quarter.

Interest expense was almost $10 million in the second quarter and included interest on our equipment, promissory note, and senior secured notes plus amortization of our debt issuance costs associated with those facilities and our ABL. This was higher than last year's second quarter due to the senior secured notes offerings in November 2017 and March 2018.

As anticipated, Warrior did not incur any income taxes due to utilization of its net operating losses or NOLs. One of the key long-term assets and strengths of the company is its NOLs which we expect will reduce our federal and state income tax liability to zero until the NOLs are fully utilized or expire. We expect this will continue to drive significant free cash flow conversion over the next several years.

Turning to cash flow, during the second quarter we generated $100 million of free cash flow which was the result of cash flows provided by operating activities of $133 million plus cash used for capital expenditures of $33 million. This compared to $145 million of free cash flow in the second quarter of 2017. This result is primarily attributable to lower operating results and higher capital spending in the second quarter of 2018.

Our spending on sustaining and discretionary capital expenditures during the second quarter was double the amount spent the same quarter of 2017. Last year's capital spending was more backend loaded and this year is more evenly spread over the entire year and is on track to meet the company's expectations for the year.

As previously mentioned, capital spending in the second quarter of 2018 included the completion of the new portal at Mine 7 in April. Cash flows used in financing activities were $367 million in the second quarter of 2018 as compared with $3 million used in financing activities in the second quarter of 2017. The increase primarily reflects the payment of the $350 million special dividend and the cash used in the May secondary offering to repurchase 500,000 shares of common stock under the stock repurchase program the company announced earlier in the second quarter.

Our net working capital decreased by $16 million from the first quarter of 2018, primarily driven by collections, lower sales volume, and lower net selling prices and decreased $7 million in the first half of 2018 compared to last year. Coal inventory increased from 316,000 short tons at the end of the first quarter of 2018 to 353,000 short tons at the end of the second quarter. the slight increase in inventories after a one week shutdown for maintenance at Mine 7 positions the company well heading into the third quarter customer demand.

The company's balance sheet continues to be strong with a leverage ratio of less than one times adjusted EBITDA and ample liquidity. Our total liquidity as of June 30, 2018 was $151 million consisting of cash and cash equivalents of $55 million and $95 million available under our ABL facility, net of outstanding letters of credit of approximate $5 million.

As Walt mentioned earlier, Warrior completed two secondary offerings and paid a special dividend during the quarter. On April 03, the company used the net proceeds of its offering of $125 million and 8% senior secured notes due 2024 together with cash on hand to declare a special cash dividend of approximately $6.53 per share of Warrior's common stock or an aggregate payment of $350 million.

In early May the company announced the pricing of an underwritten secondary offering of 8 million shares of its common stock by certain of its existing stockholders of which the company agreed to repurchase from the underwriter 500,000 shares of common stock totaling $12 million. And in early June the company announced the pricing of another underwritten secondary offering of 5 million shares of its common stock by certain of its existing stockholders. The company did not receive any proceeds from either secondary offering during the second quarter.

Now turning to our outlook for the rest of the year. In light of our successful performance in the first and second quarters, our NOL carryforwards and the expected market conditions for the remainder of 2018 Warrior is raising its guidance for the full year 2018 to reflect higher production and sales volumes. Our update guidance is as follows: coal sales of 7.1 to 7.5 million short tons, coal production of 7.1 to 27.5 million short tons, cash cost of sales FOB port of $89 to $95 per short-ton, capital expenditures of $100 to $120 million, SG&A expenses of $36 million to $39 million, reflecting the additional non-cash stock compensation expense associated with the May secondary offering, interest expense of $40 million to $42 million and a cash tax rate of 0%.

A number of factors may affect our outlook including the number and timing of longwall moves and the Platts Permian low-vol FOB Australia Index pricing. We expect to have two longwall moves in Q3 and one move in Q4 of 2018 that will lower production in those quarters. Under our current guidance for 2018 we expect to spend approximately $30 million to $37 million on discretionary capital projects. These include the new portal at Mine 7 that was completed in April of this year, a down payment on new set of longwall shields and other projects that will support our strategic goals. Due to the long lead times of developing these projects this year we expect to realize the majority of the benefits of the spending in 2019 and beyond.

I'll now turn it back to Walt for his final comments.

[Walter Scheller, Chief Executive Officer]

Thanks Dale, before we move on to Q&A, I would like to summarize where we stand from an operations standpoint. In short, we did what we said we would do on last quarter's call. Our plan for the second quarter reflected the decisions we took earlier this year. Coming off three longwall moves in the first quarter of 2017 we ran the operations harder than we originally planned to take advantage of the high price environment during the first quarter. We ran the mines an extra six days during the first quarter and that resulted in bringing forward an extra longwall move into 2018.

We also planned a six-day outage during the second quarter to complete several expected maintenance projects. While this will not necessarily reduce production at both mines, we completed the process better than expected resulting in approximately 200,000 tons more of production. As a result of record production in the first quarter of this year, we planned two back-to-back longwall moves in the third quarter. This also meant slightly less production in the second quarter as we neared the end of the panels because the coal scenes get better and mining equipment nears its required rebuilding.

As I've said on previous calls we've run the business as if next pricing downturn and geological issue is just around the corner with conservative targets and flexible operations that allow us to adjust to the market environment if it changes throughout the year. Given our strong performance in the first two quarters we feel good about our prospects for the balance of the year and that is reflected in our acreage guidance ranges.

In conclusion Warrior's outlook remains strong as we make real strides in returning our operations to the nameplate capacity of 8million short tons. We expect Warrior's premium, high CSR coal coupled with our highly flexible cost structure will enable us to continue to generate industry-leading margins and strong cash flows through this cycle.

With that, we'd like to open the call for questions. Operator?

[Operator]

[Operator Instructions] The first question comes from Jeremy Sussman with Clarksons. Please go ahead.

[Jeremy Sussman, Clarksons]

Hi, thanks very much for taking my question.

[Walter Scheller, Chief Executive Officer]

Sure, Jeremy.

[Jeremy Sussman, Clarksons]

Well, nice to see you raising guidance to 7.1 million to 7.5 million tons this year. I guess as – if I look forward over the next couple of years as sort of the 8 million ton run rate is that still the plan, I guess how should we think about that dynamic?

[Walter Scheller, Chief Executive Officer]

Yes, our plan is still to achieve that 8 million ton run rate. As you can see the first half of this year we got up to 4 million, a little over 4 million in the first half of the year and we will have these three longwall moves and we're tweaking a few things in the R&R [ph] operating plan and still growing toward that 8 million ton run rate and we still expect to be able to get there.

[Jeremy Sussman, Clarksons]

Okay and from a timing perspective, when should we start to look for that?

[Walter Scheller, Chief Executive Officer]

Our goal is still by year end you guys are going to say that the way we've performed sure looks a lot like we're getting there.

[Jeremy Sussman, Clarksons]

Perfect and I would agree with that and I guess, if I think about a very strong quarter I think generated $133 million of cash flow from operating activities. Obviously with the special dividends you are now I guess $55 million or so of cash on hand, you should generate some nice cash in the second half assuming the medical curve is reasonably accurate. Do you sort of have a target kind of yearend cash level that we should think about?

[Dale Boyles, Chief Financial Officer]

Hey Jeremy its Dale. Thanks for the question. The targets as we said before for cash we can really run this business on a minimal amount of cash because of the cost structure. Obviously we do have some fix payments now with interest on our notes and everything with no debt maturities any time soon. So we can still run at pretty low levels and we will continue to kind of manage and optimize the capital structure and look at all the opportunities that are presented every quarter from a capital standpoint either capital expenditures or other opportunities but no specific targets on cash at this time.

Let me just make a note to – it just came to my attention that our 8-K was filed and it is on our website, but I believe Business Wire has had some technical issue with issuing it in their space, so if you don't see it out in the News wire you can pick it up off our website at www.warriormetcoal.com.

[Jeremy Sussman, Clarksons]

Thanks Dale, and it sounds like just to make sure I understand it, it sounds like from a capital allocation standpoint there is no deviation from sort of how you've been running the business, is that fair to characterize?

[Dale Boyles, Chief Financial Officer]

That's right, Jeremy. We will continue with our same capital allocation policy to the extent there is excess cash available. We will return that in various forms back to shareholders either through the stock repurchase plan that we have now or other special dividends or may use it to delever or other opportunities just depending upon what we had on plans at that time.

[Jeremy Sussman, Clarksons]

Great, I appreciate it, thanks guys.

[Dale Boyles, Chief Financial Officer]

Thank you.

[Operator]

[Operator Instructions] Our next question comes from Lucas Pipes with B. Riley FBR. Please go ahead.

[Lucas Pipes, B. Riley FBR]

Hey, good afternoon everybody.

[Dale Boyles, Chief Financial Officer]

Hi Lucas.

[Lucas Pipes, B. Riley FBR]

Good job on the quarter and rising the guidance. I wanted to follow up on the cost side a little bit, obviously steel prices have increased tremendously over the past 12 months and by and large that's good news for you because you’re selling to the steel industry. But I wonder are you seeing cost pressures [indiscernible] I know I mean you are a longwall miner obviously, so it is not as pertinent to you as maybe to some others, but are you seeing cost pressure from steel components and if so to what degree could that impact your costs for the remainder of the year and then maybe also on the capital side would that have an impact? Thank you.

[Dale Boyles, Chief Financial Officer]

Sure, we see nothing significant at this point and as we look to our capital allocations and our expectations, most of that has already been built. So no, we don’t see, we had not had any significant inflationary pressures and we don’t think as we look throughout the rest of this year that that will be a factor.

[Lucas Pipes, B. Riley FBR]

Okay, and in terms of your cost structure, what percent would be associated with the steel product?

[Walter Scheller, Chief Executive Officer]

It’s a small percentage, so nothing of any huge significance. You would have to experience 100% of inflation in all of that to really have something significant material.

[Lucas Pipes, B. Riley FBR]

Got it, okay, that's helpful. Thank you.

[Walter Scheller, Chief Executive Officer]

Thank you.

[Operator]

At this time, there are no further questions. I will now turn the call back over to Mr. Scheller for any comments.

[Walter Scheller, Chief Executive Officer]

That concludes our call for this afternoon. Thank you again for joining us today and we appreciate your interest in Warrior Met Coal.

[Operator]

Thank you. And that concludes today’s conference. Thank you all for participating. You may now disconnect.