Warrior Met Coal Inc

NYSE:HCC

Earnings Call Transcript 2018-Q3

[Operator]

Good afternoon. 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 Third 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 press 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 it's website at www.warriormetcoal.com. Please note, this call 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, CEO]

Thanks, operator. Hello, everyone, and thank you for taking the time to join us today to discuss our third 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.

Warrior continued to perform in line with our expectations in the third quarter with a healthy market demand for our premium products supported by strengthen in global steel production in our key market. While sales lines were lower than the record highs we saw at the beginning of this year due to logistical issues out of our control, we continue to track with our previously issued guidance. We expect to close out the year in the upper end of that range assuming everything goes as expected.

Production volume for the third quarter was 1.8 million short tons compared to 1.6 million short tons produced in the same quarter in 2017. We successfully completed two back-to-back longwall moves in the third quarter and achieved production levels that were better than expected. This better than expected production contributed to slightly higher inventories at the end of the third quarter. A longwall move can be challenging due to several factors including the time it takes to complete the move and the degree of difficulty in rebuilding and relocating large heavy equipment. Our better than expected results demonstrate, both the significant efforts made by our employees in anticipating and planning the move, as well as their ability to adapt and adjust to challenging geologic conditions.

Sales volumes for the third quarter were 1.7 million short tons, compared to 2.1 million short tons in the same quarter 2017. As a reminder, in that quarter we benefited from the sale to approximately 400,000 short tons of excess inventory that we had held at the end of the second quarter of 2017. While sales volumes in the third quarter exceeded budget, it could have been a bit better had it not been for a 3-day port closure due to tropical storm quarter which caused a slight delay in vessel loan in September. Other smaller factors that contributed to lower sales volumes this quarter include the planned river system maintenance that was not fully offset by rail system pickup of that volume, as well as couple of train derailments at the port that slowed the movement of coal from the mine sites to the port. Inventories were a bit higher than expected for these reasons plus a better than expected production in the quarter. With this backdrop the company is well positioned heading into the fourth quarter with a strong price environment.

In the third quarter, overall market conditions kept pricing at elevated levels that we saw some volatility in pricing. The strong pricing environment has been supported by tight supply and demand balance. In addition, favorable Chinese policies that occur as more environmentally friendly production of steel. In particular, [indiscernible] that use high quality of low sulfur coals are increasingly turning to hard coking coal to meet the required emissions cuts under the government's blue sky defense action plan. We expect these dynamics to continue in the fourth quarter.

A word on tariff; while we're certainly watching the developments such as China is in a position of 25% import tax on U.S. coals, we believe the impact is likely to be limited on our operations. First, we don't sell our products into China. Additionally, we priced our product against the benchmark product sold from Australia which will continue to benefit from strong Chinese demand irrespective of any tariffs on-sales from the U.S.

Our gross price realization for the third quarter was 97% of the Platts premium low-vol FOB Australian index price reflecting a rising price environment during the quarter, especially in the month of September. Index prices rose approximately $27 a metric ton from a $174 on August 1 to $201 on September 30. Realizations of less than 100% are not only unusual in a rising price environment on a quarterly basis as we price with customers on some amount of lag time. Likewise, in the following price environment we expect our realizations to be higher and reflected timing shift of those realizations. However, as we have previously disclosed, this should even out through the cycle and over the long-term our price realizations should be nearly 100% of the index price. It's worth noting that had our gross price realizations were near 100% in the third quarter, the Company's adjusted EBITDA would have been approximately $9 million to $10 million higher.

Warrior's performance continues to demonstrate the unique value of our highly focused business strategy as a premium pureplay met coal producer. Our goal is to operate profitably and efficiently in any pricing environment, not just in the favorable conditions we've experienced over the past year or so. We've invested in the business where appropriate to support this strategy, and we have also continued to reward our shareholders as conditions warrant [ph].

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

[Dale Boyles, CFO]

Thanks, Walt. Overall, we're pleased with our results for the third quarter. Our third quarter results were in line with our expectations and ahead of our internal budgets.

For the third quarter of 2018 net income on a GAAP basis was $53 million or $1 per diluted share compared to net income of $120 million or $2.27 per diluted share in the third quarter of 2017 which included the tax benefit of $38 million of $0.71 per diluted share. Excluding one-time transaction and other expenses for the secondary equity offerings, non-GAAP adjusted net income was $56 million, or $1.06 per diluted share compared to $2.27 per diluted share in the third quarter of 2017. Adjusted EBITDA was $94 million in the third quarter as compared to adjusted EBITDA of $107 million in the same period of 2017. The Company's adjusted EBITDA margins which we calculate as adjusted EBITDA divided by total revenues was 34% for the third quarter, roughly identical to the prior period. The decrease period over period is primarily due to lower sales volume at 41%, partially offset by a 10% increase in net selling prices.

Total revenues were $273 million in the third quarter of 2018 compared to $312 million in the same period last year. As previously mentioned, this decrease was primarily attributable to 21% decrease in sales volumes partially offset by a 10% increase in net selling prices. Last year's third quarter sales volumes were positively impacted by higher than expected production levels in the first half of 2017 in which inventory levels were 612,000 short tons entering the third quarter last year. In addition, there were no longwall moves in the prior year's third quarter compared to two longwall moves in the third quarter of this year. Our third quarter gross price realization was approximately 97%, our gross price realization represents the volume rated average calculation of our daily realized price per short ton based on gross sales which excludes demurrage and other charges as a percentage of the Platts premium low-vol FOB Australian index price. Despite price volatility during the quarter, this result demonstrates the high quality characteristics of our premium low, and mid-vol products. As Walt said, 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 increased approximately 10% in the third quarter compared to the same period in 2017. The price environment is continued to be strong with prices rising in September and October on the back of strong global field production, ongoing port, rail and mine production disruptions in Australia, and uncertainty around winter cuts in Chinese steel production. Demurrage and other charges reduced our gross price realization to a net average selling price of a $159 per short ton in the third quarter of 2018 compared to $144 per short ton in the same period last year. Mining cash cost of sales was $166 million or 63% of mining revenues in the third quarter compared to $189 million or 63% of mining revenues in the third quarter of 2017. Cash cost of sales per short ton, FOB port was approximately $100 in the third quarter compared to $90 in the same period of 2017.

Transportation and royalty costs were almost $4 per short ton higher in the third quarter of 2018, primarily due to 10% higher net selling prices, net of lower sales volumes compared to the same period last year. Mining cost excluding transportation royalties were higher in the third quarter of 2018 compared to the same period last year; this increase is primarily due to the ramping of mining operations including additional CM units, increased performance and higher maintenance costs such as field inscribing [ph]. In addition, our longwall move calls are running higher this year due to the faster advancement rates. While our cash cost of sales per short-term was higher than the third 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 of sales per short ton of $94 is consistent with our previously announced guidance.

SG&A expenses were about $7 million or 2.7% of total revenues in the third quarter and approximately $1.9 million lower than the same period last year, primarily attributable to lower legal and professional expenses. Depreciation and depletion expenses for the third quarter of 2018 were $26 million or 9.5% of total revenues compared to $23 million in 2017. The increase in the third quarter was primarily attributable to the relatively higher rate of capital spending this year plus $4 million of accelerated depreciation on equipment beyond it's economic repair. Transaction and other expenses were about $3 million and were related to the completion of a secondary offerings of stock by certain stockholders of the Company. The Company did not receive any of the proceeds from the secondary offering in the third quarter. As with our previous secondary offerings this year, this process has continued to improve trading liquidity of our stock.

Interest expense was just over $10 million in the third quarter and included interest on our outstanding debt, plus amortization of our debt issuance costs associated with those facilities and our ABL. This was higher than last year's third quarter due to the 8% senior secured notes offerings in November of 2017 and March 2018. As anticipated, Warrior did not incur any income taxes in the third quarter 2018 due to utilization of it's net operating losses or NOLs. One of the key long-term assets and strengths of the company is it's NOLs which we expect will reduce our federal and state income tax liability to zero until the NOLs are fully utilized or expired. We expect this will continue to drive significant free cash flow conversion over the next several years. The third quarter of last year included a tax benefit of $38 million reflecting the impact of the favorable IRS profit letter ruling that the Company received related to the utilization of the NOLs.

Turning to cash flow, during the third quarter we generated $78 million of free cash flow which was the result of cash flows provided by operating activities of $102 million plus cash used for capital expenditures of $24 million. This compared to $82 million of free cash flow in the third quarter of 2017. This lower result is primarily attributable to lower operating results in the third quarter of 2018. Cash flows used in financing activities were almost $4 million in the third quarter of 2018, which was approximately the same amount in the third quarter of 2017.

Our net working capital decreased by $21 million from the second quarter of 2018, primarily driven by higher accrued interest expense associated with our senior secured notes and lower accounts receivable on lower sales volumes. Coal inventory increased from 353,000 short tons at the end of the second quarter of 2018 to 485,000 short tons at the end of the third quarter. The increase in primarily attributable to the better than expected production levels in the third quarter and the 3-day port closure that delayed vessel loadings in September. The company's balance sheet continues to be strong with a leverage ratio of less than one times adjusted EBITDA, plus ample liquidity. Our total available liquidity as of September 30, 2018 was $225 million consisting of cash and cash equivalents of $130 million and $95 million available under our ABL facility, net of outstanding letters of credit of approximate $5 million.

There were other key items of interest and achievement for the Company recently. We are pleased to have recently received a credit rating upgrade from Moody's which moved our corporate family rating to B2 from B3 with a stable outlook. According to Moody's the upgrade reflects the Company's strong financial performance including free cash flow generation, strong met coal prices, low financial leverage and changes in the company's shareholder base. The upgrade further reflects expectations that the Company will continue to demonstrate strong free cash flow generation through 2019. Also, shortly after the end of the quarter, our ABL agreement was amended and restated to provide $125 million of aggregate commitments and the increase of $25 million extends a returning date for five years to October 2023 and decreases the applicable interest rate margins [ph].

Now turning to our outlook for the remainder of the year. Considering our successful performance in the first three quarters, our NOL carryforwards and the expected market conditions for the remainder of 2018 we are affirming our previously issued guidance for the full year with the expectation that we will come in at the higher end of the sales and production volumes ranges if all things go as expected during the fourth quarter. This includes coal sales of 7.1 million to 7.5 million short tons, coal production of 7.1 million to 7.5 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%.

Several 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 one additional longwall move in the fourth quarter of 2018 that will lower production to some extent.

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

[Walter Scheller, CEO]

Thanks Dale. Before we move on to Q&A, I would like to summarize where we stand from an operations standpoint. Looking at the big picture for our production, we'll continue to make good progress towards our goals. We completed two longwall moves during the third quarter with a better than expected impact on production. We expect to have one additional longwall move in the fourth quarter as previously noted. Fourth quarter production will be negatively impacted by this longwall move along with less operating days in the fourth quarter for two major holidays which has been reflected in the Company's guidance.

Our operational success is a credit to the hard work and dedication of our employees, and I thank them for all they have been doing to help us perform as strongly as we have thus far in 2018. Our top priority remains working safely as that is the first and most important step to working efficiently and ultimately achieving success in the marketplace. Market fundamentals are expected to remain supportive of a positive pricing environment until the end of the year. Our customers have continued to run their steel mills at high operating rates as global demand for steel remains strong. While met coal availability remains vulnerable to supply disruptions such as mine production issues, weather related events, and [indiscernible] constraints.

One last noteworthy topic that I should discuss is the amended railroad contract. We successfully capitalized on the opportunity to amend and extend the contract with our railroad transportation partner. By working together as partners, we were able to reach a mutually beneficial agreement that continues to strengthen our relationship. Due to confidentiality and provisions in the contract, we're not able to go into details of the contract but we can confirm that our term was extended until March 2025. In addition, this new agreement should only increase our cost by approximately $1 per ton under current market conditions. We believe this is a very successful outcome for the Company considering the current coal price environment.

As I've said on previous calls, we run the business as if the next pricing downturn and geological issue are just around the corner with conservative targets and flexible operations that allows us to adjust to the market environment as it changes throughout the year. We're pleased with the Company's excellent performance this year and we appreciate the support and engagement we've received from our shareholders and of course our employees. Given how we performed year-to-date, we forget about our prospects for the balance of the year, particularly if the pricing environment continues to move the way we expect.

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

[Operator]

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

[Jeremy Sussman, Clarksons]

I guess just maybe first starting with the production guidance; I think the implied number in Q4 is about 1.5 million tons at the midpoint, and obviously that's bit below the year-to-date average. I know you have a longwall move but can you just talk about sort of -- just conservatism on your part or is there a reason why we should see our production dip from the strong levels we've seen in the first few quarters?

[Walter Scheller, CEO]

The other thing that we're really baking in here is the fact we've got two big holidays, with Thanksgiving and Christmas, and we always have a lot of absenteeism and you're never quite sure whether you'll have the crew to run the longwalls or not given where the absenteeism sits. So those two holidays are a big part of that, plus the longwall move; you know, the longwall move is not well in the third quarter and hopefully this one will as well, but we'll see.

[Jeremy Sussman, Clarksons]

And then maybe if I shift gears; another strong quarter of cash generation, I think you're upto $130 million or so of cash, $225 million of liquidity. Would it be possible to see an event of special dividend or something like that before year end or I guess how should we think about kind of that front given you've talked in the past about sort of minimum liquidity levels much lower than kind of where you're at today?

[Dale Boyles, CFO]

We were building cash in the quarter, so with $130 million at the end of the quarter, there is not set timing on special dividends or buybacks, we try to take advantage of the opportunities and we are here late in the year where we're in the middle of our budgeting process, so if I take that information and once we get it all pulled and compiled, and see what the needs of the business are before we would make a decision on the timing or whether or not we actually pay our special dividend. So it's kind of to be continued answer, it's really all I have at this point.

[Operator]

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

[Lucas Pipes, B. Riley FBR]

Just to piggyback there on Jeremy's last question; Dale, can you remind us kind of what's your targets are in terms of cash on the balance sheet?

[Dale Boyles, CFO]

Well, we've never set a target with cash on the balance sheet, we've always said with this low costs variable nature of our cost structure we don't need a lot of cash on the balance sheet to run the business, we don't have pension and post-retirement liabilities or any cash taxes to pay; so that gives us a lot of flexibility to maximize the use of our cash. So we don't really target a cash number, we target more of a liquidity being on minimum level of $100 million being a combination of cash and the ABL.

[Lucas Pipes, B. Riley FBR]

So minimum of $100 million and you have -- with the ABL I think you have $95 million, did I hear that right?

[Dale Boyles, CFO]

Yes. So combined at the end of the quarter $225 million.

[Lucas Pipes, B. Riley FBR]

And then just to turn to the operations for a little bit, compared to my estimates costs during the third quarter did come in a low but higher than I anticipated and when I look back historically, I think the last time costs were at about this level. You had three longwall moves, so can you maybe share a little bit of color as to what may have changed to elevate cost a little bit; is it labor, is it steel, maybe combination of factors? And obviously you did have two longwall moves, so maybe they were little bit different than prior one, so if you could share kind of what those added to the cost structure? That would all be very helpful. Thank you.

[Walter Scheller, CEO]

I'll start off with one and let Dale follow-up. But one of the big ones as we had about 5,320 PSI [ph] that needed to be built at Mine 7 to really take care of an area that was always just -- given us a little bit of risk in terms of what happened when -- with the air behind it. So we took advantage this year of the opportunity to go ahead and get all those seals built. A lot of that billing for those seals and payment for those seals came in in the third quarter, so that was a big chunk of what caused that price to go up. But again, in our opinion what that does is that lowers the risk for the coal mines and it's a very good thing to do.

Dale?

[Dale Boyles, CFO]

Yes, and I guess I would add to that. There were -- back in the Walter days in the Chapter 11, there is a backlog of this projects, it because a lot was done in '15 and '16; so in these price environments when we can kind of imagine with our cost, we'll spend money to kind of take care of those projects because they really do minimize the risk going forward; so that's another factor there. As I said, also in my comments that our longwall move costs are moving -- are going a little bit higher this year and in this quarter if you remember at the beginning of the year, we're only going to have two longwall moves for this year but as the first quarter really took off really well, Mine 4 has been performing we pulled an longwall move into this year. So we've been moving at much higher advancement rates than we originally projected in our guidance, so that's running a little bit higher and that's just a factor that we're performing better.

[Lucas Pipes, B. Riley FBR]

Walt, I think in your prepared remarks you mentioned potentially coming in towards the higher end of the volume range for the full year; did I hear that right? And if that is true, what are implications for the cost side for the full year? Should we be thinking about the low end or is that maybe taking it a step too far? Thank you.

[Walter Scheller, CEO]

You are correct, we certainly should be around the high end of the tons sold and tons produced. But I do think you're taking this a little too far because again, we're working on these projects and we're going to continue to one of the markets while we can deal -- we're going to work on these projects really hard and we'll continue on this throughout the rest of the year but our intention is to come in within the guidance we've provided for cost.

[Operator]

[Operator Instructions] The next question comes from [indiscernible].

[Unidentified Analyst]

Just thinking about the total nameplate capacity, I believe in some of the prior releases you mentioned that the goal is to get upto 8 million tons per year. Where are you along that spectrum; is that something you think you might hit next year or will it take longer? And how much additional CapEx if that's the right way to think about it, gets you there? In other words, I'm trying to sort of get somewhat of a sense for as what do you expect for CapEx in 2019?

[Walter Scheller, CEO]

I guess, first I'll start off with -- if you look at the first two quarters of the year, we mined 4 million tons. If you look at where the top end of our range will be, it will be at 7.5 million for the year. As nameplate is kind of being the perfect year where everything goes as well as it possibly could, and while that's what we push for and drive for, that's not what we expect. There is always issues in underground mining but we're driving to get ourselves to where on a regular basis we can perform at that level, and we'll continue to do so. As we look into next year, we've talked a little bit about the cash we have on our balance sheet and where we're sitting and where the market is, and we're going to go into next year thinking the same way. I think we did the last two years which is that -- we'll have a sustaining budget, and then as we talk to our Board, we'll probably go in with some discretionary projects that we think make the mine's more productive, more efficient and safer. So we'll be looking at doing all those things but we're in the middle of that budgeting process right now, so I really don't have a number of where we will end up on capital.

[Unidentified Analyst]

I appreciate that color but sorry, I don't recall what the sustaining CapEx is; what has that been? What's the trend been in the past for that? Is that about $50 million or so is it higher than that?

[Walter Scheller, CEO]

What we've said is that for the coal mines themselves, it's about 70-ish and then once you add in the gas companies, it takes it up in the mid-70s or as we said 80.

[Dale Boyles, CFO]

First time here we've got a little high on the sustaining level because you replaced some fans and things like that but you don't do it every single year they might be every couple or three years.

[Operator]

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

[Lucas Pipes, B. Riley FBR]

One thing I wanted to ask on is one of your neighbors recently filed bankruptcy and I wondered if there is any connection between maybe keeping a little bit more cash and liquidity at this time and potentially being some assets up for selling in the neighborhood?

[Walter Scheller, CEO]

We saw that too that they had filed and we've always talked about the fact that those assets and the development assets are right in our backyard and they would be good fit for us. That has nothing to do with where we're sitting on liquidity right now but we're surely more into paying close attention to what's going on.

[Lucas Pipes, B. Riley FBR]

And then one other follow-up; Walter if I heard you right in your prepared remarks, you mentioned something about premiums for higher quality coals and obviously there is a lot of environment regulation in China that's changed the landscape across the commodity world quite dramatically. Can you elaborate on your comments there; and I wanted to make sure I caught all of that properly. Thank you.

[Walter Scheller, CEO]

That's really focused on the fact that the mills that are running flat out in China are tending to be the ones that are down along the coast line. And those are the ones that they are able to get the lower sulfur coals in because a lot of their production is higher sulfur and that allows -- so we have more imports coming in of the high quality hard coking coal that are going in to support those steel operations. And that's kind of been an ongoing theme over the last year and a half or so as thrilling back steel capacity in areas where they can't do it as cleanly as they can along the coast line which drives demand for the high quality coal.

[Lucas Pipes, B. Riley FBR]

And in your negotiations with customers, has sulfur premium discount become an increasing part of the conversation?

[Walter Scheller, CEO]

No. Our customers have -- our sulfur and the sulfurs in the coal is coming from around here are much lower than those in the interior of China. And that's what allows these coals to be very desirable for the steel mills and both -- in our key markets, South America and Europe.

[Operator]

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

[Walter Scheller, CEO]

That concludes our call for this afternoon. Thank you again for joining us today. 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.