Warrior Met Coal Inc

NYSE:HCC

Earnings Call Transcript 2020-Q3

[Operator]

Good afternoon. My name is Raghu, and I will be your conference operator today. At this time, I would like to welcome everyone to the Warrior Met Coal Third Quarter 2020 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] This call is being recorded and will be available for replay on the company's website.

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 its website at www.warriormetcoal.com. Here to discuss the company's results are Mr. Walt Scheller, Chief Executive Officer; and Mr. Dale Boyles, Chief Financial Officer.

Mr. Scheller, you may begin your remarks.

[Walt Scheller, Chief Executive Officer]

Thanks, operator. Hello, everyone, and thank you for taking the time to join us today to discuss our third quarter 2020 results. After my remarks, Dale will review our results in additional detail and then you will have the opportunity to ask questions. The third quarter presented a challenging market environment as the COVID-19 pandemic continued its disruptive impact on the U.S. and global economies. Although, the steel and met coal industries operated well below their normal yearly levels, we started to see higher sales volumes in the third quarter, compared to the second quarter as customers in our key markets began to increase their operating rates and restock their inventories.

However, we cannot say the same on pricing as we experienced our lowest average realized met coal price since becoming a publicly-traded company. Despite these challenging headwinds in particular on met coal pricing, we were pleased once again to be free cash flow positive for the quarter. We've remained focused on preserving cash, liquidity and managing the aspects of the business that we can control, achieving our lowest cash cost per short ton since going public.

At the same time, we carefully balanced our spending on longer term CapEx investments to keep us uniquely well positioned to benefit from the eventual recovery in steel production, met coal demand and pricing. We continue to take the necessary measures to adjust our workplace environment, to comply with social distancing and personal hygiene guidelines set forth by various health organizations to protect the health and safety of our employees while maintaining our operations.

While we continue to operate our mines, as a critical infrastructure business in the state of Alabama, these are challenging times and I would like to thank all of our employees for their hard work and resilience. We've been fortunate to keep our people employed during these unprecedented times, whereas others in the industry have had to idle their operations and furlough employees.

We said on our last earnings call that we expected the worst to be behind us in terms of demand and expected the third quarter to bring higher sales volume, as well as better visibility from our customers. We're pleased to see that most geographies and steel related sectors are performing in line with these expectations. As reported by World Steel Association, pig iron production for the third quarter rose by 4.5% compared to the second quarter.

Chinese pig iron production has maintained a strong performance throughout the year, having produced 3.8% above last year's for the first nine months. Although, the majority of the regions outside of China had displayed continuous month-over-month growth from the earlier lows in the second quarter, their output remains lower year-over-year by 12.9%. India has made a noticeable increase in pig iron production in the last three months and appears to be near their pre-COVID-19 production rates.

Warrior stronger sales volumes for the third quarter were mostly due to the improvement in demand, as previously mentioned. However, we believe that our third quarter sales volumes benefited from some level of restocking by our customers that had overshot production curtailments earlier in the year as we are also taking advantage of the low market prices.

We did not expect this restocking to be repeated in the fourth quarter. As most customers appear to be well-stocked heading into year-end. Our fourth quarter sales volumes are expected to be in between the low point of the second quarter and the third quarter. We also entered the third quarter with reservations about pricing, which turned out to be true. The absence of clarity concerning Chinese import quotas, as well as the perception of a well supplied market, kept all major indices tightly range-bound for most of the quarter.

The Platts Premium Low-Vol FOB Australian Index Price oscillated between $105 per metric ton and $116 per metric ton for the first 11 weeks of the third quarter. However, following increased in buying activity in China and India, as well as further indication of demand recovering outside of China, the indices broke through their resistance level around mid-September, closing the quarter at a high of $139 per metric ton.

As a steep climb in pricing occurred in the back end of the quarter, this limited our ability to capture the benefit of the rise in our realized pricing. Similar to the challenges we experienced in the second quarter, we chose to decline several spot opportunities that failed to meet our profitability threshold. Sales volumes in the third quarter were 1.9 million short tons compared to 2 million short tons in last year’s third quarter.

Our sales by geography in the third quarter were 51% into Europe, 27% into South America and 22% into Asia. These higher volumes were a nice rebound from the low volumes in the second quarter. If you remember from our second quarter earnings call, we said that the second quarter should be the worst in terms of reduced steel production and met coal demand.

However, we also remain concerned about pricing for the remainder of the year. Production volume in the third quarter of 2020 was 1.9 million short tons compared to 2.2 million short tons in the same quarter of last year. This aligns with our thinking on our last earnings call, where we said we expected to better match our sales and production volumes in the second half of 2020.

As planned and previously communicated, inventories remained elevated at the end of the third quarter, compared to the second quarter. Inventory slightly decreased 58,000 short tons to 1.5 million short tons during the third quarter. We expect our inventory levels to temporarily remain elevated as a precautionary measure to reduce risks should the mines be disrupted or shut down by a widespread COVID-19 outbreak among our workforce.

Also the higher-than-normal inventory levels will allow us to capitalize on market opportunities that may become available as a result of our competitors being idle to shut for lengthy periods of time. Our gross price realization for the third quarter of 2020 was 90% of the Platts Premium Low-Vol FOB Australian Index Price and was lower than 102% achieved in the prior year period, which included a rapidly decreasing price environment.

Our lower gross price realization was primarily due to the rapidly rising price environment of 28% in the month of September and a higher percentage of our sales being exposed to spot sales with lower relativities due to a fundamental over supply in the marketplace. Our spot sales in the third quarter was approximately 50% compared to a normal expectation of approximately 20%.

The company spent $28 million on capital expenditures and mine development costs during the third quarter compared to $33 million in the same period last year. This amount includes the longwall panel development costs for the 4 North portal. We will continue to balance our free cash flow and liquidity preservation against maintenance and discretionary capital spending and the long-term value of capital projects for the remainder of this year.

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

[Dale Boyles, Chief Financial Officer]

Thanks, Walt. As Walt discussed, the overall financial results for the third quarter were primarily driven by a significant reduction in U.S. and global economic activity as a result of the spread of COVID-19 this year, compared to a fairly robust market environment last year. Our third quarter was about balancing competing priorities. We ran the mines without idling or laying-off employees while keeping our costs low in the extremely depressed and challenging price environment.

We balanced those results with continued to make significant CapEx and mine development investments. Our ability to remain free cash flow positive for the third quarter was an important outcome of the success for our balancing act. Overall, our total liquidity increased by $12 million from the second quarter to $280 million at the end of the third quarter.

For the third quarter 2020, the company recorded a net loss on a GAAP basis of approximately $14 million or a loss of $0.28 per diluted share compared to net income of $45 million or $0.87 per diluted share in the same quarter last year. Non-GAAP adjusted net loss for the third quarter was $14 million or a loss of $0.28 per diluted share, compared to $0.79 of income per diluted share in the third quarter of 2019.

Adjusted EBITDA was $16 million in the third quarter of 2020 as compared to $83 million in the same quarter last year. The quarterly decrease was primarily driven by a 36% decrease in average net selling prices. Our adjusted EBITDA margin was 9% in the third quarter of 2020, compared to 29% in the same quarter last year.

Total revenues were approximately $180 million in the third quarter of 2020, compared to $288 million in the same quarter last year. This decrease was primarily due to the 3% decrease in sales volumes and the 36% decrease in average net selling prices in a weaker market environment due to the impact of COVID-19. As you may recall, last year’s third quarter saw stronger met coal demand and higher pricing. The Platts Premium Low-Vol FOB Australian Index price averaged $47 per metric ton lower or 29% lower in the third quarter of 2020 compared to the same quarter last year,

The index price remain range bound most of the third quarter until the final month of September. The merge and other charges reduced our gross price realization to an average net selling price of $91 per short ton in the third quarter of 2020, compared to $141 per short ton in the same quarter last year. Mining cash cost of sales was $151 million, or 86% of mining revenues in the third quarter, compared to $189 million or 67% of mining revenues in the third quarter of 2019.

The decrease of $39 million or 21% in cash cost of sales was primarily attributable to three factors. One, a 3% decrease in sales volume, two 36% decrease in average net selling prices and three, tighter cost management in 2020. Cash cost of sales per short ton, FOB port, was approximately $78 in the third quarter, compared to $95 in the same period of 2019. Our third quarter cash cost of sales per short ton was the lowest quarterly amount since going public in 2017. The decrease from last year’s same quarter was primarily due to lower price sensitive costs, such as wages, transportation, royalties that vary with met coal pricing and tightly managing our costs in a challenging price environment.

The tons sold in the third quarter were mostly mined in the second quarter at low met coal prices under highly efficient mining rates and with a continued focus on cost reduction. In addition, we sold a higher percentage of lower costs mine 7 Low Vol coal in the third quarter than the second quarter. This lag effect is primarily due to the high levels of inventory on hand this year. We do not expect a similar cash cost for short ton in the fourth quarter, primarily due to the lower expected volumes as Walt mentioned earlier.

We expect total cash cost of sales dollars to be similar to the third quarter on lower sales volumes, which will result in a higher cash cost of sales on a first short ton basis. SG&A expenses were about $8 million or 4.5% of total revenues in the third quarter of 2020, and we're 12.5% lower than the same quarter last year, primarily due to lower professional fees and employee related expenses. Depreciation and depletion expenses for the third quarter of 2020 were $28 million and were 8.6% higher than the same quarter last year. The increase quarter-over-quarter was primarily due to a higher amount of assets placed in service.

Net interest expense was about $8 million in the third quarter and included interest on our outstanding debt plus amortization of our debt issuance cost associated with our credit facilities, partially offset by interest income. This amount was approximately $1 million higher compared to the same period last year, primarily due to incremental borrowings on our ABL facility and lower return from cash balances. We recorded non-cash income tax benefit of $8 million during the third quarter of 2020, compared to income tax expense of $8 million in the same quarter last year. This quarter’s tax benefit is attributed to the pre-tax loss and additional marginal gas well credits from our gas businesses.

Turning to cash flow. During the third quarter of 2020, free cash flow was positive and over $1 million, which was a result of cash flows provided by operating activities, a $29 million, plus cash used for capital expenditures and mine development costs of $28 million. Free cash flow in the third quarter of 2020 was positively impacted by a $20 million decrease in net working capital, the decrease in net working capital was primarily due to the income tax refund for AMT credits received during the quarter.

Operating cash flows were significantly lower in the third quarter of 2020, compared to the same quarter last year, primarily due to lower sales volumes and lower average net selling prices. Cash used in investing activities for capital expenditures and mine development cost was $28 million during the third quarter of 2020, compared to $33 million for the same quarter last year. While spending was lower by 15% this year, we continued to rationalize spending in this challenging market environment.

Cash flow is used by financing activities were $6 million in the third quarter of 2020 and consisted primarily of payments for capital leases of $3 million and the payment of the quarterly dividend the $3 million. We continue to focus on cash preservation and total liquidity during the quarter and our balance sheet remains strong with a leverage ratio of 1.5 times adjusted EBITDA. In addition, we have adequate liquidity and via are the fact we have shared our fixed cost legacy liabilities, and today have a low and variable cost structure with no near-term debt maturities. Our total available liquidity at the end of the third quarter was $280 million, consisting of cash and cash equivalent of $216 million and $64 million available under our ABL facility, net of borrowings of $40 million and outstanding letters of credit of approximately $9 million.

Now turning to our outlook for the remainder of the year. On April 29 in light of the uncertainties regarding the duration of the COVID-19 pandemic its overall impact on the global economy and the company's operations, we withdrew our full year 2020 guidance. We initially delayed the development of the Blue Creek project until at least July 1 and have now further delayed that project until at least the early part of 2021. This decision was not based on changes in the perceived value of the project, but rather on our short-term focus of preserving cash and liquidity.

We also temporarily suspended our stock repurchase program. We will continue to evaluate the impacts of the COVID-19 pandemic on our business for the remainder of the fiscal year, and expect to provide further updates to our financial outlook and the development of the Blue Creek project during our next quarterly earnings call. We also are continuing to appropriately adjust our operational needs, including management expenses, capital expenditures, working capital, cash flows and liquidity.

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

[Walt Scheller, Chief Executive Officer]

Thanks, Dale. Before we move on to Q&A, I'd like to make a few more comments. Most of the major steel demand factors, such as automobile production and construction continue to show encouraging signs of recovery. While we entered the fourth quarter with improving expectations for steel and met coal demand and better visibility with our customers, we do not expect a repeat of third quarter sales volumes.

We expect our fourth quarter sales volumes to be somewhere between the worst of the second quarter and third quarter, which contains some amount of restocking by our customers. Therefore, we're cautiously optimistic on fourth quarter volumes, and we continue to keep close contact with our customers during this period, in order to optimize our sales orders and capitalize on opportunities that meet our profitability threshold.

As previously mentioned, we expect that our current inventory levels will remain elevated through the year end, as we intend to adjust production rates in accordance with demand, and as we manage for potential disruption risks due to COVID-19. Obviously, if the opportunity to sell additional volume while meeting our profitability threshold materializes, we would expect to see a more rapid decrease in our inventory levels.

As for the outlook on met coal pricing, we believe in proving fundamental should provide a more positive pricing environment than what we just experienced in the third quarter. However, we recognize the pricing movements are often subject to market dynamics that are both difficult to predict and/or quantify. The recent indication of a ban on imported Australian coals into China is a good example and has left us without a clear indication of the direction of price for the short-term.

As I stated before, despite the many unknowns, there are a few important reasons that our business is well positioned to weather any prolonged economic challenge. One our highly talented workforce is committed to safely and efficiently driving results. Two, we maintain one of the world's quality met coal portfolios and have strong long-term customer relationships. Three, we have a strong balance sheet and adequate liquidity. Four, our low and variable cost structure enables us to drive higher margins and free cash flow across most business environments. And five, we made significant investments in our operations over the past three years, allowing us to now reduce capital expenditures as needed without significantly impacting our operations. As a result of these factors, I'm confident we will emerge from this health crisis ready to achieve our long-term growth potential.

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

[Operator]

Thank you. [Operator Instructions] And today's first question comes from David Gagliano with BMO Capital Markets. Please go ahead.

[David Gagliano, BMO Capital Markets]

All right. Great. Thanks for taking my questions. Just a couple of clarifications, first of all. When you say between the worst of the second quarter and the third quarter, I mean, is it as simple as saying second quarter was 1.5 million, third quarter 1.9, what you're saying is 1.7 million tons or it's kind of worded a little vague to me. So can you just clarify what you mean by the worst of the second quarter?

[Walt Scheller, Chief Executive Officer]

Well yes, David, what we were saying is the second quarter was worse in the year, so we expect it to be in that range, you said 1.7 and that's halfway between the 2.

[David Gagliano, BMO Capital Markets]

Okay. So – and then the cash cost commentary was basically a total dollar amount, the same volume is lower. So I mean that's pretty much it for that. And then the only other question I have is the pricing came in at 90% of the average or whatever, and I know there is timing differences. So the only other question is in terms of short-term, how should we think about the discount relative to the average for the fourth quarter, it's quite a bit wider than it has been in the past?

[Walt Scheller, Chief Executive Officer]

Well, I think you need to watch what's going on in the market and see are we in a rising market or falling market. My expectation is in a falling market, we hit 139 and now we're back down to 107. So for at least the first part of the fourth quarter my expectation would be because we sell based on 15 to 30 days before the vessel loads. To my expectation it would be a higher number for that period, I can't tell you what's going to happen the rest of the quarter if we end up having the prices go back up, then we'll end up back with a lower number at that point, just given the lag and timing.

[David Gagliano, BMO Capital Markets]

Okay. I understood. And then – yes.

[Walt Scheller, Chief Executive Officer]

The other thing that happened in the third quarter was the face that we had higher spot sales than normal we were at 50-50. Our expectation is in the fourth quarter for that to start to get a little closer, a little better and learn hopefully more like a 60-40 number even North of that. But that's the other thing that kind of drove the price down a little bit.

[David Gagliano, BMO Capital Markets]

Okay. And then in terms of the actual market itself, obviously quite a bit going on with China, et cetera and in terms of your positioning and your views towards what's going on in the spot market right now? What are you hearing on a day-to-day basis in terms of the impact? The change of policy in China is having in the similar market now. And do you have any thoughts on adjusting your volumes? Obviously you've done that in the past in a weak market, I'm just wondering if we're heading in that direction again.

[Walt Scheller, Chief Executive Officer]

We don't see a weak market, actually demand has been very strong for our products. The issue has been when China said they weren't going to take the Australian coal and you had a dozen or so vessels out there floating around that needed to be placed that immediately drove the pricing down. And until those – some of those vessels are still floating until that all gets taken out of the marketplace, I think we'll continue to see prices depressed, but the demand with our customers, we are not seeing any weakness out of our customers in Europe, South America, or even our customers in Asia.

[David Gagliano, BMO Capital Markets]

Okay. That's helpful. Thanks.

[Walt Scheller, Chief Executive Officer]

Thank you.

[Operator]

And our next question today comes from Lucas Pipes with B. Riley Securities. Please go ahead.

[Lucas Pipes, B. Riley Securities]

Hey, good afternoon, everybody and good job on the cost side and managing this environment. I wanted to ask on Blue Creek. So further delay here on the project in the prepared remarks, you commented that this is really kind of due to the uncertainties to COVID if I understood you correctly, but if there may be a broader rethinking of the merits of the project, not because of the project itself, just because of the market environment has been pretty depressed from a pricing standpoint. And when we think about where the equities are trading, maybe there are other places to put capital, even as the market comes back a little bit. So would appreciate your thoughts on that. Thank you.

[Walt Scheller, Chief Executive Officer]

Yes. I think what we've said in the past is that this was based on what was going on in the marketplace currently, we still think it's a fantastic project. Frankly, I don't think there's another project in North America that has anywhere near the value of this project. It's just a matter of us looking at how do we finance the project, how do we build it out. And when do we get started on it, because it's a big commitment for the company. And we want to be sure that once we start moving in that direction, we're ready to do it. So we have not lost confidence even at $100 a ton, I think the payback on this project is very, very high. So we are not – that's not what's driving our decision-making our own project.

[Lucas Pipes, B. Riley Securities]

That's helpful. Thank you for that. And then one of the things I often hear from investors is your track record of returning capital to shareholders in a very efficient form. I think investors really think of you as a leader in that regard. Historic commitment within the company that as prices recover, you would kind of follow that example of the last cycle or what you say with this disclosed project still being so attractive, the priorities could shift going forward.

[Walt Scheller, Chief Executive Officer]

I think what we've always said in the past is that we will return excess cash to shareholders in one form or another and we're still sticking by that. And what is excess cash will be determined at the time as we're looking at it.

[Lucas Pipes, B. Riley Securities]

Okay. That's helpful.

[Dale Boyles, Chief Financial Officer]

Lucas, this is Dale. I would just point out to, look – mostly everybody cut their dividends period altogether. But while it is a small stipend, we continue to pay our quarterly dividend as we said, we would do.

[Lucas Pipes, B. Riley Securities]

That's good to see. And you certainly done a very good job in navigating this environment. I'll try to sneak one last question in, and that's – it's a bigger picture on the demand side, but from some of the steel companies, some of the iron ore companies, we're hearing more about the desire to substitute met coal, albeit for ESG or concerns or just being in a carbon constraint world. Are you – what do you think about that threat of met coal substitution and steel production? Would really appreciate your thoughts, is this a 10-year trend or maybe something closer than that? Thank you.

[Walt Scheller, Chief Executive Officer]

I think if you look over a 10-year period, I think the – especially the very high quality coals will continue to do very well. I think the replacement you'll see is the replacement of potentially PCI coals. If anything over that short to medium term, longer term, who knows, everybody's working hard to develop ways to reduce their carbon footprint. But I think over the short to medium term, I think the demand for at least the quality of coals that we have here at Warrior will continue to be very strong.

[Lucas Pipes, B. Riley Securities]

I appreciate that very much. Walt and Dale, best of luck. And yes, I hope you can return to optimal output levels and stronger pricing very soon.

[Walt Scheller, Chief Executive Officer]

Thank you.

[Dale Boyles, Chief Financial Officer]

Thanks for the questions.

[Operator]

[Operator Instructions] Our next question comes from Chris Terry with Deutsche Bank. Please go ahead.

[Chris Terry, Deutsche Bank]

Hi, Walt and Dale, a couple of questions for me, on the company specifics and also the market. Just in terms of the coal market. I think you said you sold 22% into Asia, was the bans in place right now? Is there any opportunity to increase your percent into Asia right now for Warrior?

[Walt Scheller, Chief Executive Officer]

Well, I think again, right now you have that ban into Asia. You've got a bunch of vessels floating around in Asia that would probably be easier to place into other places in Asia than taking products from North America over there. We have not – there may have been one vessel in the last few years of Warrior coal that we didn't sell, but it was actually sold into China, but very little Warrior coal is gone into China. Our product primarily moves into Japan and South Korea.

[Chris Terry, Deutsche Bank]

Okay. And is your expectation that we follow something similar last year and that ban probably rolls off in January or is it hard to tell?

[Walt Scheller, Chief Executive Officer]

You know what, it is so hard to tell with what they're doing, our expectation is that it gets relieved in whether it's December or January, but it's just so hard to tell with what the Chinese are going to do.

[Chris Terry, Deutsche Bank]

Okay. And a couple of questions for Dale, just on CapEx, you're roughly $110 million levels, if you analyze that quarter. Can you keep it at that level for another 12 months, if coal prices don't rebound?

[Dale Boyles, Chief Financial Officer]

Well, I think what we've done and we said, look, we've tried to balance, keeping those long-term investments with the low met coal pricing, as well as challenging our costs and trying to keep them as low as possible. So to the extent, we can continue to invest as we have, we will. Just point out that, of the call it $85 million spent this year, $48 million of that's really sustaining, the rest of that is all discretionary that we could have probably trimmed back quite significantly, but we've chosen to continue to invest and managed to be free cash flow positive. So again, we're trying to balance those priorities of meeting the short-term needs and the market conditions and investing for the future as well. So that's kind of where we are.

[Chris Terry, Deutsche Bank]

Okay. That makes sense. And then can you just remind us maybe over the next couple of quarters, if you have any longwall moves?

[Dale Boyles, Chief Financial Officer]

I believe we'll have a longwall move that crosses between the end of Q4 and Q1. We're just not sure whether it hit at the end of December or early January.

[Chris Terry, Deutsche Bank]

Okay. And the last one from me, when you've obviously – $290 million of the liquidity, you'll reassess Blue Creek timing early next year, you said what's the latest thinking on the financing of that, just the cash flow from operations versus I guess using debt?

[Walt Scheller, Chief Executive Officer]

Yes, nothing's really changed there, Chris. We don’t still continue to look at all of our options. It's just, right now focused on preserving cash and liquidity in the existing market.

[Chris Terry, Deutsche Bank]

Okay. All the best, guys. Thank you.

[Walt Scheller, Chief Executive Officer]

Thank you.

[Operator]

At this time, there are no further questions. I'd like to turn the conference back over to Mr. Scheller for any final remarks.

[Walt Scheller, Chief Executive Officer]

Thank you. That concludes our call 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.