Warrior Met Coal, Inc. Q1 FY2020 Earnings Call

Good afternoon. My name is Kate, and I will be your conference operator today. At this time, I would like to welcome everyone to the Warrior Met Coal First Quarter 2020 Financial Results Conference Call. This call is being recorded and will be available for replay on the company’s website. 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 its website at www.warriormetcoal.com. Here to discuss the results are Mr. Walt Scheller, Chief Executive Officer; and Mr. Dale Boyles, Chief Financial Officer. Mr. Scheller, you may begin your remarks.

Thanks, operator. Hello, everyone, and thank you for taking the time to join us today to discuss our first quarter 2020 results. After my remarks, Dale will review our results in additional detail and then you’ll have the opportunity to ask questions. We were pleased to achieve higher than expected sales in production volumes for the first quarter than we previously communicated to you on our last earnings call. However, as we also said on that call, the COVID-19 outbreak could be a significant threat to seaborne met coal prices until we can get more clarity on containment of the virus and businesses get back to operating as usual. And that indeed has turned out to be the case. I’ll come back to that thought in a few minutes. First, I’d like to discuss how the widespread outbreak of COVID-19 has affected us all in new and unprecedented ways. 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 in the face of adversity. We’ve taken the necessary measures to adjust our workplace environment to comply with social distancing and personal hygiene guidelines set forth by various health organizations while maintaining our operations. While I know the impact of this situation is on everyone’s mind, let’s take a minute to look at the first quarter results in more detail since they do provide an important baseline. Production volume in the first quarter of 2020 was 2.1 million short tons compared to 2.3 million short tons produced in the same quarter of last year, a decrease of 9%. Sales volumes in the first quarter were 1.8 million short tons compared to 2.1 million short tons in last year’s first quarter. Our sales by geography in the first quarter were 54% in Europe, 26% in South America, and 20% into Asia. The geographical mix this year was fairly consistent with last year’s first quarter. As expected, and previously communicated inventories were higher at the end of the first quarter than the fourth quarter of 2019. Inventories increased by 129,000 short tons to 978,000 short tons during the first quarter primarily due to higher production volumes. We expect our inventory levels to remain temporarily elevated as a precautionary measure to reduce risk should the mines be disrupted or shut down by the COVID-19 outbreak among the 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 ordered to shut down for lengthy periods. We entered the first quarter cautiously optimistic about our customer’s ability to start ramping up production rates from the low levels in the fourth quarter of 2019. Global pig iron production for the first three months of the year was down by half of 1% with positive growth from China of 2.4% partially offset by a sharp decline of 5.4% observed across the rest of the world. As the quarter progressed, all major met coal industries increased due to the local dynamics in China, where resilient demand from the integrated steel mills was challenged by three temporary supply constraints. First, the drastic reduction in domestic met coal production as a result of lockdown measures in China due to COVID-19. Second, the closure of the Mongolian border in order to reduce the spread of COVID-19. And third, weather-related disruptions in the Australian supply chain. The met coal industry peaked in mid-March as these supply constraints were eventually addressed and started retreating, giving back most of their gains as the impact of the virus on global steel demand outside of China became apparent. Our customers quickly adjusted to the threat posed by the virus, taking major actions starting in early March to align their production rates with a declining forecast in orders. As expected, several smart customers withdrew existing and future tenders due to rapidly deteriorating conditions. The supply response from major US and Canadian base met coal producers has been significant, with a fairly large amount of production being temporarily taken offline. The Platts Premium Low Vol FOB Australia Index Price closed the first quarter of 2020, $8 per metric ton higher than where it started the quarter. Met coal prices rose as high as $164 per metric ton during the first quarter before falling late in the quarter. Our gross price realization for the first quarter of 2020 was 89% of the Platts Premium Low Vol FOB Australia Index Price and lower than the 98% achieved in the prior year period. Our lower realization was primarily due to an environment of rising prices combined with a higher proportion of spot sales. The company has spent $26 million on capital expenditures in mine development costs during the first quarter this year compared to $30 million last year. This amount includes longwall panel development costs for the extension of Mine 4 into the next area of the mine plan we call 4 North. We expect to be mining in that area sometime in the next four to five years. I’ll now ask Dale to address our first quarter results in greater detail.

Thanks Walt. For the first quarter of 2020, net income on a GAAP basis was approximately $22 million, or $0.42 per diluted share compared to net income of $110 million, or $2.14 per diluted share in the first quarter of 2019. Excluding non-recurring other income and losses, non-GAAP adjusted net income for the first quarter was $20 million or $0.39 per diluted share compared to $2.30 per diluted share in the first quarter of 2019. Adjusted EBITDA was $62 million in the first quarter of 2020 as compared to adjusted EBITDA of $181 million in the same period of 2019. The quarterly decrease was primarily driven by a 31% decrease in average net selling prices and a 13% decrease in sales volumes. Our adjusted EBITDA margin was 27% in the first quarter of 2020 compared to 48% in the first quarter of 2019. Total revenues were approximately $227 million in the first quarter of 2020 compared to $378 million in the same period last year. This decrease was primarily due to the decrease in average net selling prices and sales volumes, and a weaker market environment than last year. The average net selling price per short ton decreased approximately 31% in the first quarter of 2020 compared to the same period in 2019. As you may recall, last year’s first quarter saw stronger met coal demand and higher pricing. The Platts Premium Low Vol FOB Australia Index averaged $51 per ton lower in the first quarter of 2020 compared to the same quarter last year. Demurrage and other charges reduced our gross price realization to an average net selling price of $122 per short ton in the first quarter of 2020 compared to $176 per short ton in the same period last year. Mining cash cost of sales was $151 million or 68% of mining revenues in the first quarter compared to $182 million or 49% of mining revenues in the first quarter of 2019. Cash cost of sales per short ton FOB port was approximately $83 in the first quarter compared to $87 in the same period of 2019. The decrease is primarily due to lower price-sensitive costs such as transportation and royalties that vary with met coal pricing, offset partially by a 13% lower sales volume. SG&A expenses were about $8 million, 4% of total revenues in the first quarter of 2020 compared to approximately $9 million in the prior year period primarily due to lower corporate expenses. Depreciation and depletion expenses for the first quarter of 2020 were $29 million compared to $22 million in 2019. The increase quarter-over-quarter was primarily due to the high level of capital spending during 2019. Net interest expense was about $8 million in the first quarter and included interest on our outstanding debt plus amortization of our debt issuance costs associated with our credit facility, partially offset by interest income. This amount was $1 million lower compared to the same period last year primarily due to the early retirement of a portion of our debt in last year’s first quarter. We recorded non-cash income tax expense of $3 million during the first quarter of 2020 and $28 million in the same period last year. These results primarily reflect the utilization of our net operating losses for the corresponding decrease in the balance sheet account, deferred income taxes. We paid no cash taxes in the first quarter of 2020 or 2019. We continue to expect the utilization of our net operating losses will reduce our federal and state income tax liability to zero until the net operating losses are fully utilized or expire. We expect this will continue to drive significant pre-cash flow conversion over the next several years. Turning to cash flow, during the first quarter of 2020, we used $5 million of free cash flow which was the result of the cash flows provided by operating activities of $21 million plus cash used for capital expenditures in mine development costs of $26 million. Free cash flow in the first quarter of 2020 was negatively impacted by an increase in net working capital. The increase in net working capital was primarily due to higher accounts receivable and inventory, partially offset by an increase in accounts payable. Operating cash flows were significantly lower in the first quarter of 2020 compared to 2019 primarily due to the lower average net selling prices of 31% and lower sales volumes of 13%. Cash used in investing activities primarily for capital expenditures of mine development was $20 million during the first quarter of 2020 compared to $30 million for the same period last year. Cash flows provided by financing activities were $63 million in the first quarter of 2020 and consisted primarily of a withdrawal on our ABL facility of $70 million as a precautionary measure, less payment for capital leases of $4 million and less payment of the quarterly dividend of $3 million. Our balance sheet remains strong at a leverage ratio of 0.52 times adjusted EBITDA. In addition, we have ample liquidity without the fixed costs associated with legacy liability and the low and variable cost structure. Our total available liquidity at the end of the first quarter of 2020 was $303 million consisting of cash, cash equivalents of $257 million and $46 million available under our ABL facility. Net of borrowings of $70 million and outstanding letters of credit of approximately $9 million. As I mentioned earlier, we drew $70 million on our ABL facility as a precautionary measure to increase liquidity and reduce risk during these unprecedented times. We intend on retaining the funds and cash to preserve liquidity amid the growing uncertainty surrounding the COVID-19 outbreak. In summary, the first quarter results for production and sales volumes turned out as expected and previously disclosed. The overall financial results were primarily driven by lower net selling prices and slightly lower sales volumes compared to last year’s first quarter. Now turning to our outlook for the remainder of the year. In light of the uncertainties regarding the duration of the COVID-19 pandemic and its overall impact on the global economy and the company’s operations, we’re withdrawing our full-year 2020 guidance issued on February 19. We’re also appropriately adjusting operational needs including managing expenses, capital expenditures, working capital, liquidity, and cash flows. For example, as precautionary measures we’ve delayed the $25 million budgeted for the development of the Blue Creek project until at least July 1, 2020 and have temporarily suspended our stock repurchase program. We will continue to evaluate the impact 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 Blue Creek project during our second quarter earnings call that will be held in late July. We’re continuing to pay our quarterly dividend at this time, but we’ll continue to monitor liquidity in light of the COVID-19 pandemic.

Thanks Dale. Before we move onto Q&A, I’d like to make a few more comments. While we were pleased with our first quarter results, the rest of the year is less certain. We’re clearly seeing the impact of COVID-19 on global steel production and overall met coal pricing in light of reduced automobile manufacturing and a slowdown of construction projects. Although we did experience some reduction in sales orders towards the end of the first quarter, it is now apparent that the full impact of COVID-19 on met coal demand erosion may not materialize until the second quarter of 2020 and possibly beyond. As a result, the unprecedented level of uncertainty in our customer’s market has made the job of forecasting, which was already challenging, even more difficult. We continue to regularly update our business continuity plan on global steel production and met coal demand for various potential developments related to COVID-19 and we’ll continue to take precautionary measures as necessary or advisable. We’ve kept and we’ll continue to keep close contact with our customers during this period in order to optimize our sales orders and capitalize on opportunities when they appear in the marketplace. Regarding met coal pricing, we expect all industries to remain under pressure as long as the supply and demand balance remains stressed by the uncertainty of current events. Despite the unknown, there are a few important reasons that our business is well positioned to weather any prolonged economic challenge. One, we have a strong balance sheet and adequate liquidity. Two, our low and variable cost structure enables us to drive high margins and free cash flow across most business environments. Three, we’ve made significant investments in our operations over the past three years allowing us to now reduce capital expenditures as needed without impacting operations. Four, we maintain one of the world’s highest quality met coal portfolios and we have strong long-term customer relationships. And five, our highly talented workforce is committed to safely and efficiently driving results. 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?

Our first question is from David Gagliano from BMO Capital Market. Go ahead.

I just wanted to drill down a little bit on Q2, if it’s possible. I know you paused the guidance, which I get. But just directionally, can you give us a sense as to it seems like sales volume is 1.8 million tons in the first quarter. Can you give us a directional sense for the second quarter on sales volume? And also on the cash cost performance, again it’s exceptionally good, the cash cost performance of $83 I think it is in the first quarter, is that sustainable in the second quarter? That’s my first question.

Well in terms of the market in Q2, David, frankly that’s one of the reasons we withdrew guidance, things are changing on a daily basis. We have customers shifting things out of the quarter. We’ve then had customers shift things back into the quarter. So it’s really been dynamic. So we do expect to see the real impacts of COVID-19 in Q2 and probably Q3 and I don’t know what will happen beyond that. But in terms of our cost structure, I think we’re pretty solid there and I would expect us to continue to squeeze ourselves pretty hard in terms of managing our cost.

Okay, and operationally on the cost side, any upcoming nuance associated with longwall moves or anything like that relative to the first quarter that you’d be thinking about?

We have a longwall move at Mine 4 that will happen at around the end of Q2. It could be Q2 or Q3, it’s just hard to tell right now. It’s right on the cusp of the two.

Okay, and then my last question. Just regarding the pause in the spending at Blue Creek. Can you talk a little bit about the press release, like July 1 potentially, and is the timing associated with restarting the spending at Blue Creek associated with expectations for COVID-19 relief or is it related to an improvement in market conditions?

Probably a little bit of both, probably more COVID-19 than market. But right now, the way the market’s deteriorated here in the last week or two would be lying if I didn’t say that’s also on my mind a little bit.

Our next question is from Scott Shire from Clarkson. Go ahead.

Well, obviously, your mines are running very low given that you have almost 1 million tons of inventory at this stage. Is there any consideration of slowing or reducing productions to bring these levels down? I think I recall you saying the passage is 400,000 tons was about an ideal level. And the second part, how much capacity do you have to continue to build inventories?

Scott, as I said in my comments, there are a couple of reasons. We are kind of signaling at the Q4 call that Q1 would be a lot like a Q2. And in Q4 we drilled about 150,000 tons of inventory and this quarter got a little more than I expected because the mines ran a little better than we expected. So we’re not uncomfortable with where that level is right now because frankly if we would have an outbreak of COVID-19 at one of our operations, it could easily result in a multi-week shutdown and we want to make sure that we have the contractual obligations covered. Additionally, I think there is the potential of the same thing happening at other operations globally which could result in opportunities for us to potentially step in and take care of those. We’re not uncomfortable with that. I don’t know that we’ve ever really discussed our max capacity but it’s well beyond where we are today in terms of total inventory level.

Okay, that’s very helpful. I appreciate that. Switching gears a little bit, it was good to see the regular cash dividend declared and paid. I know you mentioned this in the prepared remarks a little bit, but given that we have seen many other companies in the space suspend dividend or shareholder return programs, can you just walk us through your thought process around any factors that make it time to rethink this dividend policy?

Scott, this is Dale. The pandemic continues to worsen or have a greater impact in the duration even longer I think that’s one of the other things that you put on the table. But for now, we’ve got a very strong balance sheet, with plenty of liquidity and so we didn’t see the need at this point to suspend the dividend.

Okay, that’s helpful. Thanks for taking my questions. Good luck.

Our next question is from Lucas Pipes from B. Riley FBR. Go ahead.

And good job on the cost, I just wanted to follow up. I first wanted to ask about cash flow, so Q1 was slightly negative obviously due to a few things going with working capital. But I know you suspended guidance but kind of high level, you think about where the market is today moving for example, the lower sales realizations. What costs could look like in this environment? I understand there are a lot of uncertainties but do you expect to be free cash flow positive here right in this price environment? Very much appreciated. Thank you.

Lucas, this is Dale. Yes, I think we would be free cash flow positive either you have some seasonal working capital builds we have for the last three years in the first quarter around receivables and inventories. Obviously, we’ve already talked about inventories. So that was the primary drivers. We were working on capital spending some, I wouldn’t say to the extent that we may be working on in the future, just a thing on the price environment. I think we’ll be positive. I don’t see a problem there, should we need to be able to really dial back all expenses and all capital spending.

Got it. Now that’s helpful. Thank you for that. My second question is with regards to sales commitments. Think about this environment to you getting calls from customers, you mentioned something along those lines in your prepared remarks as well. But when we think about 2020, what amount of volume is currently spoken for? I understand that pricing may not be fixed, but just in terms of having customers on the other side of it.

Again, we withdrew guidance because so much of that is in flux right now. We have customers wanting to push cargos out for a quarter and we really just don’t know how quickly things are going to pick back up in Europe with auto manufacturing. So even though we have coal spoken for, it’s not unforeseen that some of those may push out a quarter. I think in total volumes over the period of the contract, we’ll be taking care of, it’s easy to see coal that was going to move in late June and not move until July and then just pushes the whole way out through the year and you have coal, who’s going to move in December then moves into January. So it’s really difficult for me to nail that one down for you.

Okay, let me maybe try some of it differently. Typically at this time of year, what amount is volume size?

It varies. It varies based on what demand is because we’ll have times where, again customers either us or customers either want to push coal out of contract or we may, if we think we have better opportunities push coal out into the following quarter. So it’s really tough to say.

Okay. I will try one more follow-up. But I think the market is concerned about fairly severe supply of met coal and that some producers have run into problems with finding a home for their product and how do you think about that risk in this market? I know you suspended guidance but what sort of assurances would you have to find a home for the product that mines don’t have to get stopped? I appreciate your thoughts on that. Thank you.

Well that’s why we’re withdrawing guidance because we just don’t know again, I’d love to answer your question. But if I could answer your question, I wouldn’t be withdrawing guidance, so sorry I can’t give you a little more there.

And just a reminder Lucas, most of these contracts all have force majeure clauses in them so, you’ve already seen Arcelor and other large steel producers issued those letters, so that just kind of takes a step back as well when you’re talking about commitment.

Got it. I mean I understand it’s very uncertain environment and appreciate all the color. I appreciate you making these tough decisions and I wish you the best of luck and stay healthy.

Thank you. You as well.

The next question is from Matthew Fields from Bank of America. Go ahead.

You made a comment earlier about sort of maintaining liquidity and a strong balance sheet in the case of opportunities in case some of your competitors are shuttered or closed or curtailed. Are you specifically talking about sort of picking up incremental pieces of business or you’re talking about kind of M&A transactions for distressed competitors or both?

No, I’m talking about picking up incremental pieces of business.

Okay, well great. And then thank you. And then another sort of clarification on liquidity, I appreciate drawing down a piece of the revolver because of all the uncertainty in the marketplace. How do you think about kind of balancing the needs of that liquidity sort of on hand versus which is basically hedging your bets in case things are very bad versus kind of taking advantage of potentially your stronger balance sheet in case things are better than people feared, potentially buying debt at a discount or making some kind of other transaction. How do you balance those kind of two needs?

Well, it’s a daily balance. Just to think what the market looks like, that’s probably more of a real-time decision once you start to see the recovery from this pandemic and believe that you’re kind of coming out of it and you try to balance picking something along those terms. But I think for now it’s highly unknown what their true impact on demand and pricing will be, so I think our focus will be on liquidity like most everybody else and preserving that liquidity versus buying back debt at a discount at this point. You got to remember the maturity on the debt is in November this year.

Right and then sort of ties into the next question, which is you know if not if, but when Blue Creek goes ahead it’s going to be a lot more capital spending. With the current kind of bonds relatively high coupon first lien, how do you think about sort of potentially coming to the market for an unsecured deal, maybe a larger deal to boost liquidity plus get you part of the way towards funding Blue Creek, if and when the coal price becomes more amenable?

Well, I think that is something we would definitely give consideration to depending on the market conditions. I’m not willing to pay a high coupon for that, some of the spreads are pretty high out there and some of the deals as well. So I’m not sure that makes sense right now. It might later at some point, but again I think we’re focused on preservation of our total liquidity right now and we’ll look at things like that. But it’s hard to tell exactly what we might do there.

Okay, so maybe I don’t know want to put words in your mouths. But is the message right now sit on the liquidity until we have a clear picture of the future.

Yes, I think that’s pretty much what we’ve been saying.

Okay, all right. That’s it from me, I guess. Thanks very much and good luck.

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

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

Thank you, and this concludes our conference today. Thank you all for participating. You may now disconnect.