Warrior Met Coal, Inc. Q2 FY2022 Earnings Call

Good afternoon. My name is Matt, and I will be your conference operator for today. At this time, I would like to welcome everyone to the Warrior Met Coal Second Quarter 2022 Financial Results Conference Call. 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. In addition to the earnings release, the company has posted a brief supplemental slide presentation to the Investors section at its website. Here today 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.

Thanks, operator. Hello, everyone, and thank you for taking the time to join us today to discuss our second quarter 2022 results. After my remarks, Dale will review our results in additional detail, and then you'll have the opportunity to ask questions. I'm excited to share the results from yet another very strong quarter. It represented our third consecutive quarter of record net income and earnings per share since the start of the COVID-19 pandemic. We again demonstrated our ability to leverage our efficient business model to meet strong customer demand for our premium met coal and taking advantage of strong met coal pricing to deliver these results. In addition to net income and earnings per share, this resulted in record high amounts of revenue, adjusted EBITDA, cash flow from operations, free cash flow and liquidity. We were clearly the beneficiary of macroeconomic conditions driving higher pricing and strong customer demand, and we are pleased with how well positioned the company is to take advantage of these tailwinds. But is the strength, efficiency and nimbleness of our business model that are the key differentiators for us in good times and bad. We were able to see those strengths in action this past quarter in response to both industry and non-industry-related issues. For example, we felt the impact of the significant inflationary environment on our cost of sales, which Dale will speak to later. Despite these increased costs, we were able to deliver strong profitability. In addition, many industries, including ours, were impacted by shipment delays related to port maintenance, the lack of available rail transportation and port congestion. We were able to overcome these issues to deliver our premium products to our customers around the world. That's why our thinking always remains ultimately defensive. It is important for us to lean into these supercharge periods while maintaining a strong buffer during periods of macroeconomic headwinds. And most important is for us to know how to definitely adjust given how market conditions can change very quickly. We experienced this dynamic in part during this past quarter, which is the roller coaster of supply and demand. We entered the second quarter expecting our markets to experience price erosion as steel fundamentals were weakening. However, the first half of the quarter played out stronger than we had anticipated as pricing levels stayed quite high, while we saw several pricing dips that were caused by end-user selling cargoes immediately reversed. The global supply of met coal remained tight in most of the second quarter despite lower global steel production. Eventually, a clear downward trend was established later in May, which remained unchallenged until the very end of the quarter. With lower steel prices across the globe and heavy recessionary pressures affecting most economies, it was no surprise that steel demand then deteriorated. We were expecting to see buying activity from China emerged during the quarter, but there are highly restrictive COVID policies, strong domestic coal production, higher availability of Russian coals and higher than historical imports from Mongolia limited the need to purchase U.S. met coals. To illustrate how this dynamic played out, our primary index, the PLV FOB Australia started the quarter at $467 per short ton, the incline just peaked up at $481 on May 18, while closing the quarter at $274 per short ton. This correction represents a 43% decrease from its peak price achieved in the second quarter. The absolute value of the correction is by itself almost 170% higher than the 10-year average of the index. In short, we believe the first half of 2022 will go down as one of the most volatile periods in our markets, and we are pleased to emerge from what was strong results in hand. During the end of the quarter, we started to see a shift in customer demand for steel in certain industries. Overall, the World Steel Association recently reported that global pig iron production decreased by 5.5% in the first 6 months of 2022. China recorded a decrease in production of 4.7% for the period, while the rest of the world's pig iron production decreased by 7.1%. China's lower steel production is largely due to recent shutdowns related to stringent COVID restrictions and lower demand, especially in the property sector. Discussions with our customers continue to indicate that steel demand for the oil and gas, aerospace and shipbuilding sectors is strong. Automotive demand is still reported to be strong, but production remains constrained by the availability of semiconductors and components. However, all other sectors have experienced weaker demand since the latter half of the second quarter. As for volume, our sales volume in the second quarter this year was 1.5 million short tons compared to 1.8 million short tons in the same quarter last year. Sales for this quarter were lower than last year, primarily due to shipment delays due to port maintenance, lack of railcar availability and port congestion, which have hampered our ability to ship more volume this year. In addition, with the high demand for seaborne thermal coal, we're seeing higher volumes in thermal coal moved through the port, creating some congestion and impacting loading dates and times. By far, the largest impact to our second quarter results was the poor performance of our rail transportation provider that delayed getting our product to the port in a timely manner. We were not immune to the challenges posed by a very chaotic national rail system. Rail performance for the past quarter was one of the lowest we've ever experienced, causing higher-than-expected coal inventory levels at our mine sites, higher vessel demurrage costs and missed quarterly sales targets. We understand that our partners have plans in place to address the shortage, we expect to return to normal operations to be lengthy and lumpy. Therefore, we expect outbound logistics to remain challenged for the foreseeable future. Our coal inventory rose to 735,000 short tons at the end of the second quarter. We expect to bring down the level of inventory in the second half of the year as some of the shipment delay issues improve. Our sales by geography in the second quarter were 62% into Europe, 18% into South America and 20% into Asia. We sold a small amount of volume into China during the second quarter as the CFR China index price was below the Australian FOB price for most of the quarter. Production volume in the second quarter was 1.7 million short tons compared to 1.2 million short tons in the same quarter of last year. The production tons produced in the second quarter resulted from running both longwalls and 5 continuous miner units at Mine 7 and 3 continuous miner units in the longwall Mine 4. Our lead days on longwalls continue to remain solid. The mines ran well, and we're very efficient in the second quarter as we continue to ramp up production in Mine 4. We finished the quarter running the mines with a combination of salaried and hourly employees, representing approximately 60% of the normal workforce while producing nearly 83% of the normal production volume. Employee productivity was strong again during the second quarter compared to historical periods. Over the past year, the mines have trended higher in clean tons produced per man-hour worked. This increase in productivity has helped to offset some of the inflation we've been experiencing. We appreciate the significant efforts by our employees to drive higher production levels while continuing to maintain a safe working environment. During the second quarter, we spent a record high amount on CapEx and mine development of $79 million. This amount included normal sustaining capital plus discretionary capital, including the development of our Blue Creek reserves, work on the 4 North portal and the deposits on the new longwall shields. As previously disclosed, our Board approved the purchase of 2 new sets of longwall shields for the existing mines, which should be delivered in the third quarter of 2023. We made down payments on these shields in the second quarter of approximately $48 million. These shields represent another significant investment of approximately $100 million over 2 years to keep our mines well capitalized and performing most efficiently. We continue to see rising inflation and long lead times impacting our business for the remainder of this year. Despite partial mitigation of these issues with our improved productivity at the mines, we are experiencing 25% to 35% increases in cost of operating supplies and materials, repairs and major equipment rebuilds. Those price increases led to a $4 per short ton negative impact on our second quarter results. As U.S. inflation in June had another 4-decade high of 9.1%, the Federal Reserve shifted to a faster pace of interest rate increases in its efforts to bring down inflation. There are growing fears of slowing economic growth worldwide, which has led to a decline in commodity prices in recent weeks, including met coal. Before I ask Dale to address our second quarter results in greater detail, I want to take a moment to comment on the exciting and important announcements that we made during the second quarter. Specifically, we announced on May 3, first, the relaunch of the development of our Blue Creek reserves; second, our decision to accelerate stockholder returns of special cash dividends and the first special dividend of $0.50 per share; and third, an update on our approach to capital allocation. The development of Blue Creek represents a transformational opportunity for Warrior. During the second quarter, we began developing a site and constructing the service shaft and slope. We are in the preliminary stages of development and expect activities and spending to continue to ramp up over the remainder of this year. We are extremely excited about this project and look forward to seeing the results of our investment once the development is finally completed. As a result of our strong free cash flow generation, we paid a special dividend of $0.50 per share during the second quarter. In addition, we just announced additional returns to stockholders of a second special dividend of $0.80 per share to be paid in the third quarter. These returns are on top of significant investments we are making into the business, as I mentioned earlier, as part of our capital allocation strategy. I'll now ask Dale to address our second quarter results in greater detail.

Thanks, Walt. In the press release we issued on May 3, we laid out our current policy in regard to capital allocation, which focuses on our ability to fund the operations regardless of volatility in the met coal market, investing in highly accretive growth opportunities such as Blue Creek and leveraging our free cash flow to return cash to stockholders through special cash dividends or stock repurchases. Using the strong cash flow generated during the second quarter, we deployed the highest quarterly amount of capital spending and mine development ever in the business of $79 million, as Walt noted earlier. We expect full year capital spending of approximately $200 million to be a record high for the company. While deploying that capital into the business during the second quarter, we also paid a special dividend to stockholders of $0.50 per share. In addition, earlier this week, we announced our second special dividend of the year that will be paid to stockholders in late August on top of the regular quarterly dividend. As previously disclosed, there are certain key metrics that we're continuing to focus on achieving as we make those capital allocation decisions during the 5-year development at Blue Creek. They include: first, maintaining a higher amount of minimum total liquidity of $250 million, including a minimum cash balance of $150 million at all times during the development of Blue Creek. Second, staying no more than 1.5x to 2x levered over that same period. And third, balancing the value of our NOLs with stock repurchases, which could jeopardize those NOLs until they're fully utilized. While our current cash balance and total liquidity well exceeds those minimums, we continue to stockpile cash for the anticipated capital spending for the new longwall shields and the development of Blue Creek while returning excess cash to stockholders as we have demonstrated this year. Now that we have nearly enough cash to prefund the entire Blue Creek project, we are pleased to be able to continue to balance capital investments for medium to long-term growth with near-term returns to our stockholders without incurring any debt. We believe strongly that our capital allocation policy and our key metric guidelines provide the right approach. With that, I'll now turn to the second quarter results. For the second quarter of 2022, the company recorded its third consecutive quarter of record quarterly results with net income on a GAAP basis of $297 million or $5.74 per diluted share compared to a net loss of $5 million or $0.09 per diluted share in the same quarter last year. Non-GAAP adjusted net income for the second quarter was an all-time record. Excluding the nonrecurring business interruption expenses and idle mine expenses, it was $5.87 per diluted share compared to an adjusted net income of $0.25 per diluted share in the same quarter last year. We achieved an all-time record high of $431 million of adjusted EBITDA in the second quarter this year compared to $65 million in the same quarter last year. The quarterly increase was primarily driven by a 227% increase in average net selling prices, partially offset by a 15% decrease in sales volume, plus the impact of inflation on materials and supplies, labor and parts on repairs and major equipment rebuilds. Our adjusted EBITDA margin was 69% in the second quarter this year compared to 29% in the same quarter last year. Total revenues, another record high, were $625 million in the second quarter compared to $227 million in the same quarter last year. This 175% increase was primarily due to the 227% increase in average net selling prices, partially offset by a 15% lower sales volume. In addition, other revenues were positively impacted in the second quarter this year by a 130% increase in natural gas prices, offset by a noncash mark-to-market loss on our gas hedges of approximately $14 million. This mark-to-market hedge loss was attributed to the hedges put into place prior to the run-up in natural gas prices. During the second quarter, we terminated all outstanding gas hedges, and our gas operations should report revenue more consistently with current market prices in future quarters. The Platts Premium Low Vol FOB Australian Index price averaged $280 per short ton higher and was up 225% in the second quarter this year compared to the same quarter last year. The index price averaged $404 per short ton for the second quarter. Demurrage and other charges reduced our gross price realization to an average net selling price of $404 per short ton in the second quarter of this year compared to $123 per short ton in the same quarter last year. Demurrage and other charges were approximately $14 million higher in the second quarter of this year versus last year, primarily due to higher pricing and the shipment delays that Walt discussed earlier. Cash cost of sales was $190 million or 30% of mining revenues in the second quarter compared to $152 million or 68% of mining revenues in the same quarter last year. Increase in total dollars was primarily due to $61 million of higher variable costs associated with price-sensitive wages, transportation and royalty costs, partially offset by a $23 million impact of a 15% lower sales volume. In addition, our costs were higher due to inflation, resulting in increased costs for belt structure, route bolts, cable, magnetite, rotten dust and other materials, plus labor and parts on repairs and major equipment rebuilds. Despite the higher variable costs and inflation, cash margins were $281 per short ton in the second quarter compared to only $40 per short ton in the same period last year, demonstrating the leverage to higher met coal prices, driving both profitability and free cash flow. Cash cost of sales per short ton, FOB port, was approximately $123 in the second quarter compared to $83 in the same quarter last year. Transportation and royalty costs accounted for $39 of the increase, plus an increase in production costs due to the rising inflation of approximately $4 per short ton. Cash cost on price-sensitive items such as wages, transportation royalties that vary with met coal pricing were significantly higher in the second quarter this year compared to the same quarter last year. As you may remember, transportation costs lagged on a 1-quarter basis, and index prices averaged $280 higher in the second quarter versus the same quarter last year. As a result of the significantly higher prices period-over-period, variable transportation and royalty costs are significantly larger components of the cost per ton than the normal approximately 1/3 percentage. Comparable transportation and royalty costs were 54% of the cost per ton of $123 in the second quarter this year compared to only 33% in the same quarter last year, driven primarily by higher met coal pricing. We expect our transportation costs to be higher in the third quarter due to the lag effect. SG&A expenses were about $13 million or 2% of total revenues in the second quarter this year and were higher than the same quarter last year, primarily due to higher employee-related expenses. During the second quarter, we incurred incremental nonrecurring business interruption expenses of $6 million that were directly related to the ongoing labor strike. These nonrecurring expenses were primarily for incremental safety and security, legal and labor negotiations, and other expenses. There is no update on the ongoing labor strike as we continue to negotiate in good faith to resolve the matter. Idle mine expenses were $2 million in the second quarter and represent expenses incurred with the operations at both mines running at reduced capacities, such as electricity, insurance, maintenance, labor, taxes and are primarily fixed in nature. Turning to cash flow. During the second quarter of this year, we generated an all-time record high $250 million of free cash flow, which resulted from record high cash flows provided by operating activities of $329 million, less cash used for capital expenditures and mine development costs of $79 million. This resulted in a free cash flow conversion of 58% this quarter versus last year's second quarter of 82%. Free cash flow in the second quarter this year was negatively impacted by a $67 million increase in net working capital from the first quarter of this year. Increase in net working capital was primarily due to an increase in accounts receivable on higher met coal pricing, combined with higher inventories due to the shipment delays previously discussed. Total available liquidity at the end of the second quarter was a record $768 million, representing an increase of $211 million or 38% over the first quarter of 2022 and consisted of cash and cash equivalents of $645 million and $123 million under our ABL facility. Now turning to our outlook and guidance for 2022. We believe we are well positioned to fulfill anticipate customer commitments for the year. In the current operating environment and without a new union contract, we believe that we will be able to meet our production and sales volumes, including the outlook section of our earnings release.

Thanks, Dale. Before we move on to Q&A, I'd like to make some final comments on our outlook for the third quarter and full year 2022. As Dale noted earlier in his remarks, our cash cost per short ton in the second quarter of 2022 was significantly higher due to the variable components of our cost structure, such as wages, transportation and royalties and the impact of inflation. As you may remember, our transportation costs lagged met coal pricing by 1 quarter. Therefore, our third quarter transportation costs will be based on the average price of the second quarter, and we are not expected to decline further until the fourth quarter. Another factor that may negatively affect our cash cost is the impact of inflation. As we also mentioned, our inventory levels peaked at the end of the second quarter as a result of strong production and the shipment delays in getting our coal to the port. We expect to draw down on those inventory levels in the third quarter as we perform maintenance on the skips at Mine 7 for approximately 6 weeks. We expect third quarter production to be slightly lower than the second quarter but still on track for the year. Normally, the third quarter tends to be the weakest quarter in terms of demand for most steel-producing regions. This time, the third quarter does not feel like it will be normal. Steel production cuts in the form of extended or anticipated maintenance or even idling of blast and electric arc furnaces have already been announced. Hopefully, we'll provide a pool for steel prices to settle on. Although a recession in Europe seems to be a given, the uncertainty around access to Russian natural gas and subsequent impact on the industrial sectors is a concern. We are aware that China's recently announced fiscal stimulus package has the potential to provide a stronger business environment for the steel and met coal markets in the second half of the year. But we remain cautious on China due to the fragility of their property sector and the reality of their rigid COVID restrictions. As noted in previous earnings calls, we believe that the global supply of met coal should improve as the year progresses, mainly coming from the Australian producers. As such, softer demand with stable supply should keep met coal prices at much lower levels than those we've experienced in the first half of this year. We do, however, believe that pricing will remain at or above cost curve economics for the period due to the impact of the ban on Russian coals, the potential for a prolonged period of thermal coal pricing premium and the overall vulnerability of the global supply chain. Despite all of these headwinds, we remain focused on ramping up production in the existing mines as we add headcount, control our costs and continue the development of a world-class asset, Blue Creek, which represents a key development project launching at the right time to meet the significant future demand for our unique premium product to deliver value to our stockholders. With that, we would like to open the call for questions.

Our first question will come from David Gagliano with BMO.

Congratulations on a very strong quarter, by the way. I wanted to just ask about the cost guidance for the second half of the year. And for the full year, the full year guide obviously didn't change the range. And it implies kind of a flat second half versus the first half. And you talked up the third quarter number because of the lag in transport costs, and then we'll get some relief. So it's kind of a 2-part question here. First is, can you frame the order of magnitude of the increase quarter-over-quarter in cash costs and also talk about what price assumptions you're using for the second half of the year embedded in that full year range that hasn't changed?

Sure, David. This is Dale. If you look at our range, for the first half, we are right in the middle. Based on our current outlook, cash costs will be very similar to the third quarter. Although prices have decreased, you will see a reduction in royalties, but transportation costs will remain nearly the same due to a one-quarter lag effect. Additionally, we are accounting for about $4 in increased costs related to inflation. I believe this keeps us within that range for the year, which we have focused on previously. Our pricing for the full year is expected to be in the mid-300s, with potential for slight fluctuations. As prices continue to fall, we'll have to see how that impacts us, but that's our current position.

Okay. So maybe I misunderstood. So overall cash cost per ton for the third quarter is flat compared to the second quarter. Is that what you're saying? Or did I hear correctly that it has increased compared to the second quarter due to higher light transportation costs?

Well, they'll be flattish because you have opposing forces here going on. You'll have royalties decreasing, but transportation will be virtually the same but you got inflation we're having as well. So you're going to be net-net very close, very similar to where we were in the second quarter.

Understood. Okay. I appreciate that clarification. Then on a different note, recently, obviously, met has come down very sharply. And I think there's a bit of a bounce, but nevertheless, quite a decline in met. If the world stays where it is, I haven't had a chance to actually go through the math. But with CapEx accelerating in the second half and into 2023 from Blue Creek, we're sitting around 180, 200-ish Pacific Basin benchmark pricing, will Warrior continue to pay out special dividends during the second half of '22 and into 2023?

I believe that is a possibility. We are actively following our capital allocation strategy, particularly focusing on investing in growth within our existing business alongside the new shields. Additionally, there is growth happening with Blue Creek. Looking ahead to next year, we anticipate our capital spending to be around $100 million, excluding Blue Creek. Currently, we have nearly $700 million, which effectively covers the funding for Blue Creek. If we generate excess cash beyond that and the Board decides we can return it, we will do so. Therefore, there is potential for opportunity, though it will depend on market conditions. As we approach the second half of the year and consider possible slowdowns in various markets, we will need to assess the situation at the end of next quarter and proceed on a quarterly basis.

Our next question will come from Lucas Pipes with B. Riley Securities.

First, I wanted to ask a bit on the labor situation. Are you adding headcount at Mine #7, Mine #4?

We are continuing to add headcount gradually and are still hiring.

Is there possible to put some numbers around it in terms of kind of pace of additions now versus fourth quarter or first quarter?

The pace slowed down in late third quarter and early fourth quarter last year, and it's been slower since then, continuing to trickle in. We still have some individuals crossing the ticket line, and new hires are coming in as well. So it's just been a steady trickle. We built a little inventory in the second quarter, and we're quite happy with where things are at the moment. We continue to hire and move forward with that.

That's very helpful. And then across the industry, a lot of executives are noting skilled labor is difficult to come by. What's your experience in this market? Is it challenging to find skilled labor? Or would you say you're well positioned from that perspective?

Finding skilled labor has been quite challenging, as all mines are operational whenever possible, making it hard to locate experienced workers. We are training some new employees, and they are performing well.

Good. Good. Then the last point I wanted to touch on is thermal coal pricing versus met coal pricing. Of course, there is a big spread between the 2. Are you able to sell into the thermal coal market? And if so, is there a way to quantify it here at this point?

We will continue. We are looking into selling into the thermal market. As you know, these quality coals on met coal like this one from a BTU standpoint is a much stronger coal than normal thermal coals. So we'll continue to explore that. And as we have opportunities present themselves and we can achieve higher realizations and still meet our customer commitments, we'll do so.

Our next question will come from Nathan Martin with The Benchmark Company.

Congratulations on the quarter. I'm trying to understand the production and sales shipments as we transition from the second to the third quarter. You mentioned there might be some downtime at Mine #7 in Q3, so it seems like production will likely decrease compared to the previous quarter. On the sales side, you pointed out inventory levels, but more importantly, there are ongoing transportation issues, particularly with rail. I was hoping you could provide more details about the transportation challenges. Do you anticipate an increase in shipments from one quarter to the next as those issues improve and you reduce inventory?

Our goal is to reduce inventory from now until the end of the year, especially in the third quarter. CSX is working on plans to enhance their performance, and we are optimistic about seeing results from those efforts. Additionally, we completed significant maintenance at the port in the second quarter, including the reconstruction of one of the car dumps for railcars. These factors contributed to some slowing at the port, along with the added congestion from other coal, including thermal coal, being processed. We anticipate that congestion will persist, but the port facility should be operational soon, and we hope to see better performance from the railroad.

Got it. Very helpful. I guess you guys still have the ability to barge some coal as well.

We do. We barge some of our coal. We have our own barge load out. We barged some Mine 4 and Mine 7 coal, and we continue to do that to the extent we can. We're pushing the barge facilities as much as we can.

Got it. Perfect. That's all I really had left. I appreciate it, guys. Best of luck in the second half.

Our next question will come from Ken Kamon with Pacific Rim Investments LLC.

Walt and Dale, Lucas already asked about the thermal coal, but could you explain the specific qualities of our low volatile and mid-volatile products? Are they suitable for use in thermal plants? I understand that high coking quality can sometimes be a disadvantage if used in a thermal plant. Would we need to mix the coal with another product to make it suitable for burning? I'm curious about the chances of us benefiting from the higher thermal prices before the opportunity passes.

That's really an issue that varies by power plant. Different power plants around the world can operate using different types of coal. You are correct; some valves can present challenges when using thermal coal. However, the BTU quality often encourages efforts to blend and utilize it, as it can offer a premium of about 15% to 20% in quality.

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

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

Thank you. That concludes today's conference. Thank you all for participating. You may now disconnect.