Earnings Call Transcript - NRP Q2 2023

Tiffany Sammis, Manager of Investor Relations

Thank you. Good morning, and welcome to the Natural Resource Partners second quarter 2023 conference call. Today's call is being webcast and a replay will be available on our website. Joining me today are Craig Nunez, President and Chief Operating Officer; Chris Zolas, Chief Financial Officer; and Kevin Craig, Executive Vice President. Some of our comments today may include forward-looking statements, reflecting NRP's views about future events. These matters involve risks and uncertainties that could cause our actual results to materially differ from our forward-looking statements. These risks are discussed in NRP's Form 10-K and other Securities and Exchange Commission filings. We undertake no obligation to revise or update publicly any forward-looking statements for any reason. Our comments today also include non-GAAP financial measures. Additional details and reconciliations to the most directly comparable GAAP measures are included in our second quarter press release, which can be found on our website. I would like to remind everyone that we do not intend to discuss the operations or outlook for any particular coal lessee or detailed market fundamentals. Now I would like to turn the call over to Craig Nunez, our President and Chief Operating Officer.

Craig Nunez, President and Chief Operating Officer

Thank you, Tiffany and good morning, everyone. NRP generated $82 million of free cash flow in the second quarter and $308 million of free cash flow over the last year. Our strong financial performance enabled us to make further progress toward our goal of retiring our long-term debt and preferred equity, which we believe will in turn maximize future free cash flow available for common unitholders. During the second quarter, we permanently retired $81 million of our 12% preferred equity, increasing our total preferred equity retirement for the year to $128 million and lowering our outstanding balance of preferred equity to $122 million. Following this redemption, our total obligations, which include debt, preferred equity, and warrants decreased over 10% since last earnings call down to about $385 million as of today. Moving to our Mineral Rights business. While metallurgical coal prices declined during the second quarter and were well off the record levels seen in 2022, our Mineral Rights segment generated a solid $56 million of free cash flow during the quarter. We continue to believe that the supply-demand balance for met coal will remain well supported for the foreseeable future primarily due to long-term demand trends and the lack of investment in new met supply. Thermal coal prices also weakened in the second quarter due to relatively mild winter weather and inventories at many coal-fired power stations increased significantly as a result. While we believe North American thermal coal will face near-term headwinds and continue its long-term secular decline, we also believe underinvestment in new sources of thermal coal production will likely provide price support at levels that are relatively strong when compared to historical norms. We continue to see significant index price movement across the coal markets quarter-over-quarter and year-over-year, but believe the strides taken to delever and derisk our business over the years position us well to generate robust free cash flow despite market volatility. Our soda ash investment in Sisecam Wyoming continues to be an important source of free cash flow generation as NRP receives $32 million in distributions this quarter from Sisecam Wyoming due to strong realized sales prices and early payment of the second quarter distribution normally received in the third quarter. Softening soda ash demand coupled with new capacity from China has recently caused a significant drop in spot prices, which is likely to weigh on results for Sisecam Wyoming in the second half of the year. Despite these near-term pricing pressures, we believe the long-term fundamentals of the soda ash industry remain favorable. Sisecam Wyoming is well-positioned with its low cost of production and strong balance sheet. Turning to our carbon-neutral initiatives. We remain focused on exploring opportunities to expand our carbon-neutral portfolio with the goal of monetizing our assets through lease transactions for permanent underground CO2 sequestration, forest sequestration, and the generation of electricity using geothermal wind and solar energy. Additionally, we continue to evaluate other potential opportunities in the carbon-neutral space which may include soil and grassland sequestration, lithium production, and methane destruction credits. We believe our potential long-term future cash flows related to carbon-neutral initiatives could be significant, all while requiring no capital investment by NRP. And with that, I'll turn the call over to Chris to cover our financial results.

Chris Zolas, Chief Financial Officer

Thank you, Craig and good morning, everyone. During the second quarter, we generated $81 million of operating cash flow and $70 million of net income. Our Mineral Rights segment generated operating cash flow of $55 million, free cash flow of $56 million, and net income of $53 million in the second quarter of 2023. When compared to the prior year quarter, segment net income and free cash flow decreased $17 million and $15 million respectively, primarily due to the lower metallurgical sales prices. Although metallurgical pricing has declined over the past year, it remains relatively strong compared to historic norms. And we believe the many challenges operators face to increase production and sales that include transportation and logistics, labor, and limited access to capital should provide ongoing price support. In regard to our met thermal coal royalty revenue mix, metallurgical coal made up 70% of our coal royalty revenues and 55% of our coal royalty sales volumes for the second quarter of 2023. Moving to our Soda Ash business segment. Net income in the second quarter of 2023 was $27 million as compared to $15 million in the prior year period. This $12 million increase was primarily driven by strong soda ash demand and higher sales prices. Free cash flow from our Soda Ash business segment, in the second quarter of 2023, increased $22 million as compared to the prior year period. This increase was due to two main factors: the timing of distributions received from Sisecam Wyoming and the improved operating performance driven by higher sales prices. Regarding the timing, during the second quarter of this year, we received an $11 million quarterly distribution related to the first quarter performance and a $21 million distribution related to the second quarter's performance. In the past, we received quarterly distributions from Sisecam Wyoming approximately two months following the end of each quarter. Shifting to our Corporate and Financing segment. Costs for the second quarter of 2023 were $9 million compared to $17 million in the prior year period. This $8 million cost decrease was primarily due to lower interest expense in 2023 from our continued deleveraging and having less debt outstanding. In addition to this cost decrease, our Corporate and Financing segment free cash flow in the second quarter of 2023 improved $12 million as compared to the prior year period as a result of less cash paid for interest. In addition to debt repayment, we continue to make progress on the redemption of our preferred equity. As Craig mentioned, in the second quarter, we were able to permanently retire an additional $81 million of our preferred units at par with cash, bringing our total preferred unit redemptions to $128 million and lowering the outstanding amount of preferred units to $122 million. We will save over $15 million annually in preferred unit distributions with these redemptions. Finally, regarding our quarterly distributions, in May of this year, we paid a first quarter distribution of $0.75 per common unit and $6.1 million cash distribution to our preferred unitholders. And this morning, we announced the second quarter distribution of $0.75 per common unit and $3.65 million cash distribution to our preferred unitholders. With that, I'll turn the call back over to our operator for questions.

Operator, Operator

The floor is now open for your questions. We did receive a question from the line of Charles Fisher from Raffles. Please go ahead.

Unidentified Analyst, Analyst

Yes. I saw there was a decrease in production in the Illinois Basin. Could you give a little color on that?

Chris Zolas, Chief Financial Officer

Sure. We'd be happy to. And what happened there in the Illinois Basin was, as part of the mine plan, they were temporarily off of our coal and part of their mine plan as they go on and back off of our coal. During that period, they were temporarily off of our coal for that period, which is not uncommon.

Unidentified Analyst, Analyst

Great. Thank you.

Operator, Operator

Our next question comes from the line of Nat Stewart. Please go ahead.

Unidentified Analyst, Analyst

Yes. Thank you for taking my question. I was curious about the non-cash charge related to the paydown of the preferred securities. Could you explain that a bit more?

Chris Zolas, Chief Financial Officer

Sure. This is Chris. Happy to do that. Yes. What's happening there is that's the difference between the par value that we're paying for the preferred units and the book value that we had when we recorded them back in 2017. When we entered into the preferred units, there were also warrants associated with those preferred units. The $250 million we received back in 2017 on our balance sheet is allocated to both the preferred units and the warrants. So when we redeem our preferred units, the amount of cash we pay is more than the book value that is being taken off and that was allocated to those preferred units. Therefore, there's no impact on the income statement. It's on the balance sheet. And there is an impact on the earnings per unit that's calculated and allocated to the common unitholders.

Unidentified Analyst, Analyst

Okay. Great. That makes sense. So what are the priorities? Clearly, there has been a significant reduction of diluted securities over the last couple of years. It appears this will create a substantial capacity for distributions soon. What are the priorities for this paydown? Is anything changing? I was somewhat surprised by the extent of the paydown of preferred securities this year, which exceeded 33%. What is the strategy for the next six months or even further out?

Craig Nunez, President and Chief Operating Officer

This is Craig. Good question. We intend to continue to pay down our preferred and debt as rapidly as we can to the extent we can borrow on our credit revolver at a lower cost than the 12% on the preferreds and to the extent that we can have the preferred holders waive the make-whole premium, which is called a MOIC. If we can replace 12% obligations with something more like 7% or 8% obligations, we'll do that as much as possible and then immediately begin paying down the revolver with cash that we generate as well. Our goal is to pay down the preferreds, the bank revolver, and then, of course, continue paying down our private placement notes which are on an amortization schedule. By the time they settle in the first quarter of 2025, we want to settle our warrants that are outstanding. We're going to aim to get rid of all of those obligations as soon as we can.

Unidentified Analyst, Analyst

Great. Yeah, I think that's what's kind of remarkable about this is how rapidly that's been able to occur. Do you know what the M-O-I-C is now?

Craig Nunez, President and Chief Operating Officer

Yeah, I think it's around 10% or so right now.

Chris Zolas, Chief Financial Officer

That's correct.

Craig Nunez, President and Chief Operating Officer

It's currently not appealing to borrow from the credit facility to repay them. The implied return on paying a premium over par isn't attractive yet. However, that return will decrease each time we make a preferred distribution. By the first or second quarter of next year, the return will be negligible. Therefore, when you purchase the preferreds, you essentially receive a guaranteed implied return of 12%, even if the preferred holders do not waive the return, which will no longer exist.

Unidentified Analyst, Analyst

Great. Okay. Well, I think me and I think many of the unitholders are very happy with the strategy you guys have done and we see it as creating a tremendous amount of value for the unitholders. So please keep it up and thanks for doing a great job.

Craig Nunez, President and Chief Operating Officer

Well, those are kind words. I really appreciate it. I think that there needs to be equal thanks that go back to our unitholders. We don't have a lot of turnover, so most of our unitholders have been with us a long time. And you all know that this has been a very long-term strategy. This has been going on since 2015 where we turned a new page in our book. We have been steadfast and resolute in this strategy. Given the commodity exposures that we have in our business, the fact that we are nonoperators in the assets we have, so we have limited levers that we can pull to enhance performance, and given the pressures that face capital sourcing for fossil fuels in general, and particularly companies that have large exposures to thermal and/or met coal, we think this is the most prudent approach. We derisk and delever the balance sheet, and then we have commodity price exposure and volume exposure. We think this will allow us to receive the best valuation in the market. Most importantly, we also think we'll have the most stability of free cash flow that we possibly can. And all the free cash flow will be essentially attributable to common unitholders and available for common unitholder purposes. So thanks for the kind words, but also thank you to all on this call that have been with us and patient with us all these years.

Unidentified Analyst, Analyst

Great. Thanks.

Operator, Operator

We have another question from the line. Please go ahead; your line is open.

Unidentified Analyst, Analyst

Can you hear me? Hello, can you hear me?

Operator, Operator

Yes.

Unidentified Analyst, Analyst

This is actually Andrew Shirley. Thanks for taking the question. If you pay down your entire preferred and have less than 1x leverage, is there any reason why you can't reinstate a more full payout ratio in the first half of 2024 prior to taking debt down to zero?

Craig Nunez, President and Chief Operating Officer

There's no legal reason. There's no contractual reason that we could not do that, but that is not our strategy. Our strategy is to eliminate all of these obligations we have; the preferreds, the debt, and settle our warrants before such time as we begin to raise the distributions or look at considering raising the distributions. We have learned firsthand that it would be imprudent for a company such as ours, with our business profile, to rely at all on sourcing capital from banks or from capital markets to fund our business in the future. Thus, when you can no longer rely on rolling forward or refinancing your credit obligations, you have to assume that you operate with no permanent debt in your capital structure. We want to clean everything up, stay on the same path we have been on now for quite a while. Once we have the capital structure fully clean, then we will evaluate capital deployment strategies. It's not going to be too long in the grand scheme of things; we see light at the end of the tunnel. But early 2024 is too soon because even when we take out those preferreds, we're simply switching the obligation from preferred units to debt. This philosophy maximizes value for common unitholders on a risk-adjusted basis.

Unidentified Analyst, Analyst

Okay. Fair enough. I assume that over the next couple of quarters the preferred — the remaining balance of the preferred could get taken out by free cash flow even after the distribution you're already paying. But I don't mean to split hairs on that so that there wouldn't be any incremental debt. But just a question on the warrants. Is there any mechanism to settle the warrants and — or even at the expiration of the warrants? How do you expect to settle those warrants?

Craig Nunez, President and Chief Operating Officer

Well, the warrants are basically — the fate of the warrant is in large part in the hands of the warrant holders. They get to choose when they want to exercise. Once they make that election, we have a choice of how to settle those warrants. We can either settle them by delivering them units or we can settle them by paying them the value of the in-the-money options of those units. To the extent the market price of the unit is higher than the exercise price of the warrants we can pay that differential in cash, if we want to. Our decision on that will be based on whether we have the liquidity to pay in cash versus issuing units and what we believe the intrinsic value of the units is. If the intrinsic value of the unit is materially higher than the market value of the unit, and if we have the liquidity, we'll settle in cash. If both of these criteria are not satisfied, then we would settle by issuing units. Just for frame of reference, we did have an exercise of one tranche of units back in 2021, and we chose to settle those units with the payment of cash.

Unidentified Analyst, Analyst

Thank you for that detail. Regarding your CO2 efforts, I understand you signed a couple of agreements and had some upfront payments. When do you expect to have visibility on receiving recurring revenue from those CO2 deals?

Craig Nunez, President and Chief Operating Officer

In theory, there will be. This is a great question. It's one that I don't think anyone can answer, not just anyone in our team, but anyone in the industry. If the CO2 sequestration business develops as a viable business globally — if it becomes a functioning viable business with many players that are emitters capturing their emissions, and has developers capturing emissions of others and being paid a fee to handle transport and sequester the CO2 underground, we believe these projects with Oxy and Denbury will eventually reach a point in time when there will be visibility and very predictable income that could be quite material. However, it's a bit of a conditional probability as to whether we'll receive that type of income because the first thing that has to happen is the industry has to develop. I know from what's been announced publicly that both Exxon and Oxy are aggressively moving forward with their build-out of their CO2 sequestration activities, and they are active on our projects. But we really need to see the industry evolve for these projects and potentially others on our 3.3 million acres of CO2 sequestration acreage in the Gulf Coast to reach their potential. I call these our call options on greatness. They cost us nothing to maintain, and we actually receive a small fee from the operators to keep these leases. If the industry doesn't play out, then they may not either. But if the industry plays out, they could be quite significant for NRP.

Unidentified Analyst, Analyst

It does. Thank you. And I noticed as you pointed out that Denbury and Oxy as a percentage of your acreage, it's a very small percentage. Are those potentially just the tip of the iceberg, or are those the best locations and therefore the lowest-hanging fruit?

Craig Nunez, President and Chief Operating Officer

I would say that those are two of our better locations, but we have a number of others like it. The tip of the iceberg question is interesting because if the industry takes off, when you look at our acreage, you'll see that it all has the right geology and is close to emission sources. Combined with our legal ownership, where in most states it's ambiguous as to which property owner has the right to grant a lessee the right to store CO2 in the subsurface, our 3.5 million acres are fairly unique. We believe that if the industry as a whole develops and moves forward as perhaps Exxon thinks it will because of the large investments they're making in carbon-neutral initiatives, then more of our acreage is likely to become attractive for CO2 sequestration in the future. We're watching and cheering for the industry to progress as we have a unique position if this industry develops.

Unidentified Analyst, Analyst

And very lastly, on the Denbury and Oxy deals, I'm sure you guys have kind of calculated what they might generate in a couple of years out. Can you provide any guidance on potential dollar amounts?

Craig Nunez, President and Chief Operating Officer

We have analyzed that, but I can't give you guidance. My lawyer would advise against it, but it is material.

Unidentified Analyst, Analyst

Okay. Thank you very much.

Craig Nunez, President and Chief Operating Officer

You bet. Good questions.

Operator, Operator

I would now like to turn the call over to Craig Nunez for closing remarks.

Craig Nunez, President and Chief Operating Officer

Thank you very much. Really, I want to express again what we talked about earlier here. Thank you to all of you who have been with us for a long time. We've been through some difficult times. We're not completely out of the tunnel that we entered into eight-plus years ago, but we see light at the end of the tunnel. We're looking forward to achieving all the goals we set out to achieve, what seems like a long time ago now. Appreciate everyone's support, your participation in the call, your questions, and look forward to continuing to do business with you in the future. So thank you, everyone, and talk to you next quarter.

Operator, Operator

Thank you, ladies and gentlemen. This does conclude today's call. Thank you for your participation. You may now disconnect.