Warrior Met Coal, Inc.
Q4 2018 Earnings Call Transcript

Published: 24 Feb 2019

[Operator:]

Good afternoon. My name is Jamie and I will be your conference operator today. At this time, I would like to welcome everyone to the Warrior Met Coal Fourth Quarter and Full Year 2018 Financial Results Conference Call. [Operator Instructions] Thank you. Before we begin, I have been asked to note that today’s discussion may contain forward-looking statements and actual results may differ materially from those discussed. For more information regarding forward-looking statements, please refer to the company’s press release and SEC filings. I have also been asked to note that the company has posted reconciliations of the non-GAAP financial measures discussed during this call in the tables accompanying the company’s earnings press release located on the Investors section of the company’s website at www.warriormetcoal.com. In addition to the earnings release, the company has posted a brief supplemental slide presentation to the Investors section of its website at www.warriormetcoal.com. 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.

[Walt Scheller:]

Thanks, Jamie. Hello, everyone and thank you for taking the time to join us today to discuss our fourth quarter and full year 2018 results. After my remarks, Dale will review our results in additional detail and then you will have the opportunity to ask questions. Warrior performed exceptionally well and exceeded our expectations in the fourth quarter, which led to a record year in production and sales volumes for 2018. These operational records also drove strong financial performance. We are proud to announce that we achieved a record $1.4 billion in revenue, $601 million of adjusted EBITDA and free cash flow of $458 million. In addition, we continued our commitment of returning capital to stockholders which includes $400 million of cash dividends and stock repurchases over the course of 2018. Our strong fourth quarter and full year 2018 results continue to demonstrate the key strengths of our business model

[Dale Boyles:]

Thanks, Walt. 2018 was a record year in operational financial performance for the company. The company exceeded guidance targets recorded over $600 million of adjusted EBITDA, generated $458 million of free cash flow and distributed returns to stockholders of nearly $400 million. For the fourth quarter of 2018, net income on a GAAP basis was $374 million or $7.11 per diluted share compared to net income of $97 million or $1.83 per diluted share in the fourth quarter of 2017. Excluding the non-cash income tax benefit recognized upon the release of the valuation allowance on deferred tax assets associated with Warrior’s net operating losses and a non-cash adjustment to our asset retirement obligations due to a change in reclamation estimates, non-GAAP adjusted net income for the fourth quarter of 2018 was $125 million or $2.38 per diluted share compared to $1.83 per diluted share in the fourth quarter of 2017. For the full year 2018, net income on a GAAP basis was $697 million or $13.17 per diluted share compared to net income of $455 million or $8.62 per diluted share in 2017. Excluding the non-cash income tax benefit, non-cash asset retirement obligation adjustment, incremental stock compensation expense and transaction and other expenses, non-GAAP adjusted net income for 2018 was $459 million or $8.67 per diluted share compared to $468 million or $8.86 per diluted share in 2017. Adjusted EBITDA was $162 million in the fourth quarter as compared to adjusted EBITDA of $86 million in the same period of 2017, an increase of 87%. The company’s adjusted EBITDA margin was 45% in the fourth quarter compared to 36% in the fourth quarter of 2017. The quarterly increase was primarily driven by a 45% increase in sales volume, an increase in average net selling prices and lower cash cost. For the full year 2018, Warrior recorded a record high adjusted EBITDA of $601 million compared to $518 million in 2017, an increase of 16%. The yearly increase was primarily driven by 17% increase in sales volume. Adjusted EBITDA margin was 44% in each of the last 2 years. Total revenues were $360 million in the fourth quarter of 2018 compared to $240 million in the same period last year. This increase was primarily due to a 45% increase in sales volume, on strong customer demand and a 5% increase in average net selling prices. For the full year 2018, total revenues were a record high at $1.4 billion on sales volume of 7.6 million short tons compared to $1.2 billion in 2017 on sales volume of 6.5 million short tons. Total revenues in 2018 grew $209 million or 18% over 2017 primarily due to a 17% increase in total sales volumes. The average net selling price per short ton increased approximately 5% in the fourth quarter compared to the same period in 2017. The price environment continued to be strong with index prices rising in the fourth quarter to a high of $236 per metric ton. Our gross price realization of 93% was reflected by the rising price index throughout the fourth quarter. Demurrage and other charges reduced our gross price realization to a net average selling price of $178 per short ton in the fourth quarter of 2018 compared to $169 in the same period last year. For the full year of 2018, average net selling prices increased 2% to $176 per short ton. Mining cash cost of sales was $183 million or 52% of mining revenues in the fourth quarter compared to $137 million or 60% of mining revenues in the fourth quarter of 2017. Cash cost of sales per short ton, FOB port was approximately $93 in the fourth quarter compared to $101 million in the same period of 2017. The decrease is primarily due to higher sales volumes, lower spending offset slightly by higher transportation and royalty cost, which are price sensitive to met coal pricing. Cash cost of sales per short ton, FOB port, was approximately $94 for the entire year of 2018 was in line with our guidance and was approximately $3 per short ton higher than 2017. This increase in the cash cost per short ton is primarily due to higher spending associated with a higher sales and production volume in 2018. Cost of other revenues, which is primarily composed of our gas and land operations, was income rather than expense in the fourth quarter of 2018 resulting from the previously mentioned non-cash adjustment of $21 million to our asset retirement obligations. This large non-cash adjustment reflects changes in estimates of spending required to reclaim the stirred above and below ground property and gas wells and the timing of future cash outflows of approximately $20 million and a change in discount rates of approximately $1 million. SG&A expenses were about $8 million or 2% of total revenues in the fourth quarter and approximately $6 million lower than the same period last year primarily due to lower stock compensation expense and performance-related bonuses. SG&A expenses of $36 million for the full year 2018 were within our guidance and flat compared to 2017. Depreciation and depletion expenses for the fourth quarter of 2018 were $25 million or 7% of total revenues compared to $18 million in 2017. The increase in the fourth quarter was primarily due to the relatively higher rate of capital spending over the last 2 years. For the full year 2018, these expenses were $22 million higher than last year primarily due to higher capital spending plus $4 million of accelerated depreciation on equipment beyond its economic repair reported earlier in 2018. Net interest expense was about $9 million in the fourth quarter and included interest on our outstanding debt plus amortization of our debt issuance costs associated with our credit facilities offset by interest income. This was higher than last year’s fourth quarter due to the 8% senior secured notes offering completed in March 2018. For the full year 2018, net interest expense was $37 million and in line with our guidance. The increase of approximately $30 million over 2017 was due to the timing of the issuance of the senior secured notes in November 2017 and March of 2018. The company recorded non-cash income tax benefit of $226 million during the fourth quarter of 2018 primarily reflecting the release of the valuation allowance on deferred tax assets associated with the company’s net operating losses. The release of the valuation allowance reflects management’s belief as of the end of 2018 that more likely than not the company will fully utilize its net operating losses before they expire based on its past trend of earnings and projected future taxable income. We paid no cash taxes in 2018 as indicated in our guidance and continued utilization of our NOLs will reduce our federal and state income tax liability to zero until the NOLs are fully utilized or expire. We expect this will continue to drive significant free cash flow conversion over the next several years. Turning to cash flow, during the fourth quarter, the company generated $105 million of free cash flow, which was the result of cash flows provided by operating activities of $131 million, less cash used for capital expenditures of $26 million. This compared to $61 million of free cash flow in the fourth quarter of 2017. This higher result is primarily due to the higher operating results in the fourth quarter offset by an increase in working capital of $39 million on higher accounts receivable and income tax receivable. Our cash flows from operating activities for the full year 2018 were $550 million and were $125 million or 29% higher than 2017. These higher results were driven by higher operating results in 2018 offset by a modest increase in working capital of $11 million. The company generated free cash flow of $458 million in 2018, an increase of $116 million or 34% over 2017. These results demonstrate the strength of free cash flow conversion of our adjusted EBITDA margins of 76% this year compared to 66% last year. Cash used in the investing activities for the purchase of capital expenditures was $26 million during the fourth quarter and totaled $102 million for the year. For the year, we spent $69 million on sustaining capital and $33 million on discretionary capital. The discretionary spending in 2018 was primarily for the completion of a new portal for Mine 7, development of infrastructure in Mine 4, a hoist upgrade and various other operational improvements, which we expect will increase efficiency, increase the production and lower cost over time as these projects become fully operational. Cash flows used in financing activities were $27 million in the fourth quarter of 2018 and consistent with the payment of the quarterly dividend plus $25 million of repurchases of the company’s common stock. The company repurchased 1.1 million shares of its common stock during the fourth quarter. For the full year of 2018, we repurchased a total of 1.6 million shares which was 3% of outstanding shares for $38 million. As we previously stated, the company remains committed to returning excess cash to stockholders in various forms. For the full year of 2018, cash flows used in financing activities were $282 million, which include the net proceeds of a tack-on notes offering in March 2018 of $125 million, repayments on outstanding debt of $3 million, distributions of dividends of $361 million, and stock repurchases of $38 million. Total cash distributed to stockholders in 2018 through dividends and stock repurchases totaled $400 million. This amount is on top of the approximately $800 million distributed to stockholders in 2017. The company’s balance sheet continues to be strong with a leverage ratio of less than 0.5x adjusted EBITDA plus ample liquidity without the fixed cost associated with legacy liabilities that some competitors have on the balance sheet. Our total available liquidity as of year end was $326 million consisting of cash and cash equivalents of $206 million and $120 million available under our ABL facility, net of outstanding letters of credit of approximately $5 million. We believe our strong balance sheet and significant free cash flow generation will give us flexibility if we decide to pursue our Blue Creek growth project. In summary, we finished with another strong performance in the fourth quarter that drove record operational and financial performance for the entire year. Now turning to our outlook and guidance for 2019, as a result of strong production in 2018, we expect to complete two additional long-wall moves for a total of 5 long-wall moves in 2019 compared to the three moves we had in 2018. Despite additional long-wall moves, we are increasing the upper end of our guidance for coal production in coal sales for 2019 compared to the guidance provided for 2018. Our guidance for the full year 2019 reflects our view of continued operational strength and expected market conditions and is follows

[Walt Scheller:]

Thanks, Dale. Before we move on to Q&A, I would like to make a few more comments about the company and its prospects. We are very pleased with the company’s strong operational and financial performance in 2018 and we appreciate the support and engagement that we have received from our stockholders and of course our employees. As our production volumes have increased, we benefited from the increased operating leverage by investing in the long-term projects that will benefit the operations in the future. 2018 was a record year for global steel production with key regions like China and India displaying strong year-over-year growth, while South America and Europe continued producing steel at high levels. Although we have seen overall conditions temper off in early 2019 mainly due to concerns around the potential slowdown in certain major economies as well as the implicit uncertainty of the China-USA trade discussions and the Chinese New Year we anticipate another good year for steel production. Indications from our global customers reflect this premise with their current forecasted production volumes nearing closely to those observed this past year. With the expectations of strong steel production volumes at or near 2018 levels coupled with the absence of material changes in the supply of hard coking coal, we believe that demand for our premium products will also remain consistent throughout the year. The recent decline in the Australian premium low vol index from the highs achieved in the fourth quarter of 2018 was mostly within expectations and remains at favorable values. Additionally, while spot prices have declined recently, forward prices remain robust and are above forward prices seen at this time last year. This provides us with confidence that pricing should stabilize in the near term at or near current levels and remain within a reasonable range for the rest of the year. We recognized that certain economic indicators such as the potential slowdown in regional GDP growth rates as well as a reduction in steel demand in Europe have the potential to create a softer pricing environment for hard coking coal. However, barring any unforeseen material events, we believe current fundamentals should remain relatively healthy through our markets. In light of these expected market conditions, we are establishing our 2019 guidance targets with cautious optimism. As I said on previous calls, we run the business as if the next pricing downturn and geological issue are just around the corner with conservative targets and flexible operations that allow us to adjust to the market environment as it changes throughout the year. We expect to update our 2019 guidance during the year as necessary to adapt the changing market conditions and changes in the business. As Dale indicated earlier, we expect our 2019 capital spending to range from $100 million to $120 million consisting of sustaining capital spending of $70 million to $87 million, including our gas business requirements and discretionary capital spending of $30 million to $33 million. The sustaining capital range includes new ventilation shafts that are necessary every few years and other key equipment rebuild projects that occur every few years. The discretionary capital spending is primarily for the future development of Mine 4 and the completion of some smaller projects that began in 2018. Lastly, I want to comment on our other news release today. We continue to generate significant free cash flow despite significant investment in our operations. We plan to use the excess cash of $300 million available at the end of March to repurchase a portion of our senior secured notes from our bondholders on one hand and return capital to stockholders of special cash dividends and/or stock repurchases on the other. We believe these actions will allow us to continue to maximize value and drive returns for our stockholders. With that, we would like to open the call for questions. Operator?

[Operator:]

[Operator Instructions] And our first question today comes from Lucas Pipes from B. Riley FBR. Please go ahead with your question.

[Lucas Pipes:]

Hey, good afternoon gentlemen. I wanted to first ask a little bit about capital returns throughout the prepared remarks. It sounded like you made a couple of references to your intention of returning capital to shareholders again in various forms. I think that’s what you said could you maybe elaborate on that? Obviously, you are tendering for the $150 million on the debt side, is that the right size to think about and how soon could something like $150 million be returned to shareholders? Thank you.

[Dale Boyles:]

Lucas thanks for your question. Yes, as I said in my remarks, we are looking to distribute a total of $300 million of cash that we should have on hand by the end of March and that would be split $150 million in the restricted payment offering to bondholders and the other $150 million for special cash dividend and/or stock repurchases. So that’s the plan. Depending upon the results for the restricted payment offer and tender offer, if there are amounts that are declined in the restricted payment offer, those amounts could be potentially added to the special dividend and/or stock repurchase returned. We will just have to wait and see how those results turn out, but that’s our plan that we have right now.

[Lucas Pipes:]

Got it. No, that’s very helpful. And then, you disclosed a lot about Blue Creek, I appreciate that and I appreciate the level of detail that you provided, how do you think about this project at this time? Is it more like permitting, seeking investor feedback or do you intend to maybe come out with a date at which you might sanction this growth project? I would appreciate your thoughts. Thank you.

[Walt Scheller:]

Well, right now, as we said, we have been doing some work, some further engineering work. We have got a lot of permitting that’s already completed. We intend to do some additional permitting this year on things such as the refuse areas, slurry disposal and rail loop. So those are the areas we will be focused on this year. We’ll do some additional engineering studies, do some core drilling. And again, our goal is to put the work into it this year that we are ready to start if we decide to pull the trigger that we are ready to start in early 2020.

[Lucas Pipes:]

And how do you – so you have been very – you have returned a lot of capital to shareholders and I think you stand out among your peer group. So how do you balance returning capital to shareholders with a growth project such as Blue Creek? Thank you for your thoughts. Thank you.

[Dale Boyles:]

Yes, Lucas, I think nothing has changed from a capital allocation standpoint. We remain committed to returning excess cash to our shareholders in the various forms and so until we make a final decision, none of that has changed, but I will tell you, look, we’re really excited about this. This is really the future growth of the company as we have been working our way up to the nameplate capacity. This is reserve that we already control 114 million short tons. So clearly, it makes a lot of sense to really start working on this project now and looking at when do we take those next steps. So we’ll take a holistic approach, a returns based approach kind of the capital allocation once we get to that point of making a decision on Blue Creek. As we said look, once we complete these things in 2019, some additional core drilling and things like that, we think this project is shovel ready early 2020 and we can make a decision at that point.

[Lucas Pipes:]

Got it. Very helpful. I appreciate your comments. I have more questions. So I will jump into queue. Thank you.

[Operator:]

Our next question comes from Jeremy Sussman from Clarksons. Please go ahead with your question.

[Jeremy Sussman:]

Thanks for taking my questions and congratulations on another very strong quarter guys.

[Walt Scheller:]

Thanks, Jeremy.

[Jeremy Sussman:]

I guess from the production standpoint, I guess obviously very strong year in 2018. I assume the reason for the modest downtick in ‘19 is the 5 long-wall moves. And I guess, along those lines, should we still think of Warrior as an 8 million ton per annum producer when fully ramped or I guess how should we be thinking about the production profile?

[Walt Scheller:]

Jeremy, this year, yes, the fact that we have 5 long-wall moves is going to play a factor and how successfully we can complete those long-wall moves will drive whether or not we see where we end up in our range or exactly where we finish the year from a production standpoint. I still do think our production potential, we say is 8 million tons and there is going to be years where we should be able to get there and there is going to be years where with things like 5 long-wall moves where we have to step back and say that doesn’t quite make sense this year. I’m real proud of the progress our operations have made. I think they had a fabulous year, last year, and I expect them to perform very well, again, this year.

[Dale Boyles:]

Jeremy, just let me add to that. If I remember, from the last 2 years, our production levels have well exceeded our expectations. So what’s happened with that strong performance, we have actually pulled these moves in sooner. So if you remember we pulled in an extra move into 2018 that was scheduled for 2019 because we have done so well. So we have kind of pulled some of these forward, but that’s because things had been going well.

[Jeremy Sussman:]

That makes perfect sense. And maybe Dale just to follow-up, so the restricted payment offers is obviously, I think at 103% and then you’ve got the tender offer at 104.25%. So assuming the maximum amount is ultimately tendered between the restricted payment and the tender offer, could you just remind us is there any difference between the two in terms of what your ability to pay a special dividend would be?

[Dale Boyles:]

Well, what we try to do is provide optionality to the bondholders and to allow the company to economically increase the amount of cash that we could share with our equity holders as well. So, to the extent under the restricted payment offer, they are declined amounts and I will point you to Page 2 of that particular press release where it gives you an example. If there are declined amounts in that, that essentially creates capacity for your return of capital. And if you look on that second page where we have given an example of the $300 million and where actually $95 million of that gets paid because it’s still on a pro-rata basis, create capacity of $55 million for extra capital returns, so you could increase your $150 million by another $55 million there, Jeremy.

[Jeremy Sussman:]

Understood. Thank you very much, Dale.

[Dale Boyles:]

Thanks.

[Operator:]

[Operator Instructions] Our next question comes from Matthew Fields from Bank of America.

[Matt Castellini:]

Hey, guys. Matt Castellini here on for Matt Fields. So I just wanted to clarify one thing. In aggregate, those two tender offers are basically referred to $300 million of the 8% of ‘24. I know you mentioned excess cash flow would – $150 million, I believe you said would go to fund that, but I guess what else would that be funded with beyond sort of excess cash flow?

[Dale Boyles:]

Well, as we said, we expect to have $300 million on hand at the end of the first quarter. We have already over $205 million – I think its $205 million at the end of December. And so the way the RP and tender offer work is you participate in either or. So again, we will fund the payment, which is a maximum amount to the notes of $150 million and then $150 million to capital returns for stockholders.

[Matt Castellini:]

Okay, understood. Thank you very much.

[Dale Boyles:]

Alright. Thanks very much.

[Operator:]

And our next question is a follow-up from Lucas Pipes from B. Riley FBR.

[Lucas Pipes:]

Hey, good afternoon again and thank you for taking my follow-up question. I wanted to circle up a little bit on the cost guidance for 2019. It appears modestly lower at the midpoint compared to 2018 despite the lower production guidance. So I wonder if you can maybe just provide a little bit more color as to the drivers for the 2019 cost guidance? Thank you.

[Dale Boyles:]

Yes. I think we are going to start to see some of the capital investment paying off, Lucas and we expect to kind of get some of the efficiencies of these projects that we have been spending on. So that’s the reason for driving that down primarily. We did spend a lot this year on particular improvement projects, one was the portal that we’ve talked about and reducing overtime, but we’re starting to see that these projects really pay off, not just better equipment, utilization, but also incremental volume and lower cost.

[Lucas Pipes:]

Okay, that’s helpful. And you are spending a little bit more, as you noted in the prepared remarks in 2019. What’s the list of projects that you’re trying to tackle with additional capital? And could we be thinking about a similar return on those or as you kind of capture some low hanging fruits, the return maybe a little bit lower than what you saw on the 2018 capital spend? Thank you.

[Walt Scheller:]

Well, this is Walt. On the sustaining projects what we said is we have got more shafts this year than normal, so that’s accounting for some of that additional sustaining capital spend. The discretionary capital spend is the development of the future for Mine 4. We have always called that Cassidy, but I think we are now calling it [indiscernible]. So it’s really about the development of the mine towards that project and the beginning of sinking the shafts in that area that will be the mine life for Mine 4 for probably the next 20 years. So, on that project that’s really a several year project that will enable the continuation of long-term success in Mine 4 and the rest of the sustaining capital is pretty standard in some of the smaller discretionary capital projects. Yes, we hope to see some benefit from those, but we haven’t banked on that.

[Lucas Pipes:]

Very helpful. Thank you. And Mine #4 in north when do you plan to transition into that mining area and what’s roughly the capital spending for this new section?

[Walt Scheller:]

We have about 5 years of mining left in what we consider to be the kind of the eastern part of Mine 4. And when we need to have developed the area in Cassidy from now until that is completed, so we will actually be mining long-wall coal at that side of the mine side of the mine probably in 5 or 6 years, it could be a little earlier, but probably about that timeframe.

[Lucas Pipes:]

Perfect. This is very helpful. I will leave it here and best of luck. Good job.

[Walt Scheller:]

Thank you.

[Operator:]

[Operator Instructions] And at this time, it is showing no further questions. I would like to turn the conference call back over to Mr. Scheller for any closing comments.

[Walt Scheller:]

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 call. We thank you for participating. You may now disconnect.