Alliance Resource Partners, L.P. (ARLP) Q1 2016 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the First Quarter 2016 Alliance Resource Partners LP and Alliance Holdings GP LP Earnings Conference. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. [Operator Instructions] As a reminder, this conference call is being recorded. I would now like to introduce your host for today’s conference Mr. Brian Cantrell, Senior Vice President and Chief Financial Officer. Sir, you may begin.

Thank you, Chrisville, and welcome everyone. Earlier this morning, we released 2016 first quarter earnings for both Alliance Resource Partners, or ARLP, and Alliance Holdings GP, or AHGP. And we'll now discuss these results as well as our outlook for the balance of the year. Following our prepared remarks, we’ll open the call to your questions. Before we begin, a reminder, that some of our remarks today may include forward-looking statements that are subject to a variety of risks, uncertainties, and assumptions, which are contained in our filings from time to time with the Securities and Exchange Commission, and are also reflected in this morning's press releases. While these forward-looking statements are based on information currently available to us, if one or more of these risks or uncertainties materialize or if our underlying assumptions prove incorrect, actual results may vary materially from those we projected or expected. In providing these remarks, neither partnership has any obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events, or otherwise. Finally, we will also be discussing certain non-GAAP financial measures. Definitions and reconciliations of the differences between these non-GAAP financial measures and the most directly comparable GAAP financial measures are contained at the end of the ARLP press releases, which has been posted on ARLP’s website and furnished to the SEC on Form 8-K. Now that we're through the required preliminaries, I'll turn the call over to Joe Craft, our President and Chief Executive Officer. Joe?

Thank you, Brian. Good morning, everyone. ARLP’s – excuse me, ARLP’s operating and financial performance – excuse me, I am sorry. We’ll start all over again. ARLP’s operating and financial performance for the 2016 quarter was solid. Tons produced, coal sales price per ton, segment adjusted EBITDA, expense per ton, margins per ton, and distributable cash flow were all better than our expectation. While tons sold were approximately 600,000 tons below our plan, as customers defer contractually scheduled shipments due primarily to reduce burn caused by the mild winter weather. The lower sales volume attributed to these deferred shipments impacted the current quarter’s EBITDA and net income by approximately $12 million. On our last earnings call, we discussed at length the headwinds facing the U.S. thermal coal markets and the overall decrease in coal demand predicted through 2016. We discussed the fact that we alone with the rest of the industry would be forced to reduce supply due to this lower demand expectation. Our late half ARLP’s decision to address this uncertainty by producing fewer tons, and over the last several months, we have worked to strategically adjust our production levels to more closely match ARLP’s contracted coal sales position. By shifting production to our lower cost mines, idling higher cost operations and reducing unit shifts and production days, our operating teams have trend capital expenditures and kept cost per ton in check despite lower volumes. These actions are consistent with our guidance for total production in 2016 at 34.7 million tons at the mid point of our guidance range or 15.8% below 2015’s level. We continue to believe these actions have established a reasonable baseline from our sales and production in light of the current market realities. Our competitors had aggressively cut supply as well. Production of coal in the U.S., during the 2016 quarter, dropped more than 30% compared to the first quarter of 2015 and was down approximately 17% compared to the sequential quarter. We anticipate production cuts are likely to accelerate throughout the rest of the year as coal markets remain oversupply. Later this year, the reducing supply picture for both coal and natural gas should bring the markets more in balance and support higher prices for both commodities. On the marketing front, ARLP strengthened its contract by obtaining new commitments for the delivery of approximately 782,000 tons in 2016 and 2.35 million tons in 2017. As a result of these transactions, we have now secured price and volume commitments for 2016, 2017, 2018 and 2019, 34.5 million tons, 21.5 million tons, 14.5 million tons, and 7.1 million tons respectively. Since ARLP’s last earnings call, our finance team has made progress towards enhancing our debt capacity. We added additional operations to the receivables securitization pool, increasing the available utilization of these 100 million facilities by approximately $17 million since year-end. ARLP is also in the market with a new capital sale lease back transaction, which is expected to close early next month. Additionally we began discussions with our banks and other lenders to address in May 2017 maturity at ARLP’s current credit facilities. During these discussions it has become clear that even in this difficult commodity market ARLP’s strong performance positioning and balance sheet will provide us with a variety of financing options to meet our objectives. It has also become clear that however that the financial struggles facing most of our competitor have caused the capital market to become laser focused on lenders preserving liquidity in the near term. As a result our Board has made the decision to proactively reduce quarterly distributions to ARLP and AHGP share holders. Even though the distributable cash flow for 2016 is expected to come in as previously guided. This decision was made to ensure that Alliance maintains the access to a reasonable level of capital necessary to prudently manage its business for the future. This decision while difficult will generate a $140 million of annual cash savings to enhance the liquidity or repay indebtedness. As many of you know my family and our management team and I own a very significant portion of AHGP so we are very well aware of the impact of reducing distributions to our unit holders. I am confident however that this was the right decision for us to make and if these adjusted distribution levels for ARLP and AHGP are sustainable establish a platform for return to future distribution growth and provide Alliance with needed financial flexibility to manage through the current market turmoil. I will now turn the call over to Brian for a review of our financial results. Brian

Thanks Joe. Financial results for the 2016 quarter were largely driven by lower coal sales and production volumes. As Joe mentioned over the past several months ARLP has taken strategic steps to adjust production to more closely match our contracted position. These steps included the idling of our Onton and Gibson North mines in the fourth quarter of 2015 and the planned depletion of reserves at our Elk Creek mine at the end of the 2016 quarter. In addition reduced unit shifts on production days resulted in lower production at our River View, Pattiki, Warrior and Hamilton Mines in the Illinois basin and at the Tunnel Ridge and MC Mining operations in Appalachia. Reflecting these planned adjustments coal production fell 15.4% and 8.5% compared to the 2015 and sequential quarters respectively. Comparable sales volumes were down by 21.5% and 25.2% respectively primarily driven by the previously mentioned customer deferrals of scheduled shipments and market driven production adjustments. Lower sales volumes were largely responsible for reduced coal sales revenues, which declined by 22.5% and 23.6% compared to those of 2015 and sequential quarters respectively. Other sales and operating revenues for the 2016 quarter were approximately $30.5 million lower compared to the 2015 quarter primarily due to the termination of coal royalty and surfacing facilities agreements upon the closing of the White Oak acquisition in July 2015. Lower sales volumes and revenues negatively impacted EBITDA and net income for the 2016 quarter. EBITDA for the 2016 quarter declined to $135.8 million compared to EBITDA of $192.2 million for the 2015 quarter and adjusted EBITDA of $186.8 million for the sequential quarter. Net income also declined in the 2016 quarter falling to $47.3 million compared to $106.5 million for the 2015 quarter and $88.4 million of adjusted net income for the sequential quarter. Turning now to our balance sheet liquidity at the end of 2016 quarter was a very healthy $374.1 million. As anticipated our leverage ticked up slightly but remained very comfortable at 1.38 times net debt to trailing 12 months adjusted EBITDA. As Joe mentioned earlier our strong balance sheet leaves ARLP well positioned to execute on financing opportunities that we plan to pursue over the next year. With that I will now take a look at an update of ARLP’s 2016 full year guidance. As outlined in our release this morning based on results to date and current expectations for the balance of 2016 we are maintaining our previous 2016 full year guidance for coal production in a range of 33.7 million to 35.7 million tons. Coal sales volumes in a range of 34.6 to 38.1 million tons, and total revenues excluding transportation revenues in a range of $1.82 billion to $1.95 billion. ARLP is also maintaining its 2016 estimates for EBITDA in a range of $545 million to $615 million and net income in a range of $230 million to $300 million. ARLP currently anticipates that at average coal sales price per ton will be approximately flat to 6% lower than 2015 realizations segment adjusted EBITDA expense per ton will be plus or minus 3% of our 2015 results, and Segment Adjusted EBITDA Expense per ton will be approximately 5% to 12% below the prior year. Capital expenditures of $33.3 million during the 2016 quarter, where well below our expectations, and ARLP continues to evaluate opportunities to minimize future capital expenditures. As a result we are reducing the anticipated 2016 total capital expenditures by approximately $27 million at the midpoint of prior guidance, to a range of $105 million to $115 million for the full year. In addition to these capital expenditures, ARLP continues to anticipate funding investments in 2016 of $60 million to $70 million related to its commitment to acquire oil and gas mineral interests. Distributable cash flow is expected to be $384 million at the midpoint of our EBITDA guidance range of $580 million. We have not adjusted maintenance capital per ton for long-term distribution purposes, even though our actual maintenance capital for the 2016 quarter was below expectations. And as I mentioned, we did lower total capital expenditure estimates for the 2016 full year. With these forecasts and a new distribution level, ARLP’s distribution coverage improves meaningfully to nearly two times over the remaining three quarters of 2016. This now concludes our prepared comments. With Chrisville’s assistance, we’ll open the call for your questions. And then following that, we will turn the call back to Joe for closing comments. Chrisville?

Thank you. [Operator Instructions] And our first question comes from Mark Levin from BB&T Capital Markets. Your line is now open.

Good morning guys and congratulations on a very good quarter. My first question has to do with the distribution, obviously, you guys mentioned being covered two times for the remaining three quarters. My question relates to 2017 distribution level. I think you mentioned on the last quarter you going to look at it on a quarter-by-quarter basis. It would appear that you guys are reasonably safe, obviously, through – beginning of this year. But when you think about 2017, if you assume or if you were to assume that coal prices just didn't recover or whatever the reasons in volumes were sort of steady state. Put another way, just a continuation of where – way things are today, would you have to cut the distribution again or could you maintain the distribution now at its present level?

We believe we would be able to maintain it. So stress – we have stress test. Our 2017, our existing prices – as shown by the various indexes and we believe that we would have a coverage ratio of about 1.2 in 2017 with slight increases in production. So we believe we will have the opportunity to increase our production next year as there are a couple of contracts that are expiring that we believe we will be more competitive to secure from those that are currently have those contracts. So we do anticipate increased production. And with that increased production and even current prices that you see, we do believe we will have a 1.2 coverage ratio, and it could be a little higher depending on how the market responses towards the – end of this year.

Joe, when you referenced some increased production, are you talking about a couple of percent here and there or are you talking about a meaningful increase or how would you characterize…

Couple of million tons roughly.

Couple of million tons. Got it. Second question is more of a big picture question. So if you look at the first quarter annualized production run rate for U.S. coal for about 650 million tons plus or minus. And I think even the two of the last three weeks have been well below the 600 million ton annualized run rate. You mentioned that you thought coal production would continue to rationalize through the course of the year. Is there a view around on around those numbers that I gave you like how many more tons need to come out of the market before meeting the producer starts to regain some leverage with the customer?

If we look at our market region, specifically Northern App and Illinois Basin, we believe with the customers’ current stockpiles, there's probably a 20 million ton overhang still. So that would be the tonnage that needs to be either supply needs to come up or demands needs to go up from first quarter levels to eradicate that overhang.

Got it. And then last question, 2017 cost, I know it's early, you don't want to get into talking about cost, in future a lot of things can happen between now and then. But is it reasonable to assume that if you guys were able to increase production several million tons, and given all the efficiency you guys have made that cost would not necessarily increase, in fact, they could stay flat with where they are?

It's reasonable to say yes.

Okay, great. Thanks very much. I appreciate it, gentlemen.

Thanks, Mark.

Thank you. [Operator Instructions] And our next question comes from Lin Shen from HITE Hedge. Your line is now open.

Hi, this is actually Matt Niblack for HITE Hedge. So in terms of the decision to cut the distribution, given leverage was low, given coverage was there. How did you arrive at that decision and the decision to cut it by this much, is there something strategic about this capital investment or acquisitions that you want to be able to finance or do the banks really just say if you don’t do this, it’s going to be harder to get your maturities refinance. What was the logic there?

I think to answer your first part as to why the level. I think the level was established really driven now and what we think could be sustainable through 2017. And we do believe that we will see even better results. As we look further out, I’m sorry, that my Vetis's throat today. But as we look further after 2018, we do believe that this will be a foundation to grow, because we believe prices will strengthen and tonnages and volumes will be able to be returned back to where we were a year ago plus. So really our focus is how do you get through the current, really the 2017 time period. And we wanted to make the reduction to a level that we felt comfortable that it was sustainable based on what we know today. And so that’s how we got to the amount. Now why today versus later that was not mandated by anyone, this was the Board decision. What we did just started discussion with lenders. And one of the things that just sort of jumped out of the page looking to 2017 that it was obviously there would have to be some adjustment given the – assuming that we don’t want to borrow to pay distributions which we don’t do. That we will have to make some adjustments so we felt that we’re still ahead addressing with the Board and go ahead and make the decision now so that we will provide clarity to our lenders, as well as our unitholders, so they didn’t have to worry about what, when and where as they were trying to evaluate where the proper dividend level should be.

Got it. And in terms of opportunities for acquiring companies or properties, given that the – given your relative strength, given that after this move you’re going to use that relative strength is only going to improve, do you see an opportunity or press more opportunities earlier in the cycle to go out and acquire some assets, expand the footprint?

There aren’t opportunities as we mentioned over the last call there was some discussion about that. We continue to look at that. I think financing a transaction or acquisitions a little bit more challenging than financing transaction – financing just extending our current debt level. So the actual opportunities to ahead to our footprint in a material way would require the current debt holders with the existing sellers to participate and try to be flexible and come up with some creative solutions to support the transaction.

All right thank you.

Hi, Matt it’s James. Can I just follow-up maybe with Peabody bankruptcy and others, I mean, how was the competitive dynamic changed by having major competitors that are bankrupt or near bankrupt?

I think that from a competitive nature it’s strengthened our position, in a sense that from a customer perspective the credit quality of their suppliers is always an issue. So when they enter into a contract they want to know that the supplier has the financial ability to discharge that contract and also not have their contract be rejected. So from that standpoint it’s been a strength to us, as you think about how it affects the financing market it has to strengthen lenders, we were spending lot of time trying to protect the loans that they made to bankrupt companies. So trying to get into what we would consider to be a reasonable dialogue or a company that’s got less than two times net to EBITDA coverage and distinguish us from others. It just takes more time to try to go through the dialogues so that they remember they are talking to us and not some other competitors who are in bankruptcy. So that’s manageable, but it does affect the process. As far as tons that will be on the market, I think most of the bankruptcies in years past, a lot of the bankruptcies, there were still lot of capital available to those companies within bankruptcy. And so therefore they could come out and reorganize, get new financing and keep the production levels just rolling. I think the investment market today is different. So I think the creditors are going to won – more than likely the debt financing size, as well as the creditors who want to get these companies out of bankruptcy sooner than later. So they won’t try and drag it out. And secondly, I think that they are going to force these debtors to go ahead and rationalize their production is truly above – their costs are above their contract position is not sustainable, so that they can extract the value of the contracts they’ve got. So that’s one reason why I believe there will be an acceleration. Supply going down because I think the lenders are going to evaluate the true cost of these operations and the sustainability of those and rather than these folks continuing to [indiscernible] with high cost mines in making the small amount of money on above market contracts that they will bring some disk on the failure [ph] leaving lot of money on the table here so why don’t you go and check that production down, sell the contract or buy some production to put on that contracts so that we all get more cash flow to take care of your obligations.

And last one from me in terms of the warm winter, I mean how much do you think that that contributed to the quarter here and how would a normal winter help you?

As I said, when we – so typically we will sit down, I mean all our contracts pretty much require ratable shipments but they also having that the parties will sit down and discuss on a quarter-by-quarter basis what the shipping schedule would be. So in the fourth quarter we establish a shipping schedule for the first quarter and the warm weather impacted that by the 600,000 tons for us. So those tons were committed I mean, they were committing contracts but verbally we had shipping schedules for those tonnages that were in our plan that did not get delivered as we went through the quarter we were getting push back saying our inventories are full, we’re not burning we don’t need it and you just delay it. We’ll take it by the end of the year but we need some help here because our inventories will full. At the – they were at a level they didn’t want to increase them I should say. And so that’s for us it was about 600,000 ton impact on our sales.

All right. Thanks very much.

Thank you. And our next question comes from John Bridges from J.P. Morgan. Your line is now open.

Good morning, I hope your throat will get better soon, Joe.

The allergies of spring you know.

I’m just wondered, you’ve been planting the seeds of your next businesses, I just wondered if you could talk a little bit about to what you doing there obviously you keep on spending there so you’re enthusiastic about it, talk a little bit around that and where you see that side of the business going? Thank you.

The question really refers same specifically to our minerals investment.

Yes.

And yes, we are back leased we continue to fund that investment consistent with what we’ve shared with you in the past, so we’re spending and we investing, I should, say $4 million to $7 million a month is anticipated. So we have been successful in acquiring some minerals primarily in the STACK play in Oklahoma, as well as the Permian which accounts for most of our ownership. We feel like we are aggregating large positions there that as we grow and scale it just increases the value what we are bringing to the table. So we are comfortable with that investment and we believe it is going to remind us some very nice returns as we look forward to the minerals being produced. As far as cash flows we expect this – we’ve already were seeing to some modest distributions from the royalties in lease bonuses or some leases that we’ve already entered into. And we expect that these cash flows begin to ramp up next year and in the following years. So this is a long-term investment where we expect to make mid to high teens unlevered returns on our cap.

Very nice. How big a part of your business do you think this could become in the medium-term.

We’ve made $144 million commitment accounting that our first tranche and our second tranche when you look at the exact ownership that we have, we had this was an annual program that started last year rolling into this year, so we will need to sit down all day to talk about continuing that program probably starting in the third quarter of this year to determine whether we can continue this at the same pace or whether there are opportunities to accelerate that. But right now we are hopeful that we can continue at some level going forward but we have not – we don’t have an option so it will have to be a negotiated transaction with them to determine a mutual interest to continue investing at the level we’ve been investing.

Okay great. Well, congratulations on the results. And get well soon, thanks Joe and Brian.

Thank you John.

Thank you. And I’m showing no further questions from our phone lines, I’d now like to turn the conference back over to Joseph Craft for any closing remarks.

Thank you Chrisville. In conclusion, ARLP’s financial strength and low cost strategically located operations leave us well-position to benefit as coal pricing and demand recovers. Being willing to make the difficult decisions necessary to see us through this challenging market downturn until the market recovers we are confident of our ability to deliver on our goal, of creating long-term value for ARLP and AHGP unitholders. We appreciate your time this morning, as well as your continued support and interest in both ARLP and AHGP. And our next quarterly earning release and call are currently schedule for late July 2016. And we look forward to discussing our second quarter results with you at that time. This concludes your call, thanks to everyone for your participation.

Ladies and gentlemen, thank you for participating in today’s conference. This does conclude the program and you may all disconnect. Everyone have a wonderful day.