Warrior Met Coal, Inc. (HCC) Q2 2017 Earnings Report, Transcript and Summary

Good afternoon. My name is Rocco, and I will be your conference operator today. At this time, I would like to welcome everyone to do Warrior Met Coal Second Quarter 2017 Financial Results Conference Call. [Operator Instructions] Before we begin, I’ve 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’ve 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. Here today to discuss the company’s results are Mr. Walt Scheller, Chief Executive Officer of Warrior Met Coal; 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 2017 results. After my remarks, Dale will review our results for the quarter in additional detail, and then you’ll have the opportunity to ask any questions you may have. On our last call in May, our first as a newly public company, we outlined the factors behind our unique value proposition; namely, the strength of our premium high-quality product to commence high-price realizations in a unique go-to-market strategy; highly productive world-class assets; a flexible operating profile; and a low variable cost structure that allows for a high cash conversion. I’m pleased to say that our performance this quarter validates our business model and our strategic positioning. Our revenues and profits were again at record highs, and we generated adjusted EBITDA of $188 million in the second quarter. The drivers behind this performance are predicated on several key factors. We have a flexible mine plan, a variable cost structure in areas like labor, royalties and logistics and a clean balance sheet. All of these allow us to provide an agile operational response to price swings in the hard coking coal price, in this case, ramping up quickly and successfully to capture meaningful upside in the current market. At the same time, our exceptionally low cost structure combined with a high premium quality product results in us our having some of the highest price realizations and operating margins of all U.S. met coal producers. I want to emphasize that because operating and cost flexibilities are important we’re committed to maintaining our unique model so that we can perform strongly across a full range of market conditions. Last year second quarter was the company’s first period since we acquired our assets, so comparisons to 2016 are of limited use because we run our operations very differently than the company from which we acquired the assets. Both mines and all three longwalls were in production during the second quarter of 2017 as compared to the second quarter of 2016 when only one longwall was in production, and the other two longwalls were idle. In addition, we were running eight continuous miners in the second quarter of 2017 versus three in the second quarter of 2016. Total production in the second quarter of 2017 was 1.9 million short tons compared to a little more than 900,000 in the second quarter of 2016, representing a 109% increase. Sales volumes in the second quarter of 2017 were 1.9 million short tons compared to 1.1 million short tons in the second quarter 2016, representing a 72% increase. Warrior’s cash cost of sales per short ton was $82.22 for the second quarter of 2017 and $86.45 for the six – first six months of 2017. These amounts include the higher transportation and royalty cost associated with higher realized prices compared to 2016. Remember, those figures are FOB at the port in the vessel, which differs compared to many other U.S. coal companies that report FOB at the mine. These figures reflect tight control on spending and the leverage of the higher production from the mining operations. As many of you know, there was no hard coking coal industry benchmark price set for the second quarter of 2017. The industry benchmark price was replaced by a new average index pricing methodology beginning with the second quarter settlements. I’ll provide further comments on the industry shift away from the quarterly negotiated benchmarks later in my prepared remarks. For our customers who priced exclusively on the set benchmark price, we agreed to use the industry index-based pricing formula for our second quarter settlements. For reasons I will explain later, this settlement use the average of the Platts and TSI indices for the months of March, April and May and resulted in the second quarter industry index price of approximately $194 per metric ton or $176 per short ton. Met coal prices spiked in April, which we believe was primarily attributable to the temporary supply disruption impact of Cyclone Debbie in Australia. Prices trended down over the remainder of the second quarter, as coal mines and infrastructure in Australia resumed their full capabilities. Early in the second quarter, we were able to capitalize on the higher spot market prizing, as demonstrated in our average sales price realizations and higher volumes. We sold a number of vessels priced at a 3% to 5% premium to the index price when prices spiked. We sold 1.9 million short tons in the second quarter at an average net selling price of $181.14 per short ton, which represents a gross price realization of a 104% of the industry index price less 1% for quality adjustments and the merged cost for a price realization of a 103% of the industry index price. As this quarter demonstrates, we have the production capacity to participate fully in market up swings, even as we maintain a lean cost structure that will serve to protect the company’s operations and financial stakeholders from the downside risk of future pricing cycles. In fact, our production ramp-up continued in both mines during the second quarter, marking further progress toward our nameplate capacity of approximately 8 million short tons per year. We added another 33 miners and one continuous miner section during the second quarter and expect to add approximately 120 more miners by the end of the year. We produced 1.9 million short tons of coal in the second quarter, which brings our year-to-date total to 3.5 million short tons produced with only one longwall move. Production in the second half of 2017 will be lower than the first half, reflecting the need for three longwall moves based on our current mining plan. As we near the end of the mining in the current longwall panels, tons per foot are reduced, equipment is nearing rebuild and mining conditions can be much more challenging. In addition, our second half of the year will include significant capital spending on new equipment orders as well as repairing and rebuilding existing equipment. However, we are on track to meet our full year guidance as we have outlined in our press release issued earlier today. As a result of the higher production for the first half of 2017, we ended the second quarter with 612,000 short tons of coal inventory. While this amount is higher than we would like to have on hand normally, it was the result of a strong ramp-up in production coupled with Tropical Storm Cindy in the Gulf, which impacted the loading of two vessels at the end of the second quarter. We believe these inventory levels will decreased as the longwall moves reduce production in the second half of the year, and we opportunistically sell the additional tons to our customers or on the spot market. We believe we are well positioned with our inventory levels to take advantage of the current market price conditions. I’d like to thank all of our employees for a job well done so far in 2017. Their performance in the operations, attention to safety, compliance, production and cost are what makes us a successful organization with the results we have achieved so far this year. It is no question that safety is a top priority for Warrior and a mindset which is at the forefront of everything we do each and every day. We’re committed to working safely everyday as we drive forward Warrior success in the marketplace. I’ll now ask Dale to address our second quarter results in greater detail.

Thanks, Walt. We are very pleased with our results for the quarter. While this is only our second quarter results as a public company, we are not a new operator, and Warrior’s second quarter results should provide further reinforcement for the long-term strength of the company’s financial and operating platforms. As the second quarter of 2016 was the first full quarter following the closing of the asset acquisition last year, our second quarter 2017 results are the first to provide a year-over-year comparison using periods in which Warrior’s new corporate and cost structures were largely in place. Please keep in mind that the degree to which Warrior’s operations have changed compared to Walter Energy still limits the usefulness of comparisons involving the first three months or first six months of this year versus the same periods in 2016. As Walt stated earlier, both mines and all three longwalls were in production during the second quarter of 2017 as compared to the second quarter of 2016, when only one longwall was in production and the other two longwalls were idled as a result of difficult pricing environment back then. For the second quarter of 2017, net income was $130 million or $2.46 per diluted share. Adjusted net income was $133 million or $2.52 per diluted share, which excludes the nonrecurring transaction cost associated with the IPO in April. Year-to-date, net income totaled $238 million or $4.52 per diluted share, and adjusted net income was about $250 million or $4.73 per diluted share. Both net income and adjusted net income in the second quarter of 2017 well exceeded the second quarter 2016 amounts. Adjusted EBITDA for the second quarter of 2017 was $188 million and increased $53 million over the first quarter of 2017. This increase reflects the higher sales volume and a lower cost of production in the second quarter, offset by somewhat lower average net selling prices. Adjusted EBITDA in the second quarter of 2016 was only $8 million. Adjusted EBITDA for the first six months of 2017 totaled $324 million and reflects good progress in the ramp-up of our operations and a positive pricing environment. Total revenues for the second quarter were $363 million, which included met coal sales of 1.9 million short tons at an average net selling price of $181.14 per short ton. Total revenues in the quarter exceeded the second quarter of 2016 by $272 million on significantly higher sales volume and average net selling prices. Our second quarter gross price realization was a 104% of the industry index price, with a net realization that was significantly higher than the second quarter of 2016, which reflected a low met coal price environment at that time. Cost of sales was $160 million or 44% of total revenues. These costs primarily consisted of met coal sales of 1.9 million short tons at an average cash cost of sales of $82.22 per short ton compared to $93.75 in the first quarter of 2017. Our cash cost of sales was positively impacted by higher production volumes and good cost control during the second quarter and the first six months of the year. SG&A expenses were almost $9 million or 2% of total revenues, which continue to reflect the benefits of a restructured business without Walter Energy’s legacy cost and liabilities, which were not assumed in the asset acquisition. The second quarter expenses were almost $3 million higher than in 2016, primarily reflecting expenses associated with being a public company. These included incremental independent auditor expenses, legal expenses, D&O insurance expenses and stock compensation expenses. Depreciation and depletion costs for the second quarter of 2017 were $20 million or 5% of total revenue. Transaction and other costs decreased to $4 million in the second quarter compared to $9 million in the first quarter of 2017. These expenses primarily consist as nonrecurring professional fees incurred in connection with the initial public offering in April. Interest expense was $642,000 in the second quarter and included interest on our equipment promissory note plus amortization of our ABL facility debt issuance cost. For the first six months of 2017, interest expense totaled $1.2 million. The company recognized income tax expense of $33 million for the second quarter of 2017 and $35 million for the first six months of 2017. The increase in income tax expense was mainly the result of higher pretax income from higher sales volume and pricing in the second quarter. The income tax rate also increased in the second quarter of 2017 as compared to the first quarter, in significant part as a result of limitations in our ability to utilize the company’s available net operating losses or NOLs, which are currently limited in the amount that can be used in any given year under Section 382 of the Internal Revenue Code. For the full year 2017, the limitation is estimated to be just slightly higher than $140 million. However, our effective tax rate for the second quarter of 20% was less than the statutory rate, primarily as a result of changes in our valuation allowance against deferred tax assets and percentage depletion deductions. We continue to maintain a significant valuation allowance against net deferred tax asset positions due to our cumulative losses in recent years, which limit our ability to look to future taxable income in assessing the realizability of these assets. Since we have exceeded the estimated annual use limit of our NOLs under Section 382 of the tax code for 2017, we would expect our effective tax rate for the remainder of 2017 to be closer to the statutory rate depended upon many factors, including the volatile met coal pricing environment and the evaluation of the company’s need for a valuation allowance against deferred taxes assets. In addition, if we receive a favorable decision on the private letter ruling that was submitted IRS, it would allow us to utilize all of our federal NOL carryforwards without an annual limitation, which would significantly reduce our tax rate for the remainder of 2017. There can be no assurance the IRS will grant this private letter ruling or that they will rule favorably on our request. During the second quarter, the company generated a $145 million of free cash flow, which was the result of cash flows provided by operating activities of $162 million plus cash used for capital expenditures of $17 million. Free cash flow increased by $9 million or 167% from the first quarter of 2017, mostly on higher sales volumes, pricing and less use of working capital. Cash flows used in financing activities were $3 million in the second quarter of 2017 and $194 million year-to-date, primarily due to dividends paid. Our net working capital decreased by about $13 million from the first quarter of 2017 on lower accounts and other receivables, higher accounts payable and accrued liabilities and somewhat lower sellable coal inventory. Sellable coal inventory decreased from 674,000 short tons at the end of the first quarter to 612,000 short tons at the end of the second quarter of 2017. Our capital expenditures were $17 million during the second quarter of 2017 and totaled $28 million for the first six months. We expect that the long lead times on purchasing new equipment or rebuilding key pieces of machinery equipment will result in the majority of our cash spending to occur in the second half of 2017. We expect our total 2017 spending on capital expenditures to be in the range of $97 million to $117 million. We evaluate our capital spending on an ongoing basis in connection with our mining plans and the prices of met coal, taking into consideration the funding available to maintain our operations at optimal production levels. Our total available liquidity as June 30, 2017, was $256 million, consisting of cash and cash equivalents of $156 million and $100 million available under our ABL facility. We currently do not have any outstanding borrowings under the ABL facility. As we noted in our first quarter earnings call, the Board adopted a policy of paying a quarterly cash dividend of $0.05 per share. Earlier this week, the company announced its next quarterly dividend of $0.05 per share to paid on August 23, 2017, to stockholders of record at the close of business on August 14, 2017. Now a word on our outlook for the full year of 2017. Given the results of our second quarter and the three planned longwall moves in the second half of the year, we are reiterating our previously issued guidance for the full year of 2017. I’ll turn it back to Walt.

Thanks, Dale. Before we move on to Q& A, I’d like to discuss the new index pricing formula for our traditional benchmark customers as well as provide an update on how we are looking at the marketplace. The new industry pricing formula for establishing the quarterly price will be the average of the prices of the Platts and TSI indices on a one-month lag basis. For example, the industry average index price for the third quarter will be the average of the two indices for the month of June, July and August. It is likely that the method will be adjusted as the process evolves over time. This change is part of what is shaping up to be an industry-wide response to the rapid reduction of supply from Queensland following Cyclone Debbie. The significant market dislocations underscored the limitations of using a quarterly benchmark price for hard coking coal, and we have joined a number of the major players in the marketplace in adopting a more flexible solution for the months and years ahead. We know this impacts our modeling, so we’ll do our best to keep you updated on how this works. Bear in mind, there maybe further changes given it’s still in early stages. We believe this new approach represents an improvement over quarterly benchmark pricing and approaches deficiencies were apparent even before the recent supply disruption in Queensland. Bilateral negotiated settlements have at times been protracted and difficult, with market participants struggling to arrive at a consensus amidst large swings in pricing. By moving to an index priced – based pricing mechanism, both producers and consumers of hard coking coal will enjoy greater transparency and easier settlements. In terms of a financial impact on Warrior, we believe the long-term implications of this switch will be relatively limited because of Warrior’s world-class, high-premium products and go-to-market strategy. The old quarterly benchmark allowed for a fixed price with limited upside and downside exposure, provided settlements could be negotiated in line with the benchmark. The new index-based pricing formula could expose market participants to great volatility. This will allow us to more readily participate in both the downside and upside of changing market conditions. The pricing environment continues to be very volatile. We saw spot prices spike to over $300 per metric ton in April and turned downward to a low of $139 on June 15. Since that date, prices have risen to over $170 per ton in July. The seaborne met coal market continues to be driven by supply and demand factors coming out of China and Australia. On the demand side, China’s met coal imports have been strong, in line with its strong economic results, with Q2 GDP of plus 6.9% year-over-year. On the supply side, some Chinese mines are voluntary choosing to rationalize production as they struggle to maintain normalized levels of production, while Australian producers have had to cope with flooding in Queensland and the seasonal maintenance as well as several coke works said to be down for maintenance or as a result of a lack of coal in mid-July. In closing, we’re extremely pleased with our results for the quarter, and we believe we are on track to meet or exceed our goals for the remainder of the year. With that, we’d like to open the call for questions. Operator?

Thank you. [Operator Instructions] Today’s first question comes from Curt Woodworth of Credit Suisse. Please go ahead.

Hey, good afternoon, guys.

Hi, Curt.

Hey, Curt.

Just a question on the cost guidance. I think during the IPO process you guys talked about a $200 per ton benchmark you’d be roughly $95 a short ton cash costs. You came in at $92 a short ton this quarter on somewhat of an equivalent benchmark. And the guidance implies sort of second half costs basically above, I think, the 1Q level. Yet you had a longwall move in 1Q and, obviously, the benchmark price is extremely high, so the sensitive cost there. So can you just talk me through – is anything changing? Like why would you potentially not lower your cost guidance? And what is the benchmark assumption, I think, embedded in your cost guidance? That’s my first question.

Yes. I think, Curt, there you can’t take a single quarter in isolation here when you look at that guidance because in the first half we only had one longwall move, and we have three in the second half. So as we said in our prepared remarks, production won’t be as high as it was in the first half. So you do not get the full leverage in the second half. And obviously, prices being as high as they were in Q1 and Q2, we certainly don’t expect that in the second half. And even though, they’re fairly high today, I think around $180-ish per metric ton, but that’s – we’re running favorable to where we thought we would be. But again, as I said, the second half we’ve got three longwall moves, and they’re pretty tight in timing. And you could have some disruptions from just all those moves in the second half, and that will influence that cost number.

Okay. Makes sense. And just on the ASP realization getting the premium to benchmark. Can you just comment on the ability to continue to do that? I know that you had some deals through, I think, Xcoal that were based on benchmark plus. Will those continue into the third quarter?

Well, our partnership with Xcoal is already proving to be very helpful. And as we said during the last call, we were able to achieve a few sales that were above the index price. And my expectation is that our partnership continue to deliver strong results and favorable results. So my expectation is we will continue to do very well with them as a partner.

Okay. And then just lastly on capital allocation. Has the board or you guys made any more formal decisions around returning capital to shareholders? I mean, you generated 20% of your enterprise value roughly in free cash flow the first half of this year. So would it be safe to say that by the end of this year or soon after you – there would be capital returned to shareholders?

Well, it’s a possibility in the second half. To start with, this is only our second quarter of posting results publicly. And we’ll be very thoughtful in evaluating all of our different options here as we look into returning cash to shareholders. One thing just to point out, as we said in our prepared remarks, we do have to fund the majority of our CapEx in the second half this year, and that’s over $80 million just in the second half. But with that said, we are very focused on utilizing our cash flow to maximize value creation for our shareholders. And we’ll continue to evaluate our options with respect to the capital allocation. I think we’ve demonstrated by announcing earlier this week our second quarterly dividend. So we have implemented that part of it. We did talk about a capital allocation program that was announced in our Q1 call. So we are committed to it. Once we do reach our formal decision, we’ll provide some more clarity around that later this year.

All right. Congrats on a great quarter. Thank you.

Thank you.

And our next question today comes from David Gagliano of BMO Capital Markets. Please go ahead.

Great. Thanks for taking my questions. Curt actually hit a lot of them, but I did – I just wanted to actually follow up on one of his questions on the cost guide for the year. I totally understand the impact or the comment regarding longwall moves, but there – presumably, there are again some offsets with prices being lower and the pricing-related components not hitting costs in the second half. So I’m just wondering if you could help quantify what you expect the impact to be from longwall moves on unit costs? And – in the second half versus the second quarter, any offsetting impact associated with pricing being lower? And then maybe in those comments, you could answer the question that Curt asked on what price are you assuming for the second half of the year to calculate that cost number?

All right. Thanks, David. I’ll answer the first part of that question. In terms of the cost changes based upon the longwall moves. Each one of these longwall moves, we anticipate an impact of 100,000 to 150,000 tons. So we have three longwall moves throughout the remainder of the year. And you still have all the associated mining costs with running these operations go in those moves, so you have the associated increase in costs with the lower ton. We’re being conservative in our approach. And that is in part because these three longwall moves will happen within, I would say, about a 60-day period during the rest of the year. And packed that close together, a lot of this equipment we use on each of these moves. So we’re trying to be careful in how we are projecting the performance through these longwall moves. So that’s what’s driving that. In terms of the cost differentials associated with the lower price, where that will play itself out is to be seen because with the index pricing we don’t know where that pricing is going to end up. And the real impacts for that are going to be around transportation primarily, and hopefully, the price will stay up high enough that it’s not an impact on our labor costs. But Dale, I don’t know if you have anything to add?

No. I think we have upside for our cost number there, can be in the lower end of our range. We’re just – everything has gone so well in the first half you can’t always expect it to go as well for all of those 12 months, so we do have a little caution in that’s this is only our second quarter reporting and we’re ramping up. We have a tremendous amount of new people that we’re training, and some – a large number of these people have never been through a longwall move. So you have inexperience people completing some of these moves. So we’re just being cautious in our estimates, and there is potential for upside.

Okay. Great. Completely understood and appreciate the answer. And congrats on a good quarter.

Thank you.

And our next question today comes from Jeremy Sussman of Clarksons. Please go ahead.

Hi. Good afternoon, Walt and Dale.

Hi, Jeremy.

Hey.

Can you – Walt, can you remind, or Dale, of the sort of mix of what you would maybe characterize as stock versus you’re kind of the new index kind of quarterly contracts this past quarter?

This past quarter the – we still had a lot of customers that were expecting benchmark, so when that didn’t happen – they weren’t really spot sales. A lot of them were based on an expectation, an index. But looking at the index for anywhere 20, 30 days before or after loading, it was kind of a mishmash of how we did. We had some of the benchmark customers that at the end of the quarter went with the new formula that is – was proposed from the Japanese settlements with those customers. So we had a little bit of a mishmash of everything, Jeremy. We had some spot sales, some index and some based on the formula.

Okay. And going forward, once things seem to normalize, if you will, what sort of mix should we should think of?

Well, I don’t know what normal is going to be yet. I think we still have maybe 20% of our tons where customers – we know customers want to use those – that formula on a lot of the others. Some of them wanting to set a fixed price, which is kind of a spot price. And some of them are continuing to use the – some type of an index formula based upon a number of days before and/or after the loading.

Okay. That’s helpful. And maybe just one quick follow-up. It sounds like you have a decent amount of coal in inventory. There’s been some talk in one of your Alabama competitors having some production issues. Have you guys any sort of increased – any benefit, any increased increase on that front recently?

You know what? There are some – with those issues, we are – we do have some inbound calls, and we’re looking at our sales book for the third quarter and making sure that we’re trying to maximize the value of that inventory. But, yes, there are some inbound calls.

Got it. All right. Well, good luck and very nice quarter. Thank you.

Thank you.

And ladies and gentleman, our next question comes from Alex Hacking of Citi. Please go ahead. Hello, Alex?

Hi. Yes. Hi, Walt and Dale. Sorry, I was on mute there. Could you remind us of the timing of the three longwall moves between the third quarter and the fourth quarter? Will they be…

Two of – I’m sorry. Two of the moves will definitely occur in the fourth quarter. The third move is straddling the third and fourth quarter. So it could happen late third quarter, early fourth quarter.

Okay. And I seem to remember at some point – and I could be misremembering here, but you guys saying each longwall move would typically impact production by about a 100,000 tons. Is that fair? And if so, it does seem like your production guidance for the second half seems a little conservative?

Well, we’ve been a little very conservative. And what I said – I think I said earlier was 100,000 to 150,000. And that’s because with these three longwall moves all being piled up right on top of one another back-to-back, we have to realize there is an awful lot of equipment that has to be rebuilt, turned very quickly and move back into the next operation in order for the next longwall move. And with them packed this tightly together, we’re just – we’re taking a conservative approach to our expectations. Naturally, we will push as hard as we can to get those longwall moves done as quickly as we can, but we don’t want to be unrealistic in our expectations.

Okay. And any guidance on how much ideally you would like to reduce inventory in the second half?

You know what? We are – we are going to – as we watch what’s happening in the markets, we’re going to do our best to maximize the value of that inventory and get it to what we consider to be the minimum level we can by year-end. I think we said early in the year that we expect that the inventory to be – or the sales to lag production by a couple hundred thousand tons, which would indicate an inventory growth in our full year projections of a couple hundred thousand tons. And I think we started the year at a little over or a little under 200,000. So our expectation is, hopefully, below that 400,000 mark but definitely below where it is today.

Okay. And then just one final question on pricing, if I may. So some of your competitors struggle to achieve the benchmark price for the quarter. And the reason given was a fairly logical one. It was that there was not much volume that was transacting during the price spike in the quarter. And therefore, they – if you look at kind of a volume-weighted benchmark, it would have been lower than what the printed benchmark was. How did you guys – I mean, is there a reason that you managed to avoid that naturally realize above the benchmark? I guess any explanation. Is there something about the way that you’re selling that meant that you were able to keep selling even into what looked like very thin volumes at those higher prices?

I think there is a few things that contribute to that. One of it is I need to give credit to our sales and marketing team here on doing a great job. I think the partnership we have with Xcoal certainly paid dividends. And I think the quality of the product beyond where our competitors in the U.S. sit is clearly a reason for – when you look at the impacted tons out of Australia, these were very high-quality tons, tons that we can replace and most other people in the U.S. cannot. So I would say it’s those factors of a strong performance by our team and our partner and the coal quality.

Okay. And just let me add to what the others said, congrats on a really strong quarter. Thanks.

Thank you.

Thank you.

And our next question today comes from Lucas Pipes of FBR & Company. Please go ahead.

Yes, good afternoon, everybody. And I want to say it right away, a great quarter, well done.

Thank you.

So I wanted to follow up on the two key issues that keep coming up here on this call, and that’s both ASP and costs. First on the selling price. Walter, what intrigued me in your prepared remarks was how you said this new index structure may do a way with kind of bilateral agreements or maybe diminish them. Could you elaborate on that? Should we kind of think of you going to your customers from here on out saying, look, the index is the index, and you’ll have to pay us right in line with that, no negotiation, this is kind of what it is? Or are we still going to see bilateral agreements on the contracting side?

All right. Thank you. I do think a lot of that will happen. Because I think a lot of these as you look at how the formula works, those that are agreeing to using the formula are agreeing that whenever that final price gets settled based upon the index price for that three-month period that we’re agreeing to it. I think that there’s going to be far less – the problem with the old methodology was in a falling market, which – if we look over the past few years, when you’d had to have a benchmark settled, and immediately you had spot tons selling into that market at a great discount, the ability to settle a deal at a – close to benchmark was very, very difficult. And I think this helps to neutralize that potential. So I do think there will still be a little of that. There’s still going to be some premiums and some discounts here and there, but I think that to a large degree that’ll be minimized.

And the two indexes that you mentioned, the Platts and TSI, those are the ones we should be looking forward to are as it may be there some differences between Mine Number seven, Mine Number four?

Yes. The – Mine Number four is a very strong mid-wall. So it always sells at a discount to the premium hard coking coal number, and that changes based on a demand scale. And there’s actually a – I can’t remember what the index is for the mid-wall hard coking coal, but there is an index for it as well.

Okay.

Platts index.

Got it. And that would be the Australian mid-wall that we should be looking to for the Mine Number four? Or – that would be the one that would come to mind?

Yes. The Australian mid-wall.

Perfect. So essentially, we look to U.S. longwall East Coast for Mine Number seven?

No. No. I’m sorry, no. It’s the Australian premium hard coking coal for the longwall and the Australian mid-wall for Mine four, so both Australian.

Perfect. Perfect. Great. And then – so – and as you mentioned that your expectation is that there might be some haggling, but really those two indexes should drive value realizations?

I think that ought to get us close.

Okay. That’s helpful. And then on the cost side, you – maybe to take a slightly different approach. In the third quarter – in the three months ending June 30, you had about $160 million of cost of sales. So should I just kind of take that $160 million for Q3, Q4, divided by my expectation of tons produced, given – adjusting for the one and two longwall moves, respectively? And should I think about that as my cost of goods sold per ton for the remainder of the year? Or should I may be inflate or reduce that $160 million figure – the gross figure you have in your income statement for Q2?

Well, I think you guys are doing or taking the results for the quarter and trying to annualize that. And you got to remember, there was 0 longwall moves in the quarter. And we also talked about adding another approximately 120 people the rest of year. So I’m going to be adding some cost there. And then you’re not going to get the leverage from the production in the second half. So think about year-to-date our cash cost of sales is about $86. So it’s going to rise up from there the remainder of the year because we’re not going to get the same production numbers that we had in the first half, which only had one move.

And just taking that cost of sales number and trying to go from there is a little bit problematic in that the real change here – real increase in cost is in the cost of production. So the royalties and transportation costs are going to be based on the price, where the cost of production is going to be based really on more of our fixed costs and labor costs, which when spread across fewer tons naturally will be higher.

Got it, got it. Okay. Well, that’s helpful. And then maybe one last one. You annualized about 7.6 million short tons in the second quarter. I think your goal is to get to that 8 million ton rate. You just mentioned you’re looking to hire more people. When do you think you’re going to be annualizing that 8 million tons of production?

There’s a lot of things that play into that, and part of it’s going to be demand and does it justify adding the manpower and getting ourselves up to that level. We talked at one point about adding CM units, which is going to help. Each one of those CM units adds between 140,000 or 150,000 tons per year. So as we do add those CM units, we’re going to get those additional tons. Our expectation is some time late in 2018 we ought to be able to get to that run rate, assuming those – that’s what we’re still trying to achieve. I would think that we can get to it at that point. You have to remember even though the second quarter went very well if you annualize just that number to that 7.6 million that doesn’t take into consideration any longwall moves, so we still have some work to do.

Perfect. Well, good luck with that and great quarter.

Thank you very much.

[Operator Instructions] Today’s next question comes from Daniel Scott of MKM Partners. Please go ahead.

Hey, Walt, Dale, how are you doing?

Good. How are you, Dan?

Good.

Very well. Thank you. So obviously, most stuff’s been asked. As far as thinking long term here, when you’re looking at mine life remaining on four and seven and then you got the Blue Creek seam, at what point in the progression through these two mines do you – and assuming decent markets and the balance sheet you have, do you start moving forward and really thinking about bringing on the – another mine at the new reserve?

Well, we are evaluating that. And as much as anything else, that is a – that’s about market outlook and assuring that the Blue Creek mine is justifiable. So we continue to look at that. We said that the last full study that was done was still done back before the acquisition. So we’re doing some work on that and trying to really zero in on what we think the actual capital cost and what the timing of that would be.

Okay. Great.

The near-term and mid-term focus is kind of more let’s ramp up these mines to the current production levels before we start heavily focusing on developing Blue Creek.

Of course. Certainly. Now when you look your – at the balance sheet, around, I think, $155 million in cash on hand right now, is there an optimum level that you need to be at to kind of weather all cycles that above which you kind of really start to make a decision about dividends special or increases of the regular?

Well, I think we have to take the amount of cash that we need to run the business into consideration. We really haven’t set a minimum target there. We do have the full availability of our ABL. And with the kind of the cycle proofing that we’ve done with our cost structure, we feel like we can run the business on a nominal amount of cash. Again, we could distribute the large amount of cash back to shareholders when we complete that evaluation and make that final determination.

Great, obviously a great quarter. Thanks guys.

Thank you.

Thanks Dan.

And our next question comes from Mark Levin of Seaport. Please go ahead.

Terrific quarter. Most of my questions have been asked and answered. Just one specifically on rail service. Obviously, CSX has been under the gun quite a bit. My understanding is a lot that has been in Appalachia, maybe in Central Appalachia, maybe in even Northern Appalachia. But have you seen any deterioration in CSX’s service? And has it had any impact on your ability to get tons out of the country?

We have not been impacted. I want to remind you that we also have the barge load out, where we can ship coal by barge from the Warrior River down to Mobile as well. So if there have been any issues where we’ve struggled to get a train or two, we’ve simply moved that coal by barge. But to date, we’ve been very fortunate with the CSX, and they’ve been a good partner.

Great. That’s perfect. Second question, carryover tons Q2 to Q3, any potential impact there on ASP to think about?

No. Not in this quarter.

Great. Okay, that’s all I have. Thanks very much.

Thanks Mark.

Thank you.

And the next question today comes from Patrick Marshall of Cowen & Company. Please go ahead.

Hi guys. A more general question for you. Within your cost structure, you say it’s variable and can adjust to benchmark pricing. How – what buckets are there? Like what are the big parts within that, that are variable and make it so that you are essentially hedged against weak coal pricing?

Three major buckets; labor cost, transportation cost and royalties.

Could you perhaps maybe go into a bit more detail on how those are hedged?

The labor costs is hedged by having a three-tiered system, where – in different price scenarios, the wage rates are changed with a cap on the floor and one in between. And with the rail rates, we kind of have the same thing. There’s a floor and a ceiling, and it is variable based upon the prices in between the two. Royalties are more truly variable, completely up and down the scale.

Okay, that’s helpful. Thank you.

Thank you.

And the next question comes from [indiscernible].

Hi. Thanks for taking my question. Wonder can you give me a breakdown of your Number seven and Number four sales in the second quarter out of that 1.9 million ton sales volume?

Yes. We don’t usually breakdown the sales by mines. We just look at it in the aggregates. So sorry, we don’t have that information available.

Okay. Can you tell me how many you sold to Asia?

In the quarter, very little to Asia. I think it would have been less than 5% for the quarter.

Okay. And in the first quarter conference call, you mentioned that you guys were able to sell several vessels to take advantage of Cyclone Debbie. Was any of those sales at fixed price?

No. None of those particular vessels were at fixed-price. They have been above the index.

Okay, got it. Thank you.

Thank you.

All right. Thank you.

And this at this time, there is no further questions. I’ll now turn the conference back over to Mr. Scheller for any final remarks.

Well, that concludes our call this afternoon. Thank you, again, for joining us today. And we appreciate your interest in Warrior Met Coal.