Alliance Resource Partners, L.P.

Good day and welcome to the Alliance Resource Partners fourth quarter 2020 earnings conference call. All participants will be in a listen only mode. Should you need assistance, please signal a conference specialist by pressing star and then zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star and then one on a touch tone phone. To withdraw your question, please press star and then two. Please note that this event is being recorded. I would now like to turn the conference over to Brian Cantrell, Senior Vice President and Chief Financial Officer. Please go ahead.

Thank you, Tom, and welcome, everyone. Earlier this morning, Alliance Resource Partners released its fourth quarter 2020 financial and operating results, and we'll now discuss these results as well as our perspective on market conditions and outlook. Following our prepared remarks, we'll open the call to your questions. Before beginning, a reminder that some of our remarks today may include forward-looking statements that are subject to a variety of risks, uncertainties, and assumptions contained in our filings from time to time with the Securities and Exchange Commission and are also reflected in this morning's press release. 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, the partnership has no obligation to publicly update or revise any forward-looking statement, whether as a result of new information, future events, or otherwise, unless required by law to do so. Finally, we'll 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 ARLP's press release, which has been posted on our website and furnished to the SEC on Form 8K. With the required preliminaries out of the way, I'll begin with a review of our 2020 results and then turn the call over to Joe Kraft, our Chairman, President, and Chief Executive Officer, for his perspective and outlook. This morning, ARLP reported a continued rebound in our performance for the 2020 quarter, as we posted increases to all major operating and financial metrics compared to the sequential quarter. Reflecting increased sales from coal operations and higher oil and gas royalty revenues from our mineral segment, total consolidated revenues rose 3.1% to $366.5 million. Higher revenues contributed to increased net income in EBITDA, which climbed 28.8% to $35 million, and 2.1 percent to $121.4 million, respectively, each compared to the sequential quarter. The entire alliance organization remained focused on optimizing cash flows by controlling working capital, expenses, and capital expenditures, and these efforts continued to strengthen ARLP's balance sheet and financial position. During the 2020 quarter, ARLP generated free cash flow of $90.6 million, reduced debt and finance lease obligations by $67.8 million, and increased liquidity by $70.2 million. Our total leverage improved by 9.5% from the sequential quarter to 1.53 times, and we ended the year comfortably in compliance with all of our debt covenants. Turning from our consolidated results, let's take a closer look at the performance of ARLP's business segments. For our coal segment, Sales and production volumes were both higher compared to the sequential quarter, with total coal sales volumes rising 4.8% to 8.1 million tons and coal production increasing 3.4% to 7.4 million tons. Increased sales volumes more than offset lower price realizations, driving coal sales revenues higher by 2.9% to $345.6 million dollars. Ongoing expense control initiatives at all ARLP operations during the 2020 quarter led costs per ton lower compared to the sequential quarter, as total segment-adjusted EBITDA expense declined 2.3% to $27.38 per ton. Increased revenues and lower costs drove segment-adjusted EBITDA sequentially higher by 4.8% to $129.8 million. AROP's focus on reducing coal inventories and matching production to meet customer requirements reduced total coal inventory to approximately 600,000 tons at the end of the 2020 quarter, compared to 1.2 million tons at the end of the sequential quarter. The performance of our mineral segment also improved in the 2020 quarter. Compared to the sequential quarter, Stronger commodity pricing pushed ARLP's average realizations per BOE higher by 29.6% and drove segment-adjusted EBITDA for our mineral segment up 15.1% to $10.2 million. While stronger commodity prices have encouraged a gradual resumption of drilling and completion of wells on our acreage, the effects of dramatically reduced operator activity in the second and third quarters of 2020 resulted in a 10.7% decrease in production volumes per BOE from our mineral interest compared to the sequential quarter. It should not come as a surprise that the impacts of reduced global energy demand resulting from effects of the COVID-19 pandemic negatively impacted ARLP's results compared to the 2019 quarter and year. Reflecting lower coal and oil and gas volumes and prices in the 2020 quarter, total revenues fell 19.2% compared to the 2019 quarter, and EBITDA declined by 3.8%. In a testament to the efforts of our teams to respond to the pandemic, net income for the 2020 quarter actually increased 35.6% compared to the 2019 quarter, as the benefits of ARLP's expense reduction initiatives more than offset lower revenues. Total revenues for the 2020 year fell 32.3%, to $1.33 billion, leading adjusted net income and adjusted EBITDA lower to $27.8 million and $386.7 million respectively, compared to $244.6 million and $599 million respectively for the 2019 year. While we certainly experienced challenges during 2020, ARLP was able to achieve several impressive accomplishments. As noted in our release this morning, during 2020 we significantly reduced working capital requirements, capital expenditures, operating expenses, and G&A, paid down approximately $197 million of total debt and financing leases, increased liquidity by nearly $220 million, and generated approximately $280 million of free cash flow. With that, I'll now turn the call over to Joe. Joe?

Thank you, Brian, and good morning, everyone. I'd like to open my comments this morning by reflecting on the extraordinary performance of our people in 2020. We enter 2020 anticipating significant growth in our mineral segment, while at the same time prepared to manage challenging coal markets due to low natural gas prices, tepid coal demand, and an overhang of coal supply. None of us, however, could have anticipated the COVID-19 pandemic and its devastating impact to energy demand. As we have always done, the entire Alliance organization met these unprecedented challenges head on, rapidly responding to safeguard the health and safety of our people, protect our balance sheet, support our communities, and operate prudently as an essential supplier to our customers. to help ensure the reliability of the electric grid so critical to the markets we serve. Despite the disruptions encountered during the year, our teams performed at the highest levels across the entire organization, including our coal mines delivering the best safety record in the history of Alliance. The effectiveness of their response clearly demonstrated their flexibility, resilience, innovation, and determination to succeed. For their dedication, commitment, and all that they accomplished during such a tumultuous year, I extend my sincerest appreciation. We enter 2021 hopeful that economic activity and energy demand will continue to improve as vaccines become more available. In the U.S., increased power generation and higher natural gas prices point to the possibility of gas-to-cold switching and projections of increased coal demand in our primary markets. Conditions are improving in the international markets as well. Cold weather across Europe and Asia, sharply higher LNG prices, a weakening U.S. dollar, and supply disruptions related to trade disputes are all supportive of potentially increased participation by U.S. producers in both the thermal and metallurgical export markets. Consequently, ARLP continues to target a 10% year-over-year increase in total coal sales volumes this year. During the 2020 quarter, ARLP contracted for 4.1 million tons of coal sales to be delivered in 2021, lifting our commitments to 78% of anticipated coal sales at the midpoint of our guidance for this year. While pricing for the newly contracted tons were greater than published spot prices, they were mostly lower than the expiring legacy contracts. As a result, we currently anticipate ARLP's 2021 average cold sales price per ton to decline approximately 4% to 8% from last year's average. Our mines did a great job reducing operating expenses and capital during 2020, and their efforts are expected to continue to benefit 2021 as well. For the full year 2021, we currently anticipate segment adjusted EBITDA expense in a range of $27.50 to $30 per ton sold, a decrease of approximately 5% at the midpoint of our guidance compared to 2020. Estimated capital expenditures of $120 to $125 million for 2021 are comparable to last year. For our mineral segment, the significant reduction in drilling and completion activities by operators during 2020 that Brian mentioned earlier will continue to impact volumes produced from our minerals in 2021. Although drilling and completion has improved from the historic lows experienced last year, It takes time for increased activity to overcome the impact of such dramatic declines. As a result, as we saw during the 2020 quarter, AEROP currently anticipates total BOE volumes from our acreage will decline from year-end 2020 levels during the first two quarters of 2021 before gradually increasing over the second half of the year. Pricing for oil, natural gas, and natural gas liquids have shown strength recently And if the forward commodity price curves are sustained, we currently anticipate higher year-over-year price realizations in 2021 and a modest increase in the EBITDA contribution from our minerals segment this year. We believe ARLP's current outlook for 2021 supports a return to unit holder distributions this year. Assuming first quarter results are in line with our expectations and our current outlook for the future does not change, I expect management will recommend the Board consider declaring a distribution to unit holders at its next quarterly meeting in April. The Board will determine whether to do so, as well as the amount of any future distribution based on numerous factors, including business and market conditions, ARLP's future financial and operating performance outlook, and other capital allocation priorities. Looking ahead, we see a bright future for Alliance despite recent headlines and rhetoric that may suggest otherwise. Low-cost, reliable energy is critical to the well-being and success of our country. We are proud of the role Alliance plays in supporting the desires of the communities we serve to benefit from a thriving economy, a high standard of living, and a quality of life that allows them to flourish. We firmly believe that the products ARLP delivers, coal, oil, and natural gas, will remain essential to achieving these desired outcomes for years to come. We are also aware of the opportunities likely to be created by the ongoing transition toward new energy and power technologies. As we seek to create long-term unit holder value, ARLP is actively evaluating various strategies to utilize the cash flows from our existing assets to pursue opportunities in these developing areas, which we believe have the potential to generate attractive long-term returns and sustainable cash flow growth. As these evaluations crystallize, we will execute on future opportunities in a disciplined and balanced manner, focused on optimizing cash flows from existing assets, pursuing strategic external opportunities, protecting our balance sheet and returning cash to unit holders, maintaining access to capital markets, and generating attractive long-term total returns for all of our stakeholders. That concludes my prepared comments, and I'll now ask the operator to open the call for questions.

We will now begin the question and answer session. To ask a question, you may press star and then 1 on your touchtone phone. If you are using a speakerphone, please pick up your handset before pressing the keys. If at any time your question has been addressed and you would like to withdraw your question, please press star and then 2. At this time, we will pause momentarily to assemble our roster. Our first question comes from Lin Shen with height. Please go ahead.

Hi, good morning. Thanks for taking the call.

Sure.

Two questions, Joe and Brian. The first is maybe you can talk a little bit about, you know, with the new administration, we heard a lot of discussions that there's going to be more projects for wind and solar, for utilities, for energy. So what are your expectations for, like, your customers, growth in profile of their alternative energy so that your demand is going to be more, not only from natural gas, but also a lot more from their alternative energy?

It's our view that in the energy space, we're talking about really some long-term planning that needs to be made. Obviously, policy decisions made by government can influence those decisions and those plans. But when we assess the demand for coal and the length of the power plants that are going to be operating over the next two decades, we find it hard to believe that these policies are going to change much. I find there's very many contradictions in the policies that are being advanced right now. Because on the one hand, they want to put a stop to building pipelines. They want to put a stop to building natural gas plants. And I don't know how the administration can close other baseload generating units without replacing those with baseload units. We all know the technology for wind and solar is not available today to operate as a baseload operator. the transmission systems are not designed to operate with intermittent power supply. So the vision that they articulate, and unfortunately it seems like it's more sound bites than it is a vision, is not, you know, it's a very complex situation and it's not going to happen overnight as much as they are aspirational in their goals. So I can't find anyone that's been in the energy space that would suggest that the articulation of a 2035 target for fossil neutral power generation is realistic. So as we think about our business, would we prefer to have more pro-energy policy? Yes. But the practicality of the situation is such that the demand for our product It's still going to continue to be needed for the next two decades. When you look at the size, we're right at a 30 million ton producer and a 500 million ton marketplace, so there's plenty of opportunity for us. We're a low-cost producer. We feel that there will be demand. On the oil and gas side, it's the same. I think one thing that is amazing to me is that they only focus on emissions. They don't focus on all the products that oil and gas contribute to. So when you look at the daily products that we use every day with cell phones to whatever, it all requires mining. It all requires oil and gas in large quantities. And it's not a simple solution just to try to think in terms of eliminating permits and trying to have our economy move away from fossil fuels. Today, 2019, wind and solar made up less than 3% of energy usage in the United States when you combine both transportation fuels and all uses of energy. So to think that we're going to move away from fossil fuels that was over 80% of that pie chart, is just an unrealistic expectation. As I mentioned in my prepared remarks, we do think that there will be alternative business opportunities because of these policy decisions. There will be a lot of subsidies and a lot of money directed to different alternatives to try to speed up the transition. So we'll be looking at those to participate in a way that... We feel we can get the same type of returns that historically we've been able to do. We're in the energy business. We still believe strongly in coal and oil and gas and the demand and what it's going to provide for the next decade or two. At the same time, we will look at other alternatives in the event that technology develops more rapidly and at lower cost than may be anticipated in the current environment. We could spend all day talking about this subject.

I'm sorry. No, no, no. That's good. Second question, you just mentioned that in April you might resume the distribution. I guess I'm trying to ask, in your opinion, paying dividends is still a better way to return capital or share back or what is your view?

We're going to look at all ways to utilize capital allocation. But we do believe that returning distributions is a major reason why a lot of our unit holders are in the units. And so we feel that that's an expectation and that is a definable return of capital where shareholders can participate or anticipate exactly how they look at their total return when they try to evaluate investing in our company. So we believe that that's one critical element in shareholder return. Share buybacks is another. We still have some authorization, so that's a possibility. Paying down debt, buying back bonds is a possibility. Investing in growth assets, everything's on the table as far as trying to grow our shareholder value. Great. Thank you very much. Appreciate it.

The next question comes from Lucas Pipes with B Riley Securities. Please go ahead.

Hey, good morning, Joe. Good morning, Brian. I wanted to focus a little bit on the export opportunities here at this juncture. To what extent would you say this market is open or opening up and to the extent it comes to your outlook for 2021, where would you say are the pockets of potential upside from a strengthening export market? Thank you very much.

We entered the year really not anticipating much volume in our export market. Like I mentioned, in October we had essentially all of our growth in sales was anticipated to come from the domestic market. Notwithstanding, I think the export markets have been influenced by a couple of things. The biggest thing being the China-Australia dispute and how that's disrupted flows of coal in particular, both in the metallurgical arena as well as the thermal market. Currently, that dispute is has created opportunities for U.S. producers. And we took advantage of that, booking some tons that are more in the metallurgical space, not necessarily met coal, because we have a PCI coal at our MC operation in East Kentucky. So we booked around 400,000, a little less than that, or a little more than that, from that region. And we were able to book about a little less than a million tons out of our Illinois Basin region for thermal opportunities where we saw the physical market be a little bit higher than the API2 market. And we've been able to take advantage of that to book that volume. Even though we've seen some volatility in the API2 market over the last two to three weeks, the physical market continues to be making inbound calls. So we're continuing to feel positive about that market, but it's hard to answer your question of whether that it's sustainable or not or whether all of this demand is really a result of the Australia and China dispute and how the coal flows have been disrupted as a result of that. So we're taking... an opportunistic approach at this moment in time. And if we can be able to transact at prices that we feel are attractive, then we will do so. As far as thinking in terms of projecting that this is going to encourage us to bring on more supply and believe that it's sustainable, we're not there yet. So we will continue to evaluate that market and see what happens. Nobody knows, at least I don't know, whether the Australia and China dispute will get resolved tomorrow or five years from now. I just don't know. So we're taking a cautious look, but we're being opportunistic where there's opportunity to capitalize on that. If it's at attractive prices, we'll do so.

Very helpful. Thank you. And just a quick follow-up on this. The export, thermal export met coal tons that you referenced just now, when were those booked? Was that something that occurred over the last one month or three months? Just that could maybe help us get a sense for.

I would say somewhere as late as last week and the earliest was probably Middle to November forward. That's about right. When you compare it to what we had last year, last year we were about 950,000 tons. A little over 500 in Appalachia and 400 in the Illinois Basin. We've already exceeded that. We're also a little bit more... On the metallurgical side, we do feel that that has more sustainability. So we are targeting to sell about 700,000 tons into that market more. So we've already booked a little over 100,000 tons into that market. So we're looking to sell another 700,000 this year compared to last year. It was around 450 or something.

And that would be embedded in your 2021 outlook as well?

Yes. The sales targets for MET is embedded in our guidance.

Very helpful. Thank you very much for that. And then when I look at 2021 capital expenditures, it looks like, you know, you're running at, you know, very efficient levels kind of when I think about, you know, the capital budget over the last few years. How would you describe the 2021 spending levels? Is that an adjustment to a lower price environment that's more temporary, or would you say this is a level that you could sustain for the coming years? Thank you.

So we've benefited in both 20 and 21 levels by having excess equipment from mines that were closed. So when we went from 40 million ton producer to 27 million ton producer, obviously we idled Gibson North and we idled a couple units at other operations. So we've got effectively some excess equipment that's benefiting that number. I think over the next, If we stay at this production level, I believe we can sustain this for another year or so. And then we'll see.

Got it. Got it. Thank you. And then one last one for me. Just, Joe, back to Lynn's question and your response that you might consider investments in it sounded like alternatives as well. Could you narrow that down where, where, where you think you'd could have be the most, what would be the most natural extension? And I, you know, I, I hear you that you're a supplier of energy. I'm just curious that, I mean, it's a very broad space, obviously that's still evolving. And what do you think you'd fit? You'd fit in if, if, you know, if you decide to further explore any opportunities there.

It's a little premature to discuss that publicly. I can tell you that we're in the process of establishing internal teams, and we haven't decided whether we're going to be at five different areas of investigation or seven. We've already started investigating two or three, but we have identified different areas where we've got core competencies that we want to explore, and then we're looking at just the... increased demand, you name it, whether it's transmission to batteries, to battery storage, to all kinds of different technologies in the space, that if truly the EV market moves as fast as it does, there's plenty of opportunities to do things on the EV side. So we're trying to determine where best we fit, whether it's on the power side, whether it's on the EV side, whether it's in royalties and trying to expand royalties beyond just oil and gas and coal to think in terms of using those skill sets we have. So there's plenty of people out there investing and trying to find ways to get returns for the shareholder. I mean, just look at all the SPACs that have been created. So we're not setting up a SPAC, but I guess you can start thinking, well, we've got our own SPAC. We've got this cash flow coming in. What are we going to do with it? So we're looking at a little bit of everything.

Got it. Very helpful. Joe, Brian, I really appreciate the update, and best of luck.

Thanks, Lucas.

The next question comes from Shelly McNulty with Loomis Salus. Please go ahead.

hi thanks for taking my question um first going back to you were talking about base load um power i just need a better understanding like um bigger picture kind of what percent of the total power is considered base load and how does that translate to how many tons of coal would be needed to sustain the base load given that you kind of talked about the solar and wind aren't capable of supporting you know, the steady state baseload power supply. So that's my first question. Second question is on the expansion outside of coal and natural gas into other forms of energy. Just wondering how you plan on financing that is utilizing, you know, new forms of financing such as like transition bonds. Is that something you're considering or would it be done under the current, financing you have in place, like your revolver or whatnot? Thanks.

I'll take the last one first. I think financing will be a key component of that decision. I think our focus right now is, as we think in terms of having free cash flow going forward, how do we allocate that? And right now, We would be looking in that arena, but then financing is a critical component. So if banks or other lenders are going to finance any of this growth, we're going to try to understand what financing is available and see if we can't capture some of that and maybe use some of our cash flow just as equity if you want to think of it in that way that it might be outside of our bank groups, it might be in. We haven't advanced it that far to have those discussions. Back to your first question, you really got to look at it regionally, but the simple part of what I was trying to say is when you think of the way the grid is designed, it is designed for base load generation, meaning that generation is feeding the power lines on a very consistent basis, minute by minute, with no interruption. And it allows the charge through the transmission to allow the the transmission of those electrons to be efficiently delivered. I've been advised that once you get to 30% or more of interruptible power that is going through those transmission lines, it complicates the efficiency of those transmission lines and therefore requires some reconsideration of how much capital is needed to be spent to assure that the American public receives what they want, which is when they walk in a room and turn on the switch, the lights go on without interruption, without brownouts, without unreliable electricity. So we all know that today, if you tried to charge the grid with the unreliable energy of intermittent power, the grid would not function the way we're used to and expect. So without, again, this topic could take two or three hours to get into the weeds, you know, region by region. But in theory, or in practice, what I was meaning is once you get to a certain scale with the non-reliable energy products of solar and wind, you've got to have transmission upgrades. And you're talking trillions of dollars depending on how widespread you want to make that and how fast you want to make it. So all that has to be taken in consideration on the timing of how people shut down the baseload generation.

Okay, got it. And I know I appreciate, you know, the fact that you could talk about it ad nauseum, and I actually think it probably would be good for you to put these kind of comments out there and educate people on the things that aren't being talked about. Like you said, they're only like snippets of information and somehow get, you know, I think more education, the more nitty-gritty you guys can provide in supporting these statements. Actual facts might, you know, give a little bit more support to the coal industry overall.

So we do belong to an organization called America's Power that is trying to best educate the American public on that subject. So we just need to as someone like you that are interested to understand it. So we're out there trying, but I take to heart your comments. They're very well-founded, and I agree 100% with what you're saying.

I don't know. Maybe you guys should start a Reddit group or something I talk to you about.

Maybe. That's a good idea.

I don't really understand it.

I think it's a good idea. It seems to move markets. I don't know. Thank you, Shelly.

As a reminder, if you have a question, please press star and then 1 to be joined into the queue. Our next question comes from Joe Pisano, who is a private investor. Please go ahead.

Yeah, I know in my area, there's a large institution. Now, when there's a big demand for power, say in the winter, when it gets really cold, because they're dual, they're They're gas and oil, natural gas. And they're told you better switch to such and such because we don't have enough natural gas that everyone might need. Now, this is on a small scale. How is the nation going to survive if they start closing down pipelines and stuff?

Well, I'm not exactly sure. Obviously, yeah. We know natural gas has been a transition fuel and needs to continue to be. If the vision is that we can get to a non-fossil fuel environment, then you still have to rely on fossil fuels and nuclear to bridge to that technology. And it just is not going to happen overnight. Unfortunately, I believe the Biden administration knows that. I don't know why they just can't say the truth. on that.

That's my point. They can't do it like in my city. How are you going to do this nationwide? You're talking about closing down pipelines and everything. Good luck.

Well, they say... I've been around this political game for a little while. They always... One of the comments that I always hear is it's really different to campaign and govern. So... At some point in time, you've got to stop the campaigning and you've got to start governing. And I don't think the Biden administration has moved from campaigning to governing. So I think the point you're raising, it's a lot harder to have these aspirational soundbites that meet campaign promises. It's a lot difficult when you start implementing those and determining whether they're realistic. There was an article that I read last night that was published by CNBC, the guy by the name of Eric Rosenbaum, that goes through Biden's climate change plan and the battle for America's most threatened workers. But it's interesting because it gets into the complexity of how you can transition overnight and all the unintended consequences by that. if you don't think through the steps that it takes to get to where you want to go. And what I'm hearing you say is that you're asking the question from a practical perspective, how can you one day move from one fuel to the next when you see examples where it just physically is not going to work? And I'd like to believe that... when the Biden administration starts to truly think about executing their strategy, that they'll be grounded in the practicalities and they're not going to allow the lights to just go off or homes not to get heating oil or fuel that will impact people's lives. But time will tell.

Stay tuned. Thank you, Joe.

This concludes our question and answer session. I would like to turn the conference back over to Brian Cantrell for any closing remarks.

Thanks, Tom. We appreciate everybody's time this morning, as well as your continued support of and interest in Alliance. Our next call to discuss our first quarter 2021 financial and operating results is currently expected to occur in late April. and we hope you'll join us again at that time. This concludes our call for today. Thanks to everyone for your participation.

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.