Peabody Energy Corporation

Good morning, ladies and gentlemen, and welcome to the Peabody Energy Q2 2020 earnings call. At this time, all participants are in listen-only mode. Following today's presentation, instructions will be given for the question and answer session. If anyone needs assistance at any time during the conference, please press the star followed by the zero. As a reminder, this conference is being recorded today, August 5th. I would now like to turn the conference over to Julie Gates. Please go ahead, ma'am.

Thank you. Good morning, and thanks, everyone, for joining Peabody's earnings call for the second quarter 2020. With me today are President and CEO Glenn Kellogg and CFO Mark Spurbeck. Within the earnings release, you'll find our statement on forward-looking information as well as a reconciliation of non-GAAP measures. We encourage you to consider the risk factors referenced there along with our public filings with the SEC. I'd like to now turn the call over to Glenn

Thanks, Julie, and good morning, everyone. First and foremost, I'd like to thank our employees for their continued dedication to providing essential products that are vital to so many in these uncertain times. As always, the health and safety of our employees is paramount to everything we do. We continue to operate under robust protocols and procedures in line with the CDC and other health department guidelines to help mitigate against COVID. Obviously, COVID has had a significant impact across the global economy. Specific to coal supply and demand impacts are key to understanding the backdrop in which we are currently operating. So today, I'd like to start with an overview of current market conditions and then move into actions we have taken to reposition our cost structure. I'll then provide an update on key initiatives before turning the call over to Mark to cover the financials. While the global economy continues to navigate through the pandemic, the timing, scope and scale of the recovery remains uncertain. Idle steel capacity across Europe and the Asia Pacific has greatly impacted metallurgical coal demand. Year-to-date through June, global steel production was down 6%. Excluding China, global steel production was down 14%. As a result, demand from major met coal importing countries, excluding China, has been down year to date. While we have seen some supply responses, prolonged uncertainty has resulted in continued pressure on seaborne metallurgical pricing. Highlighting how uncertain this market is, China was a net importer of steel for the first time in 11 years in June, and that was even with record daily crude steel production during the month. On the thermal side, weak overall electricity generation and competition from both natural gas and LNG has resulted in challenging fundamentals as well. Furthermore, slower economic activity continues to weigh on large importing nations, In particular, India's thermal coal imports are down 20 million tonnes from the prior year through June. While Chinese thermal coal imports were up earlier this year, uncertainty around the imposition of import restrictions have begun to impact demand. Many thermal coal imports from China were down 20% year over year. Even though we've seen some supply responses, seaborne thermal coal prices remain depressed. Indonesia exports are down 17 million tonnes through June and US exports down 7 million tonnes through May. In addition, we'd expect further supply cuts as most major seaborne suppliers have revised guidance lower. In the US, COVID disruptions have been coupled with extremely weak natural gas prices and growth in renewable generation, further pressuring coal demand and potentially accelerating the secular demand decline already underway. Through June, total load was down 4%, while coal generation fell 31% to just 17% of the generation mix. Natural gas and wind both took share, rising to 39% and 9% of the generation mix, respectively. Preliminary data for July indicates improved coal generation, And just recently we've seen an uptick in natural gas prices, that if that holds, should provide a more favourable backdrop for coal, and should the railroads be able to flex up to the increased demand. Notwithstanding this, the overall weak demand, coupled with depressed pricing, has required us to continue to aggressively pursue our cost repositioning program. To date, we've made significant progress, and we have needed to. yet still more needs to be done. We have temporarily idled production at some lines, adjusted shift schedules, scaled back our workforce, and reduced the number of units in operation. I'll go into a bit of the details. From a workforce perspective, we've eliminated an additional 450 positions since April. In total, since the beginning of the year, we've scaled back our global workforce by 15%, as we continue to adapt to dynamic conditions. Over the past 18 months, our global headcount has declined by 24% due to a combination of accidents taken as well as natural attrition. Where possible, we furloughed workers, allowing them to retain benefits while we adjust to lower demand profiles. Most notably, in mid-June, we furloughed about 280 employees and contractors at our Wombo underground mine, We have restructured the Copperbella and Morvale mines to operate as a single mining complex. We have parked three production units, which includes trucks, graders, dozers, and supporting equipment. And as a result, we've also scaled back our workforce by about 15% from the complex. We'd expect these structural changes to result in increased efficiencies moving forward. In part due to these benefits, 10 out of 17 currently owned and operated mines have demonstrated cost per tonne improvements when comparing second quarter actual results to the financial year 2019 performance, and that's even with substantially lower volumes. These improvements are most notable across our surface operations that quickly responded to and overcame rapidly declining demand. Cost per tonne at our surface operations improved 6% compared to the prior year, even as volumes dropped nearly 30%. Our underground room and pillow operations have also responded well to challenging conditions. Our long-wall operations, however, have not been able to respond as quickly to lower demand. As you could imagine, slowing down production in a long-wall operation is a bit more difficult given complexities with fixed costs and often the geotechnical desire to advance the wall. While we have made significant progress, we know we cannot stop here. We will continue to pursue aggressive actions, particularly at our long-haul operations, to improve our cost performance across the entire platform. We also continue to advance several commercial processes, including the pending PRV Colorado joint venture with ARCH and options for North Gunyella, Closing arguments in the joint venture hearing will be held next week. While we have always believed in the benefits the joint venture would bring to multiple stakeholders, the case has only grown stronger in 2020. Challenging demand conditions have underscored the need for this transaction to remain competitive with other fuel sources. We look forward to the judge's ruling by the end of the third quarter. We also recently concluded the first round of the North Gunilla commercial process in which we continue to have interest from multiple counterparties. The second round is underway and we look forward to providing an update at the appropriate time. We will continue to weigh these options against strategic development alternatives. Market conditions and the status of the commercial process are continually monitored to determine the timing of any incremental spend related to ventilation and reentry of Zone B. With that, I'll now turn things over to Mark in his first official call as Chief Financial Officer to cover the quarterly results.

Thanks, Glenn, and good morning, everyone. I'll start today by walking through a few of the notable items in the financials. Second quarter revenues declined 45% from the prior year to $627 million. on significantly lower volumes and depressed pricing. Both seaborne demand and pricing were impacted by the ongoing COVID-19 pandemic. U.S. thermal volumes and prices were negatively impacted by continued weakness in natural gas prices. In addition, the closure of Kayenta in 2019 contributed to lower year-over-year revenues and volumes. Second quarter results include a $1.4 billion impairment charge at our North Antelope Rochelle mine, despite it being a fabulous asset. Lower long-term natural gas prices, changes in timing of coal plant retirements, and continued growth in renewable generation led us to change our long-term life of mine assumptions, resulting in the impairment charge. While we still believe coal is essential to a reliable energy grid and that our PRB assets are best positioned to serve that demand, as witnessed by our 19% Q2 margins in the PRB, We do expect coal's long-term share of the U.S. generation mix to remain below prior year levels. Competition from other fuel sources, particularly natural gas and wind, remains fierce, underscoring the case for the PRB-Colorado joint venture with ARCH. As litigation continued during the quarter, we incurred $13 million in transaction costs for the proposed joint venture. As Glenn mentioned, we've taken a number of actions across the business to improve our cost structure. resulting in restructuring charges of $16.5 million in the quarter. Some of the benefits from those actions are seen in the reduction in SG&A by 35% from the prior year. Year-to-date SG&A expense of $50 million reflects the lowest level for a comparable period since 2003. Turning now to segment results, let's begin with Seabourn Thermal. We sold 4.6 million tons with 2.5 million tons exported. Year-to-date export sales have totaled just over 5 million tons at an average price of $56 per short ton, largely in line with the average Newcastle benchmark price over the same period. The seaborne thermal segment responded well to an extremely weak pricing environment by delivering costs per ton of sub-$30, leading to 17% adjusted EBITDA margins. Shipments from our seaborne metallurgical operations were nearly half that of prior year level, as COVID disrupted global demand and we continue to be challenged by production constraints. Lower volumes, particularly at Shoal Creek, Capabella, and Moorville, contributed to significantly higher costs per ton of $121 for the segment. In addition, unfavorable accounting impacts related to net realizable value adjustments increased MED costs. Albeit slower than anticipated, we are continuing to progress the mainline conveyor system upgrade at Shoal Creek. We've also experienced lower yields at the mine, further impacting coal availability. During the quarter, Capabella experienced a planned dragline outage on time and budget, which also impacted costs. Costs at Moorvale improved significantly in June, following elevated overburden ratios earlier in the year. Given Moorvale's geology, there are times in which we will be primarily removing overburden, as we were for parts of the first half of 2020. We expect to remain on coal for the remainder of the year. Our U.S. thermal assets responded extremely well to rapidly declining demand, reporting average adjusted EBITDA margins of 20%. In the PRB, coal shipments declined 28% compared to the prior year, primarily due to continued low natural gas prices impacting demand. Regardless, costs improved 5% to $9.26 per ton. Compared to the first quarter, costs per ton came down $1.02. as we realized the benefit of set room regained in the first quarter and continued to reduce repair and maintenance expense, increase productivity, optimize blending of in-pit inventory, and began to realize benefits of headcount reductions taken earlier in the quarter. These cost improvements contributed to the PRB segment earning 19% adjusted EBITDA margins in the quarter. To put the PRB volume decline in perspective, year-to-date, we have shifted an annual pace of 83 million tons, compared to 2019 sales of 108 million tons. Yet, we quickly scaled down operations to meet lower customer demand, all while delivering lower costs per ton. The other U.S. thermal segment also responded well to challenging industry conditions, leading the company in adjusted EBITDA margins at 22%. Despite volume declines, costs per ton remained in line with the prior year, as the team further streamlined its operations by reducing spending on materials, services, repairs, and labor, among other items. Let's turn now to the balance sheet and cash flow. We ended the quarter with $849 million of cash and $926 million of liquidity, which marks a $262 million reduction from March 31st. During the quarter, $48 million of cash was used for operating activities including about $25 million of net interest payments and $15 million in ARO cash spend. An additional $79 million was used for investing activities, including $55 million for capital expenditures. In addition to cash usage for operational needs, availability under the accounts receivable securitization facilities declined, and we posted additional collateral for certain long-term obligations. To enhance our financial flexibility, we are undertaking a process to evaluate various strategic financing alternatives, including a debt-for-debt exchange, among other options. In line with this, we've designated our Wilp and Young line and the related legal entities as unrestricted subsidiaries in accordance with the negotiated terms of our Senior Notes and Credit Agreement. Year-to-date, Wilp and Young has accounted for 74% of total seaborne thermal segment adjusted EBITDA. Given this process is ongoing, we will withhold further comment and refrain from answering questions on this topic today. Given continued uncertainty in global markets, we are continuing the suspension of full-year 2020 guidance. Consistent with last quarter, there are a few known factors I'd like to discuss. Cash preservation remains key and is something we are focused on across the business. We've further reduced full-year 2020 SG&A by $10 million to an estimated $110 million. We've also cut capital expenditures by another $35 million to $200 million and deferred $10 million of ARO cash spend to future periods based on operational sequencing. Peabody has an outstanding reclamation track record and remains committed to restoring the land in a timely manner and in full compliance with regulatory requirements. Shifting to contracted sales. While sales volumes will ultimately be dependent upon general economic conditions, weather, natural gas prices, and other factors, as we sit here today, we expect PRB volumes in the second half of the year to increase relative to the first half of the year. We have 46 million tons committed for second half delivery versus first half shipments of 41 million tons. Other U.S. thermal shipments are expected to largely be in line with the first half of the year. We also have 2.1 million tons of export seaworn thermal sales already priced for the remainder of the year. As a reminder, we also sell export volumes on a spot basis. Moving forward, we believe it's necessary to take further action to strengthen our cash flows. Across the business, we are focused on driving improvements to counter the impacts of lower demand and pricing and better position the company for the future. I'd now like to turn the call over for questions. Operator?

Thank you, sir. Ladies and gentlemen, at this time we will now begin the question and answer session. If you have a question, please press the star followed by the 1 on your push button phone. Your questions will be answered in the order they are received. If you are using speaker equipment, you will need to lift the handset before pressing the numbers. If you find your question has been answered, you may remove yourself from the queue by pressing star 2. One moment please for the first question. Mr. Mark Levin from Benchmark Company, please ask your question.

Okay, thanks very much. A couple quick questions. Trying to stay away from guidance because I know you guys have suspended it, but maybe some thoughts on how to think about net coal volumes and cost in the back half of the year to the extent you're able to comment.

Yeah, Mark, this is Julie. So, obviously, you're right. We've suspended guidance there. It's largely going to be a factor of what demand is, right? And what we've seen here recently has been met coal demand, fall off, you know, quite a bit more. Steel production year-to-date through June was down 14%, excluding China, so that's a pretty drastic move. We're continuing to work with our customers and we'll continue to work with them to meet their demands, but it's really just a Pretty big unknown at this point.

And in remarks, I'd mentioned the focus on the longwall operations. So two of our three longwalls are met assets. And as I said, we've been particularly focused on the fixed costs associated with those mines with reduced demand levels. So that continues to be a focus of our ongoing program.

Yeah, absolutely. And it sounds like there's a lot going on in the second quarter that might be one time. I know you guys had talked in the past about getting to kind of a $95 cost number. It doesn't look like that would happen this year, but I'm just curious if there's the potential to get costs below $100 at some point in the back half of the year.

Well, certainly I'd say over time we'd want to target that level, but that would assume that we'd be operating at capacity or at normal rates. And as Julie said, that's going to be dependent upon talking to our customers, working with our customers and what the demand situation is in the second half of the year. So we're not really able to predict that at this point.

Mr. Lucas Pipes from BR Riley FBR, please go ahead with your question.

Thank you. Some of your peers who reported already, they indicated that kind of customer interest is starting to return. What are your comments on that? Are you seeing increased inbounds with economies opening back up towards this bill? Especially kind of with the Asia-Pacific markets and China, specifically around China.

Yeah, if I understand the question, because we didn't quite hear it, but I understand the question you're asking, you're hearing other folks potentially talking about customers being a little bit optimistic about the second half. Is that the sort of general nature of the question? Yeah. Look, I think for us, you know, clearly... China importing steel is probably a general positive, but we do have lockdowns occurring and idle capacity occurring across much of our target customer markets. We are starting to have the same sorts of complications you're hearing, but I think it's too early to sort of call that. I think there's still a lot of uncertainty in the market and clearly tough conditions out there. for seaborne metallurgical coal and that probably is reflected in why it's been range bound. It also probably indicates that a lot of unknowns around China and the import restrictions on met coal or coal going into China as well and how quickly those targets are going to be held and would they be relaxed in some way in the second half of this year. So still a lot of uncertainty is the picture we're trying to paint.

And then I wanted to follow up on Mark's question regarding minimal costs. I didn't hear it or see it anywhere in regards to the number on lower, but that accounts for the lower net realizable value. With minimal costs, what's the amount per ton between low to lower net realizable value?

Yeah, Lucas, thanks for the question. We had net realizable value adjustments pretty much across our MET portfolio. Round numbers, it's probably about a $20 a ton impact.

Now, with that being said, you know, it's a non-cash adjustment, I'd just point out. And then when that coal is essentially sold, it would be, you know, reversed out essentially. So it's just an accounting adjustment, but it did have a sizable impact on our cost performance, no doubt about it, certainly underscoring what tough market conditions we're in, given it's based off of stock pricing as of the end of the quarter.

Mr. Matthew Fields from Bank of America, please go ahead with your question.

of your plan for any exchanges, but just wondering how you accomplished the redesignation within the confines of these indentures. Did that come in through the permitted 150 per year of RP carve-out that you were able to redesignate Bolton's on?

Matt, it's Mark. I heard most of your question. We're having some trouble with the line, but what I would say is that we effectively... in designated Wilpin-Yong Mine as an unrestricted subsidiary in accordance with the negotiated terms of the senior notes indenture and credit agreement. We don't discuss and disclose individual baskets, but I will reiterate that everything we've done is consistent with the negotiated terms of the documents.

All right.

And then on the prepared remarks about additional collateralization, By my math, you should have had about $125 million more available. Was there any additional cash collateral you were forced to post in this quarter?

So we had about $80 million of collateral that was posted during the second quarter. Was there something additional to that?

One moment, please. Mr. Fields, please go ahead.

Okay, yeah, okay, thank you. And then do you anticipate having to post any more collateral going forward throughout the year?

We routinely have negotiations and discussions with our surety providers. Early in the third quarter, there was about $50 million that we have submitted have posted here in July. We don't anticipate significantly more at present time. However, we have those negotiations, and the sureties have the right, the contractual right, to request additional collateral up to 100% of the surety bond amount.

And, Matt, I think you're aware, but those are generally in the form of letters of credit, not cash collateral postings.

Mr. David Gagliano from BMO Capital Markets, please go ahead with your question.

Hi, I hope you can hear me. I just have a question regarding the changes to the designation of the subsidiaries at Wilping John. Does that mean potentially divesting that asset is also under consideration?

No, I'll say that the designation of a restricted or unrestricted subsidiary has no implications of whether or not that asset would be for sale. We have no current plans today to have that asset for sale.

Okay, thanks. And then in terms of the, and I apologize, I think I missed the answer here, but the met coal cash cost in the second quarter, was it just mentioned that there was a $20 negative headwind? in the second quarter, and does that go away? All else equal, cash costs should be down $20 a ton in the third quarter in net?

The question was, what was the impact of the net realizable value adjustments to inventory that we recorded during the second quarter? That impact is approximately $20 million per ton. $20 per ton. I said that twice now. $20 per ton in the second quarter. It's a non-cash charge. effectively the inventory that we have on the books is valued at the realizable price, less any cost to get it to market.

And so just a little bit of extra color there. That is based on a ton sold, right, which we're down substantially, so that we only sold about a million tons in the quarter versus 2 million tons in the prior quarter, so $20 million impact roughly, but on a per ton basis it was outsized given the weak demand that we saw in the quarter.

And going forward, just to reiterate, it's going to be a function of demand or sales that we take in the second half of the year. And also in particular, I keep going back to our long-haul operations, their ability to continue to respond to changes in demand profile.

Mr. Matt Vittorioso from Jefferies, please go ahead with your question.

Yeah, thanks for the question. Could you discuss a lot of covenant issues with your credit facility and clearly you know, you've got a bunch of cash, but you're using the credit facility to post collateral on some of those other liabilities. So are there maintenance covenants or any other covenant issues that are coming down the pipe on that facility?

Matt, yes. One, I'll just reiterate or confirm, you know, we are in compliance with all the covenants in our debt documents. The covenant that is probably what you're referring to is the net leverage ratio of two times And as we progress through the back half of the year here, that first lien net leverage ratio will start to get tight. We are going to do whatever it takes to maintain compliance and access to the revolving credit facility.

Okay. And then I guess I'll just make more of a statement than a question. I mean, you know, you guys spent a bunch of money on buying back equity a while back, and no one knew what conditions were going to look like in 2020, but To the extent that your lenders are getting on this call asking you legitimate questions about how you're maneuvering assets and what you're going to do with your cash, I think a little bit more transparency would be appreciated, just given that we didn't need to be in this tight spot. So maybe just consider that.

Thanks. Thanks, Matt. As I mentioned before, we won't discuss any specific plans today, but as I mentioned in my remarks earlier, a debt-for-debt exchange is one of the many financing options that we are considering.

Yeah, and I think it's important also to recognize that the market landscape has changed considerably and drastically within just the last six months of the year. I mean, even if we just look at net prices in Q2 of 19 versus Q2 of 20, I mean, we're talking about over $200 a ton versus 118. And so... If you think about the backdrop of when we were making those decisions versus where we sit here today, things have drastically changed, and nobody could have known that. And then COVID has obviously, you know, added to that uncertainty as well. So we're taking multiple steps across all areas of the business. Glenn's talked quite a bit today about the cost-free positioning program. We've taken... Drastic actions on that front as well. I mean, over the past 18 months, we've eliminated 24% of our headcount. So we're taking actions throughout the business and tackling it from every way that we can. No doubt about it, calf preservation remains key here, but we believe we're doing what we need to do.

Mr. Scott Shearer from Clarksons, please go ahead with your question.

Hi, good morning, everyone. If I could also follow up on some of the questions about net coal costs. Some of the reasons you cited for the elevated costs in the quarter, other than the lower volume impact with the conveyor system upgrade, pick sequencing, and then the planned dragline outage, are all of these situations kind of behind you at this point, or will some of these impacts persist into the third quarter?

Yeah, so the dragline outage at Copabella, the scheduled outage was done on time on budget. At Moorvale, because of pit sequencing, we expect to be on coal in the second half of the year. So I guess entering the year, we knew the first couple of quarters were going to have those factors. The conveyor upgrade is taking a little bit longer at Shell Creek than we envisaged, but we would expect to conclude that in the second half of the year. I think ultimately costs are going to be more of a factor of volume that's moved in our ability to respond, particularly with fixed costs. We've taken steps across really the entire platform, but if I single out, say, Metropolitan, One of our underground mines, long-wall operations, we have looked to slow that advance and take out fixed costs, work on new schedules, and reduce both contractors and workforce at that mine.

Okay, that's helpful. I appreciate that. And then staying on costs but moving to thermal and then the PRB, Costs were pretty impressive this quarter, but I think part of that was due to less maintenance expense. Do you kind of see this cost level as being repeatable through the remainder of the year, or should we expect to move higher in the third and fourth quarters?

Well, I'm not sure we singled out maintenance expense, but look, the team have done a fabulous job across our entire US thermal platform in being able to respond to significantly lower volumes. We started to, when we saw low natural gas prices and the impact on demand that was occurring in that first quarter, I think we've taken steps to respond. It's also part of our ongoing cost improvement program that's really across the entire business, but I think clearly the US thermal activity has really stepped up And I would say that what we are looking at is sustainable cost improvement. Now, it's fair to say that we've got some, particularly at our surface operations, we've got some tailwinds with respect to low of diesel prices. But we are looking, notwithstanding that, we are looking at ways in which we can capture sustainable costs, not only for the next six months, but over the life of mine plants.

There are no further questions at this time.

Well, thank you, and thank you all for participating in today's call. I'd like to especially thank our employees for their continued dedication to producing quality products and for their heightened commitment to health and safety. Even with multiple changes to the business, you've all shown the ability to quickly adapt. I'm grateful for the unwavering focus as we adapt to our new global landscape. To all, please stay safe and well. And operator, that concludes today's call.

This concludes the Peabody Energy Q2 2020 earnings call. Thank you for participating.