Cloud Peak Energy's (CLD) CEO Colin Marshall on Q1 2016 Results - Earnings Call Transcript

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Cloud Peak Energy, Inc. (NYSE:CLD)

Q1 2016 Earnings Conference Call

April 28, 2016 5:00 PM ET

Executives

Karla Kimrey - Vice President, Investor Relations

Colin Marshall - President and Chief Executive Officer

Heath Hill - Executive Vice President and Chief Financial Officer

Gary Rivenes - Executive Vice President and Chief Operating Officer

Analysts

David Deterding - Wells Fargo

John Bridges - JPMorgan

Lucas Pipes - FBR Capital Markets

Michael Goldenberg - Luminus Management

Jonathan Fite - KMF Investments Management, LLC

Jeremy Sussman - Clarkson Capital Markets LLC

Patrick Marshall - CRT Capital Group

Operator

Good day ladies and gentlemen, and welcome to the Cloud Peak Energy First Quarter Earnings Conference Call. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session and instructions will follow at that time. [Operator Instructions] As a reminder, this call maybe recorded.

I would now like to turn it to your host for today’s conference, Karla Kimrey, Vice President, Investor Relations. Please go ahead.

Karla Kimrey

Thank you, Christie. Good afternoon and thank you for joining us. With me is Collin Marshall, Cloud Peak Energy’s President and CEO; Gary Heath, CFO; and Gary Rivenes, COO.

Today’s presentation may contain forward-looking statements regarding our outlook for the company and industry, financial and operational guidance, volumes, prices and demand, the regulatory and political environment, growth strategies, capital resources and other statements that are not historical facts.

Actual results may differ materially because of various risks and uncertainties, including those described in the cautionary statement in today’s earnings release and in our 2015 Form 10-K, in our first quarter 2016 Form 10-Q.

Today’s presentation also includes non-GAAP financial measures. Please refer to today’s earnings release for the reconciliations and related disclosures. Our earnings release is available on the Investor Relations section of our website at cloudpeakenergy.com.

I’ll now turn the call over to Collin Marshall.

Colin Marshall

Thank you, Karla. Good afternoon and thank you for taking the time to listen into our Q1 2016 results goal. As Karla said, I’m joined by Heath Hill, our CFO, and Gary Rivenes, our Chief Operating Officer.

Our adjusted EBITDA are at minus $1.3 million, reflects the very low shipment rate experienced by old PRB producers during the quarter. The operations ability to reduce costs when shipments were greatly below plan, demonstrate the flexibility of our workforce and the effectiveness of the cost reduction measures that we’ve taken.

However, cost cutting could not overcome the reduction in revenue during the quarter. The midpoint of our full year guidance range has only been reduced marginally, as we expect shipments to pickup significantly in the second half of the year and the customers who do not want to take their contracted coal will provide appropriate compensation during the year.

And perhaps be able to report that during the quarter, there were no reportable injuries at any of our sites. Indeed it is now over six months since we had reportable injury, which is a significant achievement given the uncertainty that surrounds coal industry. It demonstrates how our employees remain focused on working safely during these uncertain times.

There were 121 MSHA inspection days at our sites in first quarter with only five substantial and significant citations written. So far we have been assessed fines of $2,300 for citations. There were no environmental citations at any of our sites during the quarter and it is now over two years, since our last environmental citation.

As we explained during our full results call in February, we expected first quarter shipments to be slow, but not a slow as they turn down, the winter has been exceptionally mild with energy used for heating 34% below average and electricity demand down 5% from last year. These are very large decreases by any measure.

Low heating demand reduced natural gas, which has placed forecast coal burn for many of our customers. The stockpile has filled up at the end of last year, so they could tell shipment sharply in Q1, when combined with the reduced exposure in Spring Creek, this cause a reduction in our shipments of 34% compared to Q1 last year. This was inline with the overall PRB shipment reduction report in recent MSHA data.

Across the business, we have been adjusting our operations to reduce costs in the face of this dramatic slowdown in shipments. We’ve reduced the use of contractors and over time adjusted retiree medical benefits, not filled thy completions, intensify delivery timing, and park surface equipment as well as many other measures.

As we look forward, it is clear that the dynamics of the coal industry have permanently changed, where coal used to provide base load generation, it is now much more variable depending on power demand, renewable output and the price of natural gas.

We are currently adapting to operating in an environment where shipments vary significantly from quarter-to-quarter. This is why it’s been case for the foreseeable future as coal competes with natural gas on marginal power demand, rather than providing reliable low cost base load power as historically done.

We do believe there will be significant long-term U.S. coal and international thermal coal demand even with proposed anti-coal regulations around the world. This is why we continue to progress the big metal project based on the Crow Tribe Reservation, adjacent to our Spring Creek Mine.

We are currently working with the Tribe to understand culturally significant sites, so they can be excluded from our proposed mining area. As we continue to evaluate this project, we are increasingly confident there will be domestic as well as export demand for this coal and for coal from the nearby Youngs Creek project. It is also expected to get increasingly difficult to lease federal coal due to the action of anti-coal NGOs, and administration.

Therefore we believe the development of the big metal in Youngs Creek mines will take place in a few years at least reserves decline. You maybe aware that work on the environmental impact study for the gateway Pacific project in which we have a 49% interest has been halted, this is to manage costs as we await the Army Corp of Engineers most delayed decision on the – let me try to request that the project be cancelled.

I’ll now handover to Heath to run through the financials before we’re turning to cover the outlook.

Heath Hill

Thank you, Colin. I would like to begin with an update on a reclamation bonding activities, which have been a particular focus during the period. In the normal course, we have received our approval from the State of Wyoming, Department of Environmental Quality to renew a total of $190 million of reclamation self bonding at our Antelope Mine, and our Cordero Rojo Mine.

While we are pleased that our consolidated financial position allows us to meet the requirements for self bonding with the State of Wyoming, we are proactively working to address the ongoing regulatory uncertainties regarding self bonding programs by seeking to voluntarily transition fully to third-party surety bonds.

We are in discussions with surety bond providers to potentially increase the bonding capacity by offering approximately 15% collateral in the form of letters of credit under our credit agreement. We also recently updated our reclamation bonding applications to include Wyoming DEQs, lower diesel fuel price assumption and to reflect updated reclamation plans.

Bond released applications, which incorporate recently completed reclamation were also submitted, assuming these applications are approved by the State of Wyoming by total bonding amount would be reduced inline with the State and federal regulations.

Our cash flow from operations was negative at approximately $700,000. This however, did include a $6.4 million interest payment on our 2024 bonds. We ended the period with $79.4 million in cash, when the cash balances combined with the available borrowings from our credit facility and our AR securitization program available liquidity remains strong at $558 million.

It should be noted that our liquidity will be reduced by the amount of letters of credit expected to be issued during the second quarter for the increased third-party surety bond capacity. As we consider the operating results for the period, it was mentioned during the year-end earnings call that the primary variable driving our 2016 results would be the total volume shift.

During the first quarter of 2016, our shipments and shipments from the entire Powder River basin decreased 34% as compared to the first quarter of 2015. The average realized price per ton for our three mines during the quarter was also down about 3% to $12.65 as compared to the prior year of $13.05 per ton.

While we reduced our mining cost by nearly $25 million as compared to the first quarter of 2015, our cost per ton increased to $11.15 as compared to the prior year of $10.02 due to the lower shipment rate. While $1.50 per ton margin was realized in our mining operations when this is applied to the lower 13 million tons shipping rate for the quarter, fewer earnings were generated to offset our continuing logistics negative adjusted EBITDA of $6.9 million.

The loss within our logistics business was as expected at the $8 million of take-or-pay expense associated with our amended contracts with port and rail was partially offset by the collection of $1.7 million of new cash flow hedge gain in the period. Consolidated adjusted EBITDA for the first quarter was a loss of $1.3 million as compared to the positive $39.4 million reported for the first quarter of 2015.

As we look forward, in consideration of the low level of first quarter shipments and with the continuing expectation of shipping our contracted tons, we are reducing our 2016 full-year shipment guidance. We now expect to ship between 60 million and 65 million tons.

Our expectation for 2016 adjusted EBITDA is in the range between $75 million and $95 million. There are several reasons why the decrease in forecasted volumes is greater than the decrease in our adjusted EBITDA range. These points include first what certain customers have communicated a need to lower volumes in the current year. We expect to maintain value through contract buyouts.

Second, in keeping with industry standards we have evaluated and adjusted certain of our employee and retiree benefits, which will provide significant expense reductions over the coming 3.5 years. As previously accrued amounts are reversed and incremental costs are avoided thereby reducing costs independent of tons shipped.

Finally workforce planning, it’s key to aligning our team size to the lower and varying production volumes. Our incentive-based exit programs and shift modifications will provide further cost savings going forward. A new range of $25 million to $35 million for capital expenditures will provide for completion of the dragline rebuild at our Antelope mine and maintain the health of the equipment fleet across the mining operations. Depreciation, depletion, and accretion expense will be approximately $100 million and cash interest for 2016 is expected to be approximately $41 million.

In conclusion we are working to protect our liquidity, which remains strong at $558 million at the end of the first quarter. We are focused on managing costs in a time of varying shipment rates and assuming a normal summer. We are preparing to run much harder in the second-half of this year.

With that I will hand the conversation back to Colin.

Colin Marshall

Thank you, Heath now I’d like to cover the international outlook Seaborne thermal demand continues there with supply due to the combination of a large reduction in Chinese thermal imports reduced in Indian thermal import growth, and the strong U.S. dollar. These factors are currently keeping international coal prices down we have seen Indonesian exports reduced due to low prices and increased domestic demand.

The recent strengthening of the Australian dollar will help reduce shipments and continue to delay capacity additions. Our existing customers in Japan and Korea are staying in touch that they would like to take our coal again when it is economic for us to export. In addition we have recently – we’ve received several inquiries from Southeast Asian utilities seeking reliable coal supply for their new power plants. It is encouraging to see the met-coal prices start to recover with increased Chinese steel production as we have in the factory we put a cap on thermal coal prices for some time.

Overall we continue to believe that international thermal coal prices will rise to supply and demand coming to balance and we’ll look to restart exports when they become economic. Turning to the domestic environment last year we saw utility coal burn down by around 18% across the nation. So far this year shipments were down by around 29% with PRB down 34%. And I previously said the very mild winter and subsequent very low natural gas prices have reduced coal burn and increased coal stockpiles to record levels.

The amount of the PRB coal burn is down for the whole year will depend on the summer cooling and the price of natural gas. We are currently forecasting PRB demand to 4 from around 405 million tons last year to around 320 million tons in 2016 the stockpiles are reduced. This would be a 21% year-on-year reduction.

In 2017 PRB coal demand is expected to rebound to around 250 million tons as stockpiles normalize and natural gas prices rise to more sustainable levels. When gas prices rise and coal stockpiles start to decrease there will be room for coal prices to increase to more sustainable levels too. How long this will take it’s unclear but the sharp reduction in oil and gas drilling and steep production declines from many new wells now there to be starting to reduce U.S. oil and gas production. Hopefully the reduction will become significant over the next few months the other thing that is increasing important coal burn is weather as we just experienced a mild winter had a dramatic negative impact on heating demand.

Natural gas prices and coal burn, it would be helpful if we have a hot summer this could rapidly increase gas and coal burn. Since our last call we reduced our contracted position for 2016 by 1 million tons through buyer agreed with the customer. We now have 63 million tons contracted for 2016 an average price of $12.72. Apart from additional in year sales we normally make the certain spring Creek customers we’re not expecting to make any other 2016 sales as utilities are looking to reduce their stockpiles.

We are in discussion with several customers regarding compensation through contracted coal they no longer want to take this year. There is a growing acceptance among our customers that they must pay a compensation if they do not pay their contracted tons, which will reduce the impact on our adjusted EBITDA due to low prices and a lack of RFPs we did not make any new sales for 2017 in Q1 the price was fixed on the 81 million tons of winter coal 600,000 tons were moved into 2017 from this year.

As a result, the 2017 we have currently committed to sell 42 million tons of this committed production 39 million tons are under fixed price contracts with a weighted average price of $12.53. Due to current high stockpiles and the uncertainty of the future in natural gas prices and power demand the utilities appear to be delaying their normal contract activities for next year. There have been few RFPs out so far this year, but more are expected as utilities focus on the projected 2017 coal burn over the next few months.

We will update you on contracting during our next call in July, to sum up before we take your questions. This has been a very difficult quarter due to our customers delaying shipments due to reduced burn and high coal stockpiles. Our operations have adopted well, but we are taking additional measures to control costs and increase the flexibility of our mines six months without a reportable safety incident is a great achievement by all our employees during this period.

As we mentioned we are in discussions with a group of experienced surety provide us to increase our third-party bonding I’ve submitted applications to the Wyoming DEQ this should reduce our bonding: requirement. When these things are complete we expect to be able to exit self bonding with Wyoming. We are expecting slow shipments in the second quarter, which normally has the lowest shipments of the year. The second-half of the year should be much stronger after the summer burn and as utilities focus on meeting their contracted shipments to avoid penalties – paying penalties on rail and coal contracts. As we had last year that’s a key to our performance in 2016 we’ll be getting our customers to take their contracted coal and the compensation paid by those who don’t.

We can now take your questions.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question is from the line of David Deterding of Wells Fargo. Your line is open.

David Deterding

Hi, guys. Colin, thanks for taking my question.

Colin Marshall

Hi, David.

David Deterding

Hi, we’ve talked more investors you’re actually getting bullish on natural gas as some of the drilling has fallen off here. I know you talked about needing a hotter summer, but what net gas price do you think it takes to see more switching back to coal for you guys out of the PRB and to really how long do you think it will take to work to the stockpiles?

Colin Marshall

Okay, yes in terms of the decline in the gas thing, it does seem to be some sort of consistent, commentaries now. So the decline is actually carrying that has in the oil which from the decline, because I have seen quite a few of the basin sort of make sense with the rapid decline in the actual amount of drill rigs drilling even with efficiency improvements from the rigs.

What we see here is that historically when gas was about 250, we’d see people start switching back towards PRB and we reckon that all switching would be done from our customers by the time gas got to 350 so somewhere between that 250 and 350 range we’ll be shipping sorry to be switching back towards coal. I’m clearly when you’re $2 I think anyone who can burn gas is doing so certainly that’s the way it fills in terms of the shipments.

David Deterding

Great and I think the last time I’d seen the number on potential self bonding it was around $400 million is that correct?

Colin Marshall

No the total bonding is approximately $600 million.

David Deterding

Okay.

Colin Marshall

It’s broken out between 400 of our third-party surety bond that we had historically and the $200 million roughly of self bonding. So we’re looking to replace that self bonding amount with third-party bonds.

Heath Hill

Yes, and we’re doing now as I said – as we said, by increasing the amount of third-party bonding above the 400 and also working with Wyoming DEQ to get recognition for work reclamation work we’ve done so new plans go forward and the lower fuel prices that they want us to assume to sort of bring the 640 number down and the expectation is with the top coming down and the surety bonding going up that we’ll be able to just when those things occur we should be able to exit self bonding.

David Deterding

Okay and do you have estimate for how much that might come down of the $200 million and you got self bonding now?

Heath Hill

I think at this stage let’s leave that until it cares, but is this sort of we’ll be going from underneath and will be a reduction from the top correct.

David Deterding

Okay. And just last I’m looking at your liquidity very strong again $557 million, $780 million in cash. And if you say, you have $200 million, put up to 15%, I think that’s very minimal, leaves you with over $500 million in kind of liquidity. And you could take out 60% of your kind of long-term debt for $150. I mean, I guess, I’m wondering, one, how do you think about that? And two, how do you think about your liquidity need, as you run through now and 2019, it seems pretty strong?

Heath Hill

Okay. The first point just to clarify the 15% collateral will be on all the bonding we have. So it will be on a number of between whatever it is more than just the incremental. So we are putting in place bonding for – they will have collateral for all of it. But as I say, within the group of experienced bonders, we’re comfortable with that level given the outlook for our business, which is what we want some comfort that they – they’re comfortable at this level.

In terms of liquidity, we’re really – obviously, we’re looking at a whole lot of different numbers where we’re focused on, first of all, getting the self-bonding issue, getting comfortable with that. We felt that was the first thing we need to deal with. We’re obviously talking and considering all the different things we can do with our balance sheet and we are looking at the outlook for the business.

So the discount on the bonds hasn’t escaped us – haven’t escaped on notice. But I’d just say we’re working through things and we’ll take actions as we feel they are appropriate at the time that makes sense. But the first capital of the rank is definitely sorting self-bonding and we are in the thick of that.

David Deterding

Great. Thank you, guys.

Colin Marshall

Thanks.

Operator

Thank you. Our next question is from John Bridges of JPMorgan. Your line is open.

John Bridges

Evening call to everybody. I just wanted to – I’m just curious you mentioned tweaking the way the mine operates or more flexible demand has been put on you from the utilities. What sort of things you are doing?

Gary Rivenes

Well, John, this is Gary. First off, we’re doing a lot of scheduling to make sure that our overburden movement is matching our call needs at the time. Our employees are having to reduce some various schedules. So a lot of scheduling going on. We have reduced back our workforce a little bit. We’ve offered some early retirements in voluntarily programs and reduced some hours.

So bottom line is, we’re trying not to run. And then a couple of other things is, we do have the ability to allow our equipment outages to be a little bit longer, because some of the equipment we don’t need. And so we can do that a lot cheaper with our in-house labor. And then we’re doing as much work in our rebuild shop as possible to try to eliminate our outside costs.

John Bridges

Okay. Well, certainly showing up in the way your costs are relatively immune to the lower throughput. Congratulations.

Colin Marshall

No, isn’t.

John Bridges

Well, on the status of the rail companies are hurting too and they are pushing back in raising rates. I know you are not directly exposed to that. But are you hearing that your carriers are threatening to put rates up?

Colin Marshall

I’m certainly not hearing that. I’m certainly – I’m hearing that they are suffering the same amount of downturn that we are, obviously, the trains are not turning up. The one thing I would comment on that is they have a pretty strong contracts with the utilities and they were expecting the utilities to perform with them. So that as we saw that, I think at the end of last year when one of the reasons why we ship so much coal even in the November and December and when the demand was down, because the utilities are looking to fill their contracts, both with us and with the rail.

Our expectation is that after the summer burn, shipments will increase. And one of the reasons will be utilities decide to make sure they make their minimums into their rail contracts. But in terms of actually anything to do with raising their rates at the moment, I haven’t heard anything on that.

John Bridges

Okay, great. Well done, guys. Best of luck.

Colin Marshall

Thank you.

Gary Rivenes

Thanks.

Operator

Thank you. Our next question is from Lucas Pipes of FBR & Company. Your line is open.

Lucas Pipes

Hey, good afternoon, everybody.

Colin Marshall

Hi, Lucas.

Lucas Pipes

So it sounds like you are making some very painful cuts in terms of -- on the cost side in terms of just trimming down further and scaling this business appropriately. And I wondered kind of what are you trying to manage this business too, if you look out a few years, I’m sure you must have a view on where our long-term gas price is, where long term coal price is, where is coal demand for the PRB, can you give us a sense on what kind of what do you have in your model? What should we be thinking about here? What is this business being scaled for?

Colin Marshall

Okay. Yes, that is something we spend a fair bit of time thinking about – where is this business demand going to settle out. Our expectations are at the moment, it’s something for the PRB round about 350 million tons between now and say 2020, or when the next round of reductions come through from regulations would make sense. But the thing that really struck me is that, I think we want 350 million in many of those years, we like to be above or below depending on the other factors such as the gas price and the weather and the renewable – subsidized renewable productions that.

I think what we are trying to do is build the flexibility in around the number that I think of about 350 million tonnes. But we are also very conscious at the moment because of the way things have lined up with all the closures last year and then the extraordinary mild winter with the very low gas prices. We’ve – it’s sort of we probably started off with a drop, at least, I hope that’s the way it plays out and that the amount of coal that is produced this year is actually a low because it should – it should increase back say more like 350 million, which seems like a sensible number for the next few years.

We’ll have to – I’ll first say after 2020 after that we’ll have to wait and see what the regulations the environment brings and where again natural gas prices settle out. But that’s one of the reasons why we are very keen to get to work flexibility into the way we work and operate and with our employees, because that’s what we’re going to need to be profitable going forward and obviously enough at the time we do it. But at the moment until it actually settle down, we hit a bottom, it’s pretty tough to know what you’re trying to direct around.

Gary Rivenes

Lucas one other thing is, our equipment still is in very good shape. We are not cutting, where it doesn’t make sense and then we are investing in making sure equipments in the right places as well. We’re still in the middle of a large dragline move from Cordero Rojo of Antelope so that’s been going pretty well and that machine should come online in the summer time this year.

Lucas Pipes

Got it. Okay. And then maybe to turn a little bit to the near-term, Colin. I think in your prepared remarks you mentioned some numbers for demand I think for 2016 and 2017. I didn’t quite capture them. So if you could maybe just repeat them and then I have one more question after that.

Colin Marshall

Sure. This year – our best guess at the moment is 320 million tonnes from the PRB production and then maybe going back 350 million tonnes next year once we’ve had some reduction in the stockpiles. But around those numbers, if there is a hot summer, it will be different. If it’s a mild winter and similarly if it is a milder cold winter. But that’s sort of the best to range at the moment to 320 million tonnes this year, 350 next.

Lucas Pipes

Got it. Now I would reckon at 320 million tonnes you would be taking a little bit of market share this year. Just top of my head, do you think that’s about right?

Heath Hill

I’m sorry I don’t – could you explain?

Lucas Pipes

Meaning that your production declines less than your peers, if the production has declined to 320 million total?

Colin Marshall

Well, really, that one we again have to wait to the end of the year, because it’s really, it’s obviously it’s a lot more opaque now than they used to with the – our peers not reporting the way they did and we’ll follow the the amateur data. But exactly how it that plays out between the mines, we will have to wait and see. But that’s not a precise number. That’s a best estimate at the moment. We’ll have to see how it pans out. But clearly, nobody is immune from the reduction in shipments, the utilities because we will sell to the same people. And they’re – if they’re not taking that coal then we’re all going to be slow.

Lucas Pipes

Great. And then – and just one quick last one. Obviously Q1 was pretty brutal, and I’m just trying to get a better sense for what exactly happened in terms of, I mean clearly shipments are down. But how did the conversation happened between you and your customers. It was a clear understanding that they would be taking the shipments in the back-half of the year. I’m just trying to get a feeling for why do you expect their production to increase in the back-half of the year as they clearly didn’t want the call in Q1?

Colin Marshall

Okay. Well, The conservation went to many of them, they just didn’t send the trains and said, we’ve got full stockpiles and we are at the burning or competing with very low cost gas. The reason why I think the shipments increased is special they always do. If you look historically, Q2 is normally the slow quarter. So, the first half on the freight won’t be great and the second quarter is, we’ll need to pick up in May and July – May and June, because we haven’t got into any sort of some of burn and initially coal will call off the stockpiles because to make some rooms, so that utilities can actually take some coal.

But I think it’s – the expectation is – there is still a lot of coal will be burned. What we did find is that quite a few utilities actually sort of let their coal plants go cold because the gas – it was enough gas, they could see their way in January through the rest of the winter and let me go cold. So until they file them up to some of burn, they really are being burning much collateral.

That’s obviously some of them – we still shipping at a 50 million ton right. So there is pivot of coal being burnt, but the marginal stuff that we are expecting to be shipping to get to a 60 million to 65 million ton rate that’s – a lot of that is because some of the plant – demand is down, but also some of the plants with coal. We are hearing that different ones are being fired up now and expectations for the summer burn and that should increase through May.

But clearly we’re hoping that there is an early start to summer. So they get fired up and then they can run, because once they’re running, they do produce very low cost electricity, but the other thing we do obviously is gas to go for bid because it’s too below $2. It’s – I’d say the only people losing more money than cold people then are the oil and gas producers, but that’s called comfortable moment.

Lucas Pipes

Well, I appreciate all the detail and good luck.

Colin Marshall

Thank you.

Operator

Thank you. Our next question is from Michael Goldenberg of Luminus Management. Your line is open.

Michael Goldenberg

I just had a couple of bookkeeping items. On the cash, let’s say, you have a non-cash logistic agreement expense of $8 million. Where is that show up in the income statement, is that in COGS?

Heath Hill

That is in cost of goods sold.

Michael Goldenberg

So is that in the – in cost of goods sold on the mine side or on the export side?

Heath Hill

On the export side.

Michael Goldenberg

Okay, so basically the exports even though it’s EBITDA of minus $7 million. Is that non-cash or cash EBITDA basically zero or it’s been minus $7 million non-cash – is actually cash EBITDA?

Heath Hill

At this quarter, it’s most non-cash. Some of that’s just timing of the payments.

Michael Goldenberg

But what I’m saying, when you say logistics and related adjusted EBITDA of minus $7 million, given we have an $8 million add-back in cash flow statement. Is your adjusted EBITDA for the quarter, the cash adjusted EBITDA actually is zero?

Heath Hill

I think that’s a fair way to characterize it. I would look at it as – that’s a pretty unique three- month period that has – going forward, we look at longer term for the full year.

Michael Goldenberg

Okay. And then the other part is, on the Burlington Northern deal, I thought there would be a cash payment. The support of the Burlington Northern, am I correct in that?

Heath Hill

They are combined those port and rail logistics contracts. That’s the combination of the amounts paid to both BNSF and to Westshore.

Michael Goldenberg

But last quarter in Q4 2015, there was a specific payment to Westshore where you pay to get out of the contracts so to speak. Was there a similar payment this quarter to Burlington or am I wrong with that?

Heath Hill

I’d be happy Michael to explain the specifics of the cash payments in each contract individually. But as we talked about at year end, when we announce the logistics deal, they roughly near each other in amount of upfront payment, amount of expense to be amortized in the amount of cash flow in each of 2016, 2017, and 2018.

Michael Goldenberg

Okay, fair enough.

Heath Hill

So we didn’t make payments, yes.

Michael Goldenberg

We’ll take in offline. Thank you very much.

Heath Hill

Okay, thank you Michael.

Operator

Thank you. Our next question is from Jonathan Fite of KMF Investments. Your line is open.

Jonathan Fite

Good afternoon, everyone. Thanks for taking my call.

Heath Hill

Hi, Jon.

Jonathan Fite

Just want to make sure I heard the numbers right. So after kind of voluntarily removing self bonding, you’re able to get the third-party surety bond players to step up, but roughly around $600 million of total surety bonding would be there in about 15% of that would be collateralized. Is that kind of ballpark figure is about right?

Heath Hill

Well, that’s probably be on the high side, but we didn’t give a specific number figures until the reason we were even for that still – this is first of all is very important and we do believe that we’re in a good position to actually get the increase in third-party bonding through, which is just to breaking it up obviously and we’ll actually make an announcement when we issued the rest of the credit.

Jonathan Fite

Yes.

Heath Hill

So that will come out and you will see the exact number then, which is a bit below $600, but let’s not be too precise just now.

Jonathan Fite

Yes, correct.

Heath Hill

And then the other factor is, we’ll also got work with Wyoming to bring sort of that the total bonding calculation down to get recognition for some lower fuel assumptions and for work we’ve already done and planned to do in the future.

Jonathan Fite

So given – thank you for that clarity, Colin, and given as you’re talking about this on today’s call, this is something you would expect to finalize some time in Q2, I’m expecting or summer bond?

Colin Marshall

Let’s give a little bit more time. The important point is we’re good for $190 million in self bonding today that’s all approved. We’ve just got – it will depend on things like how quickly Wyoming process there. The applications we put through. And as you can imagine, they’re getting quite a few amendments at the moment.

So it’s more – we believe it’s more of a sort of just a processing go through, but obviously until it’s done, we can’t yes, tell you the exact number. But our expectation is I’m not saying Q2, but we’ll be pushing to get it done as soon as we can.

Jonathan Fite

Great and that 15% number, there is a high degree of confidence around that – as you guys go forward with a profit?

Colin Marshall

Yes.

Jonathan Fite

That’s really fantastic news. I think again kind of speaks to you guys being able to continue to address these, as our products dramatically lower than some of the collateral requirements when you were spun out of retention, is that correct?

Heath Hill

That’s correct. It’s 40% when we started off, yes.

Colin Marshall

Yes, and quite frankly we didn’t depending on which bonding guys you talked to some of the very comfortable with zero, but to get the whole lot together and to get them comfortable, we settled to 15% and we believe that’s a solid number given all the information we given to them that comfortable with that at a number that would increase above the $400 million we got at the moment.

So what we trying to put in place is something that we’ll see us through for the next few years given the current outlook, and get these sort of any concern about running into issues with Wyoming of the table and we think obviously it’s good for Wyoming as well to have – to not have to worry about self bonding tests with traffic energy.

Jonathan Fite

Well, again I think its fantastic news. I think there was a 40% kind of data point from a few years ago, I think market expectations might have expected something even worse than that, I think this is a really good number.

If we look at what’s happened over the last couple of years or really last 18 months with some of the liabilities, which are real being settled, the port or rail settlements, you secure the self bonding now perhaps the last kind of big piece of the balance sheet on structure – or balance sheet uncertainty being surety bond piece, would you see that as kind of last big of uncertainty before you guys to maybe turn to the – that piece that was mentioned earlier or do you see any other items that you want to address maybe before you address the discounted bonds?

Heath Hill

Well, I think we will obviously – will be looking at the whole balance sheet. The debt coming due in 2019, the revolver in early 2019, and obviously our potential take or pay obligations with rail and port going forward. Those are the big items and we’re obviously looking at all of them and trying to address them as the sensibility you can and what would be a – what would be the best order is that we’re not idle.

Jonathan Fite

Well, congratulations on that. That’s I think a great achievement.

Colin Marshall

Thanks a lot.

Heath Hill

Thank you.

Operator

Thank you. Our next question is from Jeremy Sussman of Clarkson. Your line is open.

Jeremy Sussman

Hi, thanks very much for taking my question. Colin, you mentioned a number of cost initiatives. I was hoping you could elaborate on that, and I guess specifically if I look at your kind of Q1 operating cost level, is that a good base mine to work with for the rest of the year or some of the reductions towards the end of the quarter where you we should see that kind of base line number come down throughout the year?

Colin Marshall

Obviously that – some of the cost that were to do with things like – yes, just a low production – but in terms of sort of the measures we’ve taken, things like the adjustment that Heath was talking to our retire benefits going forward. That will come in from now onwards, and that’s called significant. But we’re bringing them into line with where the rest of the industry is.

So I think – the answer is yes, as time goes on more of the cost benefits will come in, but what we’ll also obviously then we’ll hopefully will – what really make the difference is we’re making actually ship at a more sensible rate for our – against our contracts. And then you will see the big decline in cost per ton, because we will actually get some volume, which is obviously what we really need to get the business and we’re working properly, which is what we will expect in the second-half. But, yes, obviously as time goes on, more and more of the cost saving things come in and there will be a change bit of a step for the rest of the year.

Jeremy Sussman

That’s helpful. And just along the last mines with the volumes step up. Should we expect much in Q2? I know you mentioned earlier seasonally Q2 usually isn’t the strongest. So go ahead…

Colin Marshall

Yes, I’m afraid, no. The Q2 is pretty slow. You only have to look at the rail data that comes through. There has not been much of a pick up yet. And so we’re optimistic it will occur. We didn’t expect it in April, which is normally one of the slowest months of the year. And really what we’re looking for is for the summer burnt power demand to go up, which means you need some – to switch from – you need switch to a cooling demand, which hopefully will start coming in May.

Jeremy Sussman

Perfect. Thank you very much.

Colin Marshall

Thanks.

Operator

Thank you. Our next question is from Patrick Marshall of CRT Capital Group. Your line is open.

Patrick Marshall

Hi. Just again on the surety bonds. I was wondering if you guys could give me some color on, I guess, kind of the rationale, is it just being proactive in reading the tea leaves, or did you receive some indications from Wyoming that they might be looking to do away with self-bonding?

Heath Hill

It was absolutely being proactive. Wyoming had been very supportive. It actually – I think it’s pass through this – well, it’s a regulation that they pass. That’s a change, it would be a big deal, it have to go through the legislature. But now we are trying to be proactive. And also, yes, we are conscious that as some of our – it’s done against financial tests and on a trailing 12-month basis. And as time goes on, as we weather through this, obviously our financers are getting weaker before they get stronger in terms of the some of the trailing 12-month numbers. So we saw this opportunity to go proactive and we’d rather do it now, rather than we got a phone calls and we got a problem.

Patrick Marshall

Sure. And then in these negations with the third-party surety bond providers. What is the, I guess, what is the timeframe under which they can, I guess, look to reopen negotiations like, I mean, so you can agree to 15% maybe today, but 15 months down the road, is there the possibility that they could ask for more?

Heath Hill

There is an ongoing conversation, they will be paying attention to this call – on each quarterly call, and we host separate tours for them. So it’s an active dialogue. Their contract does allow for increased collateral. But we feel that in this more of an insurance business type arrangement, it will be very deliberately measured against our sales positions going forward in the activity in the mining, and how responsible we are in our reclamation activities by keeping up with that. And there is absolutely a financial components.

So, liquidity, we get good credit to our liquidity. So these are all components that are very active and they’re monitored by them as well. But this is a very good introductory level and we were pleased to get that.

Patrick Marshall

Right. So can they look to – it’s on a rolling basis essentially, if they decide they need more collateral, they can ask at any time?

Heath Hill

They’re always good, that’s the nature of this sort of arrangement just the way they work. But I think the important point is that, we’ve been very open with them. They understand what they get into. And as I said a few times, we’ve been very clear about the outlook, our expectations. They understand the mines that being around them. And actually look at the engineering, they get into some remarkable detail or very knowledgeable.

And so, they know what they get into. So we have a pretty good level of confidence, but 15 is the right number for quite a range of scenarios going forward. But obviously, do have the ability to ask more collateral in that system nature of sort of the insurance.

Gary Rivenes

If I could offer too, the regulations with self-bonding are binary. It’s a pass-fail mechanism, there is less flexibility. So when you work with the third-party surety bonds, we are coming in at a specific collateral level. That helps that company manage their risk exposure to our business. And so, that conversation, it’s all about risk and risk management takes it a little bit beyond just the mechanics of the financial ratio on the balance sheet.

Patrick Marshall

Sure. And then one final question. Do you guys have any expectations for working capital this year, whether that’s a source or use of liquidity?

Gary Rivenes

Not expected to change meaningfully. You’ve seen that the AR balance has come down, but the lower sales volume, but that could rebound later in the year. We’re not forecasting other meaningful working capital and cash flow items.

Patrick Marshall

Okay. That will be all. Thank you.

Gary Rivenes

Thank you.

Operator

Thank you. And our last question is from the line of [indiscernible] Your line is open.

Unidentified Analyst

Hi. Thanks for taking the question. I just have a few questions on the cost side. So the first one is your SG&A expense on an absolute dollar basis went up quite a bit year-over-year. And I was wondering, if you could address why that would be?

Heath Hill

Yes, I’d be happy to just highlight two points. Last year there was adjustment for some stock comp release. So we had a credit last year that didn’t repeat this year and we had some unusual medical claim activity this year. So when you put the lack of a credit and incremental cost that’s the differential of the 2.5%.

Unidentified Analyst

All right. And then I know you mentioned cutting outside contractors. I’m just wondering if you decrease any of your own labor force positions?

Gary Rivenes

Yes. We’re actually in the process of doing that right now through a volunteer program. So far our employees have been reduced on their – some of their overtime hours as well and some of their base wage hours. So we are cutting labor, where we can and then looking for volunteers in the meantime. And we’ve also for an extended period now not been replacing people in many positions. And there’s over 50 positions we had a couple of years ago that no longer exist. And obviously we – every time somebody relieves, we look for every reason we can to see if we can not replace a position, and so far that’s been over 50 people.

So we put it all together and there has been actually quite a substantial decrease as we come down in our production over the last few years. But we’ve done it for the steadily and we use attrition a lot, now we’ve been incentivized early retirement. So we haven’t had to sort of had announced large layoffs. And the other point is that, if we are going to run and get somewhere near 60 million tons of production this year, we actually have to run pretty hard in the second-half of the year. And we would – we’re going to need the employees we’ve got to get the equipment.

And the thing we are going to come to terms with is that, at the moment, we’re running a 50 million ton rate, and if we’re going to do 60 million tons, we have to run a 70 million ton right to say the second-half of the year. And that that’s quite a big swing in terms of the day-to-day operations at time mines and that’s what we’re trying to get the flexibility. So we can do that. So actually we need these employees. We’ve got to make sure that there when the trends turn up.

Unidentified Analyst

Makes sense. And then I guess a longer-term question I have is with the majority of the coal companies in the PRB in bankruptcy, and it seems like a lot of them are going to get rid of substantial amounts of debt. Do you think you can complete long-term by having that on your balance sheet when they’re going to be able to get rid of that much easier through the bankruptcy process?

Heath Hill

Well, I think, we’ll obviously go through a bankruptcy process has got a few changes to take place. We will have to see what level of debt they come out with. Obviously, we’ll be looking at what measures we can take with our debt as we – as our balance sheet as we go forward. My expectation at the moment is that, we won’t be that much different to them when they emerge from bankruptcy.

And clearly, and if you actually look at the amount of debt we’ve got probably one of the reasons why we’re – we’ve managed to avoid Chapter 11, because it actually is a reasonable level for the size of our business. And obviously the burden is never quite as large as the ones that they’re bringing down. And my expectation is, I’m sure, their expectation is that, they would have some debt when they emerge, because they need to be structured appropriately to go forward and new owners presumably would want that.

Unidentified Analyst

Okay. And then probably just one more from me. I just – I’m wondering long-terms over the next 10 years, if you’ve looked at the return on invested capital number and back into what price you would need for new capital to make that IRRS as good as buying back your bonds and kind of what kind of price level you are expecting to get over the long-term?

Heath Hill

Okay. Well, we haven’t done exactly that calculation for you. But we’ve always said when you get to about 70%, 75%, it should become the economic first to ship, and those would be tonnes that we couldn’t sell domestically. So we’ll – that’s always been a sort of number that works, so that’s what we’re looking for. And it’s – we still believe that that market will come back into balance the growth in Japan, Taiwan, Malaysia, Vietnam, really it’s very real. Obviously, the Chinese what they are doing at the moment plays out, last month in the port [indiscernible] There is 800 pound gorilla. But it’s clear to me that it’s a commodity market that at the moment. There is over supply, people are making money those are the reasons it will come back into balance and people will make a return and eventually have to be able to invest in new capital. It’s certainly a lot higher than $75 to be able to actually do that and another moment of $50 bucks, it’s – there is nobody really making any money. So that can only go on for so long.

Unidentified Analyst

Okay, thanks for taking the question.

Colin Marshall

Thank you.

Operator

Thank you. And that does conclude a Q&A session for today. I would now like to turn the call back over to Mr. Colin Marshall for any further remarks.

Colin Marshall

Well, first of all thank you very much for listening into the call and for your questions. Clearly 2016 is going to be a very difficult year for all coal producers. And I would say, I’m very proud of the way our employees are adapting to the realities of the market and doing everything they can to keep our business viable.

We’re obviously expecting an increase in the second half of the year. I’m afraid the first-half including Q2 are going to be slow just, because of the stockpiles and the external environment we’ve seen, but we’re confident the shipments will step up significantly in the second-half. With that we’ll look forward to updating you during our Q2 call in July. Thank you very much.

Operator

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

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