Hallador Energy Co Q1 FY2024 Earnings Call

Good afternoon. Thank you for joining today's Hallador Energy First Quarter 2024 Earnings Call. My name is Megan, and I will be your moderator. I would now like to turn the conference over to Becky Palumbo, Investor Relations with Hallador Energy. Please proceed.

Thank you, Megan. Thank you, everybody, for taking the time today to join our discussion on our first quarter 2024 earnings. With me today are Brent Bilsland, our President and CEO; and our newly appointed CFO, Marjorie Hargrave. Yesterday afternoon, we released our first quarter 2024 financial and operating results in a press release that is now on our website. Today, we will discuss those results as well as our perspective on current market conditions and outlook for 2024. Following our prepared remarks, we will open the call to answer your questions. Before beginning, a reminder that some of our remarks today may include forward-looking statements, subject to a variety of risks, uncertainties and assumptions contained in our filings from time to time with the SEC and are also reflected in yesterday'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, Hallador has no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise, unless required by law to do so. We plan on filing our Form 10-Q later this afternoon. And with the preliminaries out of the way, I will now turn the call over to Marjorie.

Thank you, Becky, and good afternoon, everyone. First off, I'd like to personally thank Larry Martin for all of his hard work at Hallador and for making this transition so smooth and enjoyable. Larry will be on the call to assist in answering questions for this quarter. Before we get started, I'd like to define adjusted EBITDA to refresh everyone's memory. Adjusted EBITDA is the sum of operating cash flow less the effects of certain subsidiary and equity method investment activity, plus bank interest, less the effects of working capital, period changes plus cash paid on asset retirement obligation reclamations plus other operations. For the first quarter of 2024, Hallador incurred a net loss of $1.7 million, which equates to a loss of $0.05 per share for both basic and diluted earnings. Our adjusted EBITDA for the quarter was $6.8 million and our operating cash flow for the quarter was $16.4 million. Of the $16.4 million, we used $14.5 million to reduce our debt and at quarter-end, our funded debt balance was $77 million and our net debt balance was $75.4 million. We also had $18.6 million of letters of credit outstanding as of March 31, 2024. Our liquidity at quarter end was $39.5 million and our debt to adjusted EBITDA or leverage ratio was 1.58, well within our covenant of 2.25. With that, I'll turn the call over to our CEO, Brent Bilsland.

Thank you, Marjorie. Throughout the first quarter, we continued our progress on transitioning the focus of Hallador from a coal production company to an independent power producer. During the first three months of 2024, our Electric Operations revenue exceeded that of our Coal Operations revenue. Additionally, we were successful in adding approximately $138 million in forward energy and capacity sales, growing our Electric Operations forward sales book to approximately $657 million as of March 31, 2024. This represents approximately 44% of Hallador's total contracted forward energy capacity and coal sales through 2029, which is roughly $1.5 billion. However, we believe future forward sales from our Electric Operations will soon eclipse our forward sales from our Coal Operations. Since January, we have evaluated and continued to evaluate several major power and capacity sales opportunities, including one proposal made to us that if contracted will result in more than $1 billion worth of potential forward power sales. We continue to see strong indicators that demand and pricing remain on an upward trend. According to the Indiana Business Journal, in the last 12 months, there have been eight new data centers and/or Bitcoin mining facility projects announced in the state of Indiana, where our Merom Power Plant is located. We have also seen a major utility amend their integrated resource plan and publicly state that it underestimated new electricity demand growth by as much as 17 times. MISO has released information arguing that their capacity reserve margin, meaning the amount of excess generating capacity in their system, could go negative as soon as next year. Monitoring the equity markets further strengthens our belief that investors and other independent power producers (IPPs) are also anticipating similar increases in power demand, demonstrated most clearly through the more than doubling of market capitalizations of at least two of those IPPs across the previous 12 months. In support of our expectation that Hallador Power sales will continue to exceed our traditional Sunrise Coal subsidiary, we anticipate changing Hallador's SIC code to 4911 electric services from 1220 bituminous coal producer in the future. On the electric side of the business, indicators for future power pricing appear much healthier than we have seen in recent months. We believe these indicators are supported by both our forward power sales book pricing and third-party future power curves. Additionally, natural gas future prices are in contango, meaning future gas prices exceed spot gas prices that have been depressing overall power prices for the last several quarters. As we discussed last quarter, the dynamics of the natural gas market paired with the nonstandard mild weather throughout the Midwest have impacted pricing and our power plant dispatch rates thus far in 2024. Future prices seem to indicate improvement on both these fronts, which we view as a positive for our go-forward operations. In April, we also launched a targeted request for proposals for power demand supporting new development at our Merom Power Plant. Responses are due in mid-May, but early indications point to a high level of interest. The RFP is available on our website for any interested parties that did not already receive the information. Our goal is for Hallador Power to generate approximately 1.5 million megawatt-hours on a quarterly basis, which equates to approximately 6 million megawatt-hours annually. During the first quarter, Hallador Power generated 816,000 megawatt-hours or 54% of our target despite an average price of $41.90. The favorable pricing is due to experiencing sales prices as high as $250 per megawatt-hour for limited times during the quarter, balanced against several days of pricing below our variable cost to produce. In forward selling capacity, we target annual sales of around $65 million to help offset our fixed annual cost at the plant, which currently approximates around $60 million annually. We have already sold a large portion of our future capacity, which we believe makes our forward capacity sales goal readily attainable for the next several years. As a condition of acquiring the Merom Power Plant, we agreed to sell 1.66 million megawatt-hours of energy in 2024 and 1.6 million megawatt-hours in 2025 at $34 per megawatt-hour to the plant seller, representing 27% of our annual 6 million megawatt-hour goal. Since this original transaction, we have been successful in selling over 5 million megawatt-hours of energy to third parties at an average price of approximately $54 per megawatt-hour over the years 2024 through 2029. This roughly $20 per megawatt-hour jump in average pricing has us very excited about future sales. During the first quarter, our variable costs at the plant were $31.88 per megawatt-hour. While we believe that we can typically achieve a lower per megawatt-hour cost, the low energy prices during the quarter necessitated that we run our plant at slower speeds and resulted in more frequent-than-normal starts and stops to avoid selling below our cost structure. Running in this manner is less fuel-efficient than if we were able to consistently generate at a 6 million megawatt-hour pace, which we think could lower variable costs by as much as 10%. Shifting to the coal side of the business, as previously discussed, in late February, our Coal Operations segment undertook an initiative designed to strengthen our financial and operational efficiency and create significant operational savings and higher margins in our Coal segment. This step helps to advance our transition from a company primarily focused on coal production to a more resilient and diversified IPP. As part of this initiative, we idled production at our higher-cost Prosperity mine and substantially idled production at the Freelandville mine with minimal production until current reclamation projects are completed in late May or early June of this year. As we have previously stated, we expect this initiative to reduce our capital investment for coal production in 2024 by approximately $10 million. We also focused our seven units of underground equipment on four units of our lowest cost production at our Oaktown mine. We also reduced our workforce by approximately 110 employees. Mining costs for the quarter were $53.38 per ton. However, at Oaktown, we saw mining costs in March decrease into the 30s on a per ton basis. While there are several factors that impacted this cost reduction, we continue to monitor operations and strategic initiatives to better understand the longevity of these favorable conditions. Historically, Sunrise Coal has generated approximately 6 million tons of coal annually. Following the restructuring, we expect Sunrise to produce roughly 3.5 million tons of coal on an annualized basis for 2024. If market conditions warrant, our current operations are capable of producing at a 4.5 million ton annualized pace. This year, we have also secured supplemental coal from third-party suppliers at favorable prices. This allows us to diversify self-production supply risk and provides us with additional flexibility in our sales portfolio. The optionality to obtain low-cost tons either internally or from third parties, while capturing upward swings in the commodity markets for coal, should further maximize margins while optimizing fuel costs at our Merom facility. We continued our build-out of what we consider to be a best-in-class independent power producer management team. In April, we welcomed Marjorie Hargrave as our new CFO. Marjorie comes to Hallador with broad-based experience in power production and capital markets. Adding Marjorie is a continuation of the breadth and depth of the IPP talent we continue to add at Hallador. Over the last two years, we have been successful in hiring our President of Hallador Power, a Chief Legal Officer with data communications expertise, our Senior Vice President of Power Marketing, and a Manager of Environmental Engineering, all of whom are accelerating our continued development of Hallador's current operational and future power acquisition capabilities. These prospects and our strong future sales position make us at Hallador very excited about the future of our company. I also want to thank Larry Martin for his 17 years of service at Hallador. Larry has been a trusted adviser and a friend, and we wish him success and retirement later this year. That concludes our prepared remarks. I'll now open up the call for any questions.

Our first question comes from Lucas Pipes with B. Riley Financials.

First, I want to add my congratulations to Larry and my best wishes for his retirement. Brent, I want to touch on your kind of forward sales position on the power side. There is that nice jump in 2026 versus 2025 to $55.37 versus just the $36.06. And I wondered if you could remind us what drove that? I have a suspicion, but would be curious to hear more about that. And could you maybe walk us through a pro forma revenue buildup of the Power segment, assuming kind of the forward power price market holds and also you sell the remaining capacity?

Yes. As mentioned on the call, we sold a significant amount of energy for 2024 and 2025 to the plant's seller as part of the sale agreement at a rate of $34 per megawatt hour. Since then, we've sold over 5 million megawatt-hours to other market participants at $54. We are observing strong pricing in the forward sales curve, largely due to increased demand from AI, electric vehicles, and onshoring. MISO has raised concerns about the possibility of the reserve margin going negative next year, which highlights the market's tightness. We remain optimistic about pricing as we continue to make forward sales. Additionally, we have received an offer exceeding $1 billion for future energy and capacity sales, though this deal is not yet contracted and may or may not proceed. There's currently a number of RFPs in progress, mainly from data center customers looking to locate near our property. We anticipate competition in this space. In the third quarter, we added around $300 million in sales, with about $400 million in the Power division in the fourth quarter, and $138 million this quarter. We believe there is potential for substantial transactions this year and want to convey our hope for profitable deals ahead. Regarding revenue from the power plant, it primarily consists of energy and capacity sales. We haven't performed as well as we would like in the last two quarters, leading us to sell a large portion of our Power division in the spot market, where prices can fluctuate significantly. We've experienced prices as high as $250 a megawatt hour in January, but we've also faced times when prices fell below our cost structure, forcing us to reduce operations. Our aim is to secure a higher percentage of forward sales to ensure our plants can operate consistently. We've set a goal of 6 million megawatt-hours per year, which we consider achievable and are actively working towards. Expect more updates from us regarding this in the future.

So should we assume that you would be kind of more hedged in the future?

Yes. That's our goal. We've been trying to do that in a very low-risk way, right? We've talked in the past about unit contingent, plant contingent-type transactions in that if we can't produce, we don't have to cover. So those have been slower to put together, but we've been successful in putting those together. And so we will hopefully continue to do more of that. None of that is ever guarantee. We're just seeing a very large level of interest from a lot of different players. And so that's got us encouraged.

Very helpful. If you were to do something kind of behind the meter with the data center at the site, what would be a good benchmark for the power pricing? Would it be based on kind of MISO pricing in the curve? Or would this be a bilateral agreement where prices could deviate from those benchmarks?

We don't have the results back from the RFP yet, but we expect to receive them later this month. Those types of transactions will need to compete with our traditional market offerings, and we believe that competition is beneficial for us.

And can you speak a little bit to the connectivity at the site? Would your site qualify for any data center? Or could there be limitations due to constraints on the bandwidth of your connectivity?

So we have a 1-gigawatt interconnection at Merom. I believe the transmission line is flowing in and out of that substation there are around 1.6 gigawatts and so it offers an interesting situation where we can potentially supply a customer directly from the plant or those electrons can be purchased from the grid.

But in terms of the kind of fiber access, no constraints you're aware of?

Well, essentially every location needs to incorporate some level of fiber infrastructure. The first question we need to address is the size of the facility and related details. While we haven't answered all those questions yet, we previously mentioned that our Chief Legal Officer has a background in data communications. This has allowed us to leverage that network for valuable insights. Conversations with customers and advisers indicate that this is quite feasible and there appears to be significant interest.

Our next question will come from Jeff Bronchick with Cove Street Capital.

Brent, maybe just go over the cash flow implications of what we have today and the current structure is in place, and sort of an expectation for cash needs over the balance of the year as far as you can see? And then help us walk through what the model looks like under you get rid of the contractual low sales, and you're signing these conceptual big contracts. How does the cash flow model look going forward?

Well, we get a lot of questions wrapped up in one there. So I think we're clear that we don't give out forward-looking guidance. I think we can talk at a high level of what our cost structure looks like and what our revenue looks like.

I'm not asking for guidance. What I mean is that you've recognized a change in the model, and this shift clearly affects cash flow, which is currently not favorable. As a result, you're exploring various liquidity options to maintain operations. I'm curious about how, on a broader scale, a publicly traded independent power producer should be positioned in terms of cash flow. Specifically, I'm referring to free cash flow, which is my main concern.

Yes. What we're trying to convey is that, regarding revenue, we have clearly stated our prices. The average prices for energy are projected to be around $36 per megawatt-hour in 2025 and as high as $55.37 in 2026. For capacity, we are aiming for $65 million in sales. Some years will perform better than others. Dividing that by 6 million megawatt-hours gives us around $10 to $11 per megawatt-hour. When you combine these two figures, depending on the year, the revenue will range between $47 and $66 per megawatt-hour. On the expense side, we have a variable cost structure this quarter around $32 and a fixed cost that, assuming a $60 million cost divided by 6 million megawatt-hours, would be $10. So now with $60 margins and $40 cost, that gives us a $20 margin. With 6 million megawatt-hours, that totals $120 million if we can achieve all our goals. We'll see if we're successful in achieving all our goals.

Isn't it true that in the Independent Power Producer world, you wouldn't want to sell 100% of your capacity at the prices that buyers prefer, and vice versa? There's always a distinction between contracted and spot prices. Therefore, isn't the IPP model highly variable? You might generate significant cash flow one year and then need to make adjustments from the board. Can you explain how you envision this playing out over multiple years? Let's assume everything goes perfectly; that's what I am trying to understand.

Well, I think on the capacity side, we clearly list out that we have a high percentage of our capacity sold. And so obtaining that goal, there's a high likelihood of doing that because we've already got a high percentage of it sold, right? I mean if you're looking at percent of capacity contracted, it's 100% this year, it's 82% next year, it's 77% the year beyond that, it's 64% in the year beyond that. So we don't have a lot of work to do to obtain that goal. Where we've got to do work is on the energy side of the business, which is why we think in the next handful of months that we have participated in RFPs of our customers, and we've launched an RFP to target data center or industrial uses the power through an agreement with Hoosier Energy that we announced last quarter. So we'll see how successful we are, but we would like to get a decent percentage of our plant contracted out so that we can get both units up and running and at least have both units running at minimum load, which would be about 65% of our generated output to run at minimum load all the time. So that's kind of the goal. And that's, I think, what we're looking at. And then the coal side of the business, our power plant is one of our largest customers. And so that kind of has an internal hedge on our cost structure, being able to produce coal at costs and deliver it to ourselves. We do purchase some coal from outside parties just to kind of diversify that risk. And that seems to be working out as well.

The next question will be from Lucas Pipes with B. Riley Financials.

Brent, I want to ask you about the recently unveiled EPA Clean Power rule. At what point would you consider making investments? What do you think is the legal outlook for this rule? I appreciate your thoughts.

The world is trying to find a balance between maintaining a constant power supply and addressing the increasing demand for electricity, while also striving for lower carbon emissions. This creates a challenging dynamic. The power grid, which took about 150 years to establish, was built for a system dependent on baseload power and requires on-site fuel is now facing a transition that is difficult to achieve in a short time frame. Recently, a new carbon plant emerged, and it seems likely that its legal status will be challenged, potentially reaching the U.S. Supreme Court. I suspect it may ultimately be deemed unlawful, but it still provides a pathway for our business operations through 2039, particularly with the co-firing of gas. We have been examining this option for several months. As we consider these new regulations, it’s clear that significant changes are ahead. However, the most crucial factor is ensuring that power remains reliable; if it doesn't, new leadership will emerge, as rolling blackouts are unacceptable. While we are committed to reducing carbon emissions, the transition must be responsible and is likely to take longer than public discourse suggests. A few years ago, we were optimistic about achieving carbon neutrality by 2030, then 2035, and now we know our existing fleet can operate until 2039 under current rules. Should these regulations remain in effect, any new gas plants would need to incorporate carbon capture and storage, which complicates the feasibility of new projects. This situation means we may need to depend on our existing resources for a more extended period, alongside legal analyses of these provisions. The rules are complex and require careful interpretation for each fuel type. The challenging environment for new gas plant construction will necessitate creative solutions for grid expansion, as no new gas or coal plants are being constructed. Additionally, the capacity qualifications given to renewable sources such as wind and solar are very low, indicating that a significant amount of wind and solar installations would be required to meet demand. Thus, the path forward is not straightforward, but we are increasingly confident in the sustainability and profitability of our business. We are transitioning from a sector with declining demand to one experiencing growth, which will benefit our long-term shareholders at Hallador.

Very helpful. Two follow-ups on this. First, co-firing with natural gas, how much would that cost to make a plant change for that? How long would it take? And then on the back of your thesis that you just articulated, are you looking at acquisitions of other coal-fired power plants, be it in MISO or across the nation?

Yes. We are still evaluating what co-firing the plant would entail, and there are various methods to implement that. We are not yet prepared to provide a cost estimate, but it is achievable. Regarding the second part of your question about acquisitions, what was that again, Lucas?

Yes.

Yes. I think we're always in the market, and we're always having some level of conversation with someone about acquisitions and what that might look like. It's definitely something that, as we talked about on the call, we continue to build out our team of experts and kind of bolster our capabilities to acquire plants, operate plants and increase the overall value of those assets. And I think that's what we're trying to do. And that's part of the reason for the RFP with the different data center groups to see if that's another way that we can add value to the platform that we have.

There are no additional questions waiting at this time. So I'll pass the conference back over to Brent Bilsland for closing remarks.

Well, I just want to thank everyone for their time today and their continued interest in Hallador. Thank you.

That concludes the Hallador Energy First Quarter 2024 Earnings Call. Thank you for your participation. I hope you have a wonderful rest of your day.