Hallador Energy Company (NASDAQ:HNRG) Q4 2022 Earnings Call Transcript

Hallador Energy Company (NASDAQ:HNRG) Q4 2022 Earnings Call Transcript March 17, 2023

Operator: Hello, and welcome to the Hallador Fourth Quarter 2022 Earnings Call. My name is Elliot, and I’ll be coordinating your call today. I’d now like to hand over to Becky Palumbo, the floor is yours.

Becky Palumbo: Thank you, Elliot, and thank you, everybody, for joining us today. Yesterday afternoon, we released our full year 2022 financial and operating results on Form 10-K, which is now posted on our website. With me today on this call is Brent Bilsland, our President and CEO; and Larry Martin, our CFO. After the prepared remarks, we will open the call up to your questions. Before we begin, please note that the discussion today may contain certain forward-looking statements that are statements related to future, not past events. In this context, forward-looking statements often address our expected future business and financial performance, 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 understanding assumptions prove incorrect, actual results may vary materially from those we projected or expected. For example, our estimates of mining costs, future sales, legislation and regulations. In providing these remarks, we have no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise, that may be required by law. For a discussion of some of those risks and uncertainties that may affect our future results. You should review the risk factors described from time to time in the reports we file with the SEC. As a reminder, this conference call is being recorded. In addition, a live and archived webcast of the earnings call is also available on Hallador’s website.

We encourage you to ask questions during our Q&A. And if you are on the webcast and would like to ask a question, you will need to dial into the conference and that toll-free member is (844)-200-6205, access code 724924. And with that, I’ll turn the call over to Larry.

Larry Martin: Thanks, Becky, and good afternoon, everyone. Before I get into our review of operating results, I want to define adjusted EBITDA. We had defined this as operating cash flows, less the effects of certain subsidiary and equity method investment activity, plus bank interest, less effect of working capital period changes plus cash paid on ARO, reclamation plus other amortization. So, for the year ended 2022 we ended with net income of 18.1 million or $0.57 per basic earned share or/and our diluted earnings per share was $0.55. Diluted earnings per share for us is if the converted debt was converted to equity. Our adjusted EBITDA for the year is $56.2 million. Our bank debt decrease was $26.5 million, and our bank debt at the end of the year was $85.2 million, excluding layers of credit of $11 million.

So, we had $85 million of borrowed debt, $11 million of letters of credit. Our net bank debt at the end of the year was $82.2 million, and our leverage ratio, which is adjusted EBITDA — debt to adjusted EBITDA was 2.05x. I’ll now turn the call over to Brent Bilsland for his review of the year and beyond.

Brent Bilsland: Thank you, Larry. Building upon my comments from the third quarter investor call, the full year 2022 was transformational for Hallador. As the market price for coal approached all-time highs, we were able to capture significant market opportunities through forward contracted coal sales of more than 2.2 million tons at an average price of $125 per ton. We delivered a small percentage of these tons in 2022 are contracted to deliver the majority in 2023 and will continue with longer-term deliveries through 2025. To fulfill these new profitable obligations, we invested substantially in both operations and headcount growth to quickly expand our coal production capacity from approximately 6 million tons annually in 2021 to as much as 7.5 million tons in 2023.

We expanded coal production capacity by adding more units at our Oaktown Mining Complex, opening a small surface mine pit near Freelandville Indiana. And moving our Asean-hole production to a small surface mine pit near Petersburg Indiana known as Prosperity. Freelandville and prosperity production began in Q3 of 2022. Volumes from these new pits are expected to be higher cost. We will continue to evaluate the productivity of these mines in connection with market conditions to determine the appropriate operational balance. Our average coal sales price increased from $39.51 per ton in 2021 to $45.64 per ton in 2022 and will be approximately $58.7 per ton in 2023. Various factors, including inflation, operational challenges and new hire onboarding and training impacted our cost of production and margins.

However, we closed the year with fourth quarter margins of $10.41 per ton and full year margins of $8.35 per ton compared with 2021 margins of $7.35 per ton. Looking at costs, most like the rest of the world, we experienced and are experiencing increasing cost to produce. Our average gold cost increased from $33.16 per ton in 2021 to 37.28 in 2022, with fourth quarter costs, just above $40 per ton as we start to realize additional efficiencies from the experience — our added headcount continues to gain, fewer production challenges and increased production, we expect these costs to levelize out or improve throughout 2023. Additionally, in Q4 of 2022, we completed the acquisition of the 1 gigawatt Merom Generation Station. The transformational impact of acquiring Merom is not just limited to adding new revenue generation opportunities for our business.

While we expect sales of both capacity and energy to help drive growth, Merom will add support to our coal business by providing flexibility for up to 40% of our coal production to capture the greatest value between the energy and coal markets. Starting in 2024, we anticipate shipping up to 3 million tons of coal annually from our mines directly to Merom. The close proximity of the mines to the plant is about 20 miles, enables real-time adjustments that should promote additional efficiencies for both business segments. Moreover, at Merom, we anticipate 3 million tons of our coal will produce approximately 6.5 million megawatt hours that we anticipate selling into the MISO wholesale energy market. We expect to utilize funds from third-party sales of the annual capacity accreditation of Merom to cover a significant portion of the annualized fixed cost of the plant.

While the capacity market will fluctuate over time, we believe that at current capacity prices, Merom provides a low-cost option to access the highest value market for our coal production. The vertical integration also provides true optionality in terms of how and when we sell our coal and energy. In some instances, if coal prices remain high, it may make sense to divert coal away from Merom and into the open coal market. In other situations, it may make sense to increase our shipments to Merom and sell additional energy in the wholesale energy market. In either case, flexibility is a key benefit that Hallador did not have prior to the acquisition. We also recognize the challenges of operating the coal-fired generation station. Due to the volatility of power prices, our earnings will be lumpy, but we believe on the whole that our profit potential has significantly increased.

Utilizing a strategy that incorporates offers into the day ahead power markets allows us to capture a significant portion of this potential while also limiting downside risk. Additionally, for us to operate Merom beyond 2025, there will be required investment in environmental controls prior to the end of 2025 that could exceed $45 million. Based on the present state of the energy markets, the decline in capacity reserve margins of the grid and increasing frequency of grid emergency events, we expect power markets to remain elevated. Over the course of 2023, we’ll be transitioning into a company with much higher long-term profit potential, but one which will likely experience periods of great volatility. Demand is the downside risk of these volatile periods.

We continue to focus on reducing bank debt. In 2022, bank debt was reduced by $26.5 million, bringing the balance at the end of fiscal 2022 to $85.2 million. As of December 31, 2022, our liquidity stood at $32.1 million, and our leverage ratio had dramatically improved to 2.05x. Subsequent to year-end, on March 13, 2023, we executed an amendment with our credit facility, which converted $35 million of the outstanding revolver to term debt with final payment due in March 12, 2024 and extended maturity of the remaining $85 million revolver capacity to May of 2024. Looking at CapEx, our 2023 capital expenditure budget is $69 million of which $35 million is maintenance CapEx, of the $69 million, roughly half is associated with coal and the other half associated with power.

Now I’m going to flip the call back over to Larry Martin, our CFO, and ask him to walk everyone through the purchase accounting associated with the Merom acquisition.

Larry Martin: Thanks, Brent. Although the only consideration Hallador paid for the power plant was roughly $15 million, which consisted of $5 million of inventory, $3 million of transaction costs and $7 million of assumed reclamation liabilities for the ash disposal tile. We accounted for this as an asset acquisition as required by generally accepted accounting principles. We entered into the purchase agreement with Hoosier Energy in February of 2022 and closed the transaction on October 21, 2022. The energy markets were volatile during this period. Thus, in the time between signing and closing the PPA — in closing, the PPA was below market and both the coal purchase contract and the coal inventory were below market. So under generally accepted accounting principles, we accounted for this as a purchase accounting.

This resulted in a $185 million liability adjustment for the PPA contract and a $34 million asset adjustment for the below-market coal purchase contract and inventory. These two large adjustments along with the $15 million consideration and some smaller GAAP adjustments resulted in $188 million of consideration given under GAAP purchase accounting. $23 million of the $185 million PPA contract liability was recorded to revenue in 2022. Of the $160 million remaining of the liability, $88 million is in current liabilities on our balance sheet and will be recorded to revenue in 2023, 75% of this will be by May 31. Of the $34 million associated with the coal purchase contract, $3.6 million was included as expense in 2022. The remaining $30 million is recorded as a current asset and will be reversed to expense by May 31, 2023.

So while approximately $58 million of 2023 earnings will result from this GAAP accounting treatment, our free cash flow, EBITDA, reporting, debt covenants and taxable income will be unaffected by these noncash adjustments. I will now turn the call back over to Brent for closing comments.

Brent Bilsland: Well, I’d like to open up — that ends our prepared comments, and I’d like to open up the call to any questions from our investors.

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Q&A Session

Operator: Our first question today comes from Lucas Pipes from B. Riley Securities. Your line is open.

Lucas Pipes: Thank you very much, operator. Good afternoon, everyone. Brent, my first question is in regards to liquidity. When you think about kind of the amount of liquidity the business needs on an ongoing basis. So how would you frame that up? So you have the maturity not until 2024. So lots of time there, and then I would expect you to generate healthy EBITDA in 2023. But if you could maybe frame up how much of cash generation should go towards debt versus how much cash you’d like to keep on the balance sheet? I would appreciate your perspective on that.

Brent Bilsland: Yes. Thank you, Lucas. I think our goal is you can never have too much liquidity. Our game plan is to try to get this company net debt free sometime around the end of first quarter of 2024. And then have a credit facility and cash on our balance sheet that hopefully is in the ZIP code of $100 million. So, I think that’s what we look to do with our company over the next 12 months, roughly from today. And I think that with contracts in hand that we have and then this year, the majority of our earnings are from our coal division with the power plant providing minimal earnings. And then in 2024, it looks to us that we’ll be taking a much greater percentage of our coal to the plant. So, the profitability of the plant will come into focus at that time. So, I think that answers — I hope that answers your question.

Lucas Pipes: That’s very helpful. And sorry, if I didn’t catch everything there. You said that in 2023, it will be much of a contribution from the power plant. Did I hear that right? Or could you expand on that?

Brent Bilsland: Yes. So if you look at the majority of our business, so we have sold power to the seller of the plant, primarily most of the output of the plant through May of this year. And then that PPA reduces to about 20% of the output of the plant thereafter. So we will begin to ramp up some of our coal shipments to the plant. But the majority of our profitability will come from the coal division in 2023. When we get into 2024, we anticipate taking as much coal as possible hopefully up to 3 million tons to Merom and so — and convert that coal into electrons. We think that judging by the forward power curves today, big power prices change every hour of every day, but looking at the curves that we’re looking at today, that looks to be the most profitable thing to do.

So, that’s the signals that we’re seeing today. And what we’ve tried to outline is that the capacity markets today are robust and should materially cover most, if not all, the fixed cost of the plant. So, we kind of view it as we essentially have a very low-cost option with the plant to either take our tons to the third party sales market, which is traditionally what we’ve done, or take those tons to Merom and convert them into electrons, which looks to be considerably more profitable to do today. We’ll see what the market brings. We saw the markets change very quickly in 2022, which affected why we chose to, if you went back to our prior calls, why we chose to sell such a high percentage of our coal to third parties. And part of that was because we didn’t closed on the plant yet.