See accompanying notes.
See accompanying notes.
The interim financial data is unaudited; however, in our opinion, it includes all adjustments, consisting only of normal recurring adjustments necessary for a fair statement of the results for the interim periods. The financial statements included herein have been prepared pursuant to the SEC’s rules and regulations; accordingly, certain information and footnote disclosures normally included in GAAP financial statements have been condensed or omitted.
Our organization and business, the accounting policies we follow and other information, are contained in the notes to our consolidated financial statements filed as part of our 20072008 Form 10-KSB.10-K. This quarterly report should be read in conjunction with that annual report.such 10-K.
The accompanying consolidated financial statements include the accounts of Hallador Petroleum Company and its subsidiaries.subsidiary. All significant intercompany accounts and transactions have been eliminated. We are engaged in the production of coal from a shallowan underground mine located in westernsouthwestern Indiana. We also own a 45% equity interest in Savoy Energy L.P., a private oil and gas company which has operations primarily in Michigan.
As discussed in prior filings, we have entered into significant equity transactions with Yorktown and other entities that invest with Yorktown. Yorktown currently owns about 55% of our common stock and represents one of the fiveseven seats on our board.
| 2. | Equity Investment in Savoy |
We account for our 45% interest in Savoy using the equity method of accounting. On October 5, 2007 we acquired an additional 13% in Savoy which brought our total interest to 45%.
Below (in thousands) are: (i) a condensed balance sheet at September 30, 2008,2009 and (ii) a condensed statement of operations for the nine months ended September 30, 20082009 and 2007.2008.
Condensed Balance Sheet
| | Current assets | | $ 13,5258,879 | |
| | PP&E | | 14,646 12,072 | |
| | | | $ 28,17120,951 | |
| | | | | |
| | Total liabilities | | $ 6,8715,522 | |
| | Partners' capital | 21,300 | 15,429 | |
| | | | $ 28,17120,951 | |
Condensed Statement of Operations
| | | | 2008 | | 2007 | |
| | Revenue | | $ 5,587 | | $ 4,099 | |
| | Expenses | | (5,078) | | (3,207) | |
| | Net income | $ 509 | | $ 892 | |
| | | 2009 | | 2008 | |
| | Revenue | $5,556 | | $5,587 | |
| | Expenses | (7,668) | | (5,078) | |
| | Net (loss) income | $ (2,112) | | $ 509 | |
For 2008, the difference between the purchase price and our pro rata share of the equity of Savoy was amortized based on Savoy's units of production rate using proved developed oil and gas reserves. Such amounts for September 30, 2008reserves and 2007 were $332,000 and $82,000, respectively.amounted to $332,000. For 2007 such amount2009 there was amortized using proved reserves.no difference.
In late June 2007, our Indiana banks agreed to increase the Sunrise line of credit (LOC) fromDecember 2008, we entered into a new loan agreement with a bank consortium that provides for a $40 million term loan and a $30 million to $40 million.revolving credit facility. We are the guarantor of this LOC. The additional funds were used to purchase certain mining equipment, build a rail loop, and for working capital. As of September 30, 2008, we have fully drawn down $36 million; plus wethe $40 million term loan and have made or first principal payment of $2.5 million. We have outstanding letters of credit in the amount of $3.5 million, which leaves about $26 million available under the revolver. We pay a .5% commitment fee for another $3 million. The current interest rate is LIBOR (3.2%) plus 3.55% or 6.75%. As discussed below, Sunrisethe unused funds.
In connection with the old loan agreements, we entered into two interest rate swaps.
The LOC was converted to a seven year term note in July 2008. The note will mature in June 2015. The note requires monthly principal payments of $445,000 plus interest.
Aggregate maturities of debt are $1,334,000 for the last quarter of 2008, $5,337,000 in 2009, $5,337,000 in 2010, $5,337,000 in 2011, $5,337,000 in 2012, and $13,341,000 thereafter.
We have entered into two interest rate swap agreements swapping variable rates for fixed rates. The first swap agreement, is relative to the $30which initially covered $26 million LOCin debt, commenced on July 15, 2007 and matures on July 15, 2012.2012; the current notional amount is about $15 million. The second swap agreement, relates to the additionalwhich initially covered $10 million, that increased Sunrise's LOC to $40 million. This second swap agreementcommenced on December 28, 2007 and matures on December 28, 2011. The2011; the current notional amount is about $8 million. Considering the two swap agreements, fix our current interest rate atis about 8.8%6.1%. At September 30, 2009 and December 31, 2008, weour interest rates swaps resulted in a liability of $1.64 million and $2.3 million, respectively. The difference of $647,000 is included as a reduction in our interest expense for the nine months ended September 30, 2009. The recorded the estimatedvalue of our bank debt approximates fair value as it bears interest at a floating rate.
4. Income Taxes
For the nine months ended September 30, 2009, our effective income tax rate increased to 39%, a 2% increase over the effective tax rate of 37% for the two swapssix months ended June 30, 2009. As discussed in Note 5 below, we acquired the remaining 20% membership interest in Sunrise. In doing so, we derived tax basis for our coal properties and, consequently, there will not be any percentage depletion in excess of basis which is a permanent difference for tax purposes that previously served to reduce the effective income tax rate. This change caused the effective rate for the three months ended September 30, 2009 to be 45%.
5. Stock Sale and Purchase of Remaining Interest in Sunrise
On September 16, 2009, we entered into agreements to purchase the remaining 20% membership interest in Sunrise Coal, LLC (“Sunrise”), from the existing members for an aggregate purchase price of about $32.6 million, consisting of about $25.8 million in cash and 1,133,328 in shares of our common stock valued at $6/share ($6.8 million). Sunrise is now a wholly-owned entity of ours. Brent Bilsland, our new president and board member, received cash of about $3.185 million and 8,333 shares of our stock for his approximate 2% interest and his spouse received cash of about $1.775 million and 208,333 shares of our stock for her interest (slightly less than 2%). His parents also sold their approximate 8% interest in Sunrise under the same terms receiving 383,332 shares and the remainder in cash. In addition, Brent Bilsland purchased for cash 200,000 shares (at $6/share) directly from Victor Stabio, our CEO.
For accounting purposes the buyout was treated as an equity transaction among members of a $1.1 million liability.
Accounting rules require us to recognize all derivatives on the balance sheet at estimated fair value. Derivatives that are not hedges mustcontrolled group. For income tax purposes we will be adjusted to estimated fair value through results of operations. We have no derivatives designated as hedges.
We are in negotiations with a bank groupable to increase our credit facility by $30tax basis in the coal properties and receive future tax deductions; accordingly, a deferred tax asset of $12.7 million in order to fund additional mine expansion. We expect to finalize the new loan agreement by the end of November 2008.
was recognized.
The day before the purchase, in a private placement transaction, we sold 4,150,000 shares of our common stock for an aggregate cash purchase price of $24.9 million ($6/share). The proceeds from the sale were used to purchase the remaining membership interests in Sunrise as described above. All but 450,000 shares were sold to our existing shareholders and board members. Yorktown Energy Partners VIII, LP, a private partnership affiliated with board member Bryan Lawrence, purchased 2,950,000 shares and an entity affiliated with board member Sheldon Lubar purchased 750,000 shares.
4. | Fair Value Measurements |
6. Subsequent Events
We adopted SFAS No. 157, “Fair Value Measurements,” effective January 1, 2008 forNo subsequent events have occurred through November 10, 2009 that could have a material effect on our financial assets and liabilities measured on a recurring basis. SFAS No. 157 applies to all financial assets and liabilities that are being measured and reported on a fair value basis. In February 2008, the FASB issued FSP No. 157-2, which delayed the effective date of SFAS No. 157 by one year for nonfinancial assets and liabilities except those that are recognized and recorded in the financial statements at fair value on a recurring basis. As defined in SFAS No. 157, fair value is the price that would be received to sell an assetposition, cash flows or paid to transfer a liability in an orderly transaction between market participants at the measurement date (exit price). SFAS No. 157 requires disclosure that establishes a framework for measuring fair value and expands disclosure about fair value measurements.
The statement requires fair value measurements be classified and disclosed in one of the following categories:
| | | | |
| | Level 1: | | Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities. We consider active markets as those in which transactions for the assets or liabilities occur in sufficient frequency and volume to provide pricing information on an ongoing basis. We have no Level 1 instruments. |
| | | | |
| | Level 2: | | Quoted prices in markets that are not active, or inputs which are observable, either directly or indirectly, for substantially the full term of the asset or liability. We have no Level 2 instruments. |
| | | | |
| | Level 3: | | Measured based on prices or valuation models that require inputs that are both significant to the fair value measurement and less observable from objective sources (i.e., supported by little or no market activity). Our Level 3 instruments are comprised of interest rate swaps. Although we utilize third party broker quotes to assess the reasonableness of our prices and valuation, we do not have sufficient corroborating market evidence to support classifying these liabilities as Level 2. |
At December 31, 2007, March 31, 2008, June 30, 2008 and September 30, 2008, the estimated fair value of our interest rate swaps were a liability of $1.2 million, $2.1 million, $1.1 million and $1.1 million, respectively. The difference for the respective periods is reflected in our results of operations.
5. | Commitments and Contingencies |
Based on contracts in place as of November 2008, during the period October 1, 2008 through December 31, 2013 we are committed to deliver 14.3 million tons of coal at prices averaging about $42 per ton.
In order to expand coal production at the Carlisle mine, additional capital is necessary to purchase mining equipment. During the nine months ended September 30, 2008 we advanced Sunrise $6.2 million and, subsequently, have advanced an additional $1.8 million. We are currently receiving monthly interest at 6% on the $8 million. The advances and interest are eliminated in consolidation.
Effective April 8, 2008, the Board approved the Hallador Petroleum Company 2008 Restricted Stock Unit Plan. On July 7, 2008 the Plan was amended to increase the authorized issuance of restricted stock units (RSUs) from 450,000 units to 1,350,000 units.
On May 6, 2008, we awarded to certain Sunrise employees and owners a total of 180,000 RSUs which vest on April 1, 2011. The RSUs were valued at $4.25 per share based on the closing price on that date. On May 14, 2008, we accelerated vesting on 50,000 shares and recognized an expense of about $212,000. Additionally, we recognized another $40,000 in service cost for the remaining 115,000 RSUs during the three months ended September 30, 2008.
On July 7, 2008, we awarded to certain of our and Sunrise's key employees 820,000 RSUs, all of which vest on July 7, 2011. Of the 820,000 RSUs awarded, Victor P. Stabio, our CEO received 450,000 units and Brent Bilsland, Sunrise's President, received 300,000 units. These RSUs were valued at $3.55 per share based on the closing price on that date. During October 2008, we accelerated vesting on 815,000 RSUs, of which 450,000 were issued to Victor Stabio and 300,000 were issued to Brent Bilsland, and the remaining 65,000 were issued to others. Our stock was selling in the $2.75 to $2.85 range on the dates of acceleration. During the fourth quarter 2008, we will recognize an expense of about $2.3 million for these RSUs.
Vesting occurs at the end of three years of employment. Upon vesting, each RSU entitles the recipient to receive one share of common stock. If the RSU recipient’s employment with us or Sunrise ceases for any reason prior to vesting, the RSUs will be cancelled and the recipient will no longer have any right to receive any shares of common stock. Due to employee resignations during the third quarter, 15,000 RSUs were forfeited back to the Plan.
As of November 12, 2008, we have 365,000 RSUs available for future issuance and there are 165,000 RSUs outstanding which have not vested.
8. | Sales of Common Stock and Purchase of Additional Interests in Sunrise |
On July 21, 2008, we sold 5.5 million shares of our common stock for $22 million ($4 per share) in a private placement transaction to existing shareholders. On July 24, 2008 we purchased an additional 20% interest in Sunrise from certain of its existing members for $11.8 million, bringing our ownership in Sunrise to 80%. The purchase price was allocated to coal properties.
Prior to the purchase of the additional 20% interest, we consolidated 100% of the Sunrise operations with a 13% minority interest. Subsequent to the purchase, we are now using an 8% minority interest. Once we receive our $22.9 million funding commitment (as previously discussed in prior filings), plus interest of 10%, the minority interest will change to 20%.
At December 31, 2007 we had NOLs of about $8.8 million. The NOLs will expire in 2026. The second quarter 2008 is the first time we have shown a profit since our involvement with Sunrise. Accordingly, until management is satisfied that we will be profitable on a continuing basis, we will not recognize any tax benefits resulting from our NOLs.
ITEM 2. MD&A.
THE FOLLOWING DISCUSSION UPDATES THE MD&A SECTION OF OUR 20072008 FORM 10-KSB10-K AND SHOULD BE READ IN CONJUNCTION THERETO.
OutlookCap on Carbon Emissions
If pricesOn April 17, 2009 the Obama Administration declared that carbon dioxide threatened the planet. The landmark decision lays the ground work for federal efforts to cap carbon emissions. The Environmental Protection Agency (EPA) officials are on record saying they would take a go-slow approach. New regulations driven by the finding could be years away; but, unless superseded by congressional action, the EPA ruling eventually could lead to stricter emissions limits.
Under our current contracts, any new taxes or costs relating to these events can be passed on to the customer. We are unable to determine what effect these events will have on future coal demand.
Our management is in favor of reasonable and mine conditions continue as they werepractical steps to protect the environment. We are not in favor of the current cap and trade bill passed by the House and being discussed in the third quarter we expect fourth quarter earningsSenate. Unless countries like Mexico, China, India and cash flowsRussia pass and enforce similar laws any reduction in carbon omissions in our country would be inconsequential to exceed the third quarter.ultimate goal.
Sales of Common StockLiquidity and Purchase of Additional Interests in SunriseCapital Resource
On July 21, 2008, we sold 5.5 million shares of our common stock for $22 million ($4 per share) in a private placement transactionWe plan to existing shareholders. On July 24, 2008 we purchased an additional 20% interest in Sunrise from certain of its existing members for $11.8 million, bringing our ownership in Sunrise to 80%. The remainder of the proceeds will be used forfund future mine expansion.
Mine Expansion
Due to the recent increases in coal prices, we made the decision to expand the mine from its current capacity of 1.8 million tons per year to 3 million tons per year. This expansion will involve the purchase of additional mine equipment, the construction of another wash plant, and the hiring of about 130 new employees. We expect the expansion to be completed during the first half of 2010.
Funding for the expansion will come fromthrough a combination of (i) advances to Sunrises, (ii) additional bank borrowings,draws from the revolving credit facility with our banks and (iii) cash from operations. We anticipatehave about $26 million available under the costrevolver due to outstanding letters of credit. Our budgeted capital expenditures for the expansion to belast quarter of 2009 are about $45 million.
We have committed to advance Sunrise up to $13$8 million and $20 million for the mine expansion of which $8 million has been advanced to date. We are charging Sunrise interest at 6%. The advances and interest are eliminated in consolidation.
Negotiations are ongoing with our bank group to provide the remaining funds for the mine expansion.
In July 2008 we amended one of our three coal contracts so that we will have a market for the aforementioned production of 3 million (MM) tons per year in 2010. Our current average sales price is about $31 per ton and we expect our average price to rise to $43 per ton in 2010. We expect 2008 production to be 1.9 MM tons with an average price of $36.50; 2009 production to be 2.4 MM tons with an average price of $43; and 2010 production to be 3 MM tons with an average price of $43.
Gain on Sale of Unproved Lease Acreage
In late October 2008, we sold our interest in 10,000 acres in southeast Wyoming for about $2 million and will recognize a gain of about $1.3 million. Upon the favorable outcome of a pending lawsuit regarding the title to certain acreage we could receive an additional $450,000. The purchaser is now bearing the cost of the litigation. Assuming an unfavorable outcome, there is no loss to us other than we would not receive the additional $450,000. We retained a 2% overriding royalty interest (ORRI) on the 10,000 acres we sold plus an additional 2% ORRI on an adjacent 10,000 acres which resulted from an arrangement we had with one of our partners in this prospect.
As a result of this sale, we have minimal unproved acreage in our inventory. Since entering the joint venture with Sunrise in June 2006, we have sold about $10 million of oil and gas properties to support the development of the Carlisle mine. We will continue to evaluate possible oil and gas lease plays in the Rocky Mountain region.
Liquidity and Capital Resources
We have no material off-balance sheet arrangements.
Results of Operations
Year to Date
CoalThe recession has reduced power demand, which has reduced the need for coal. Stockpiles at some of our customers are high and, accordingly, during July we were asked by one of our customers to defer a total of 400,000 tons through December 31, 2010. These tons will be shipped in 2011-2013. We have agreed to assist our customer because of our valued relationship.
Due to the reduced power demand, we estimate fourth quarter sales began in February 2007. For the nine months ended September 30, 2007 we sold 617,000for 2009 to be about 737,000 tons at an average selling price of $44.50/ton. We expect 2010 sales to be about 3 million tons at an average price of $29.30/$42. The reduction in average prices is due to higher priced coal being deferred to later years.
For 2009 we sold 1,931,000 tons at an average price of about $44/ton. For the nine months ended September 30, 2008 we sold 1,355,000 tons at an average price of about $30.75/ton.
In early July 2007 we soldDuring 2009 our interestequity loss in the San Juan properties for $2.3 million. We recognized a gain of about $1.8 million. During the first quarter 2008, we sold some unprovedSavoy was due to lower oil and gas propertiesprices and recognized a gain of $494,000.higher operating costs relative to 2008.
Savoy's income declined due to a higher dry hole costs and seismic expenses. In addition, we had amortization expenseCost of $332,000coal sales per ton averaged $25/ton in 20082009 compared to $82,000$20.35 in 2007. This2008. The increase was due to inefficiencies during our mine expansion and construction, temporary adverse mining conditions and higher costs associated with government impositions. Our mining employees totaled 290 at September 30, 2009 compared to 190 at September 30, 2008. We expect the additional 13% interest in Savoy we acquired in October 2007. The difference between the purchase price and our pro rata share of the equity in Savoy is amortized based on Savoy's units of production rate. Due to declining oil and gas prices, Savoy's fourth quarter revenues will decline.
Cost of sales increased due to a substantial increase in the tonscost of coal sold. On a per sales to average $23-24/ton basis, they dropped by about $3 per ton due to increases in mining efficiencies.
for the remainder of 2009.
The increase in DD&A was due to nine months of coal salesthe significant increase in 2008 compared to eight months in 2007. In addition, our coal properties have increased.sales. There were no significant changes in our coal reserves.
During July and August 2007,
SG&A increased primarily due to the Board allowed Mr. Stabio's and Mr. Bisland's restricted stock awards to vest. We took a chargehigher level of about $1.8 million for these vested shares. During 2008 we incurred higher stock compensation expense of about $300,000.operations.
Included in 2009 interest expense was a credit of $647,000 relating to our interest rate swaps; such amount for 2008 was a credit of $57,000. In addition, we capitalized $293,000 in interest expense for 2007 was $165,000 related to the fair value of our interest rate swap and $260,000 for accretion of the contract termination obligation. We ceased amortizing such obligation on December 31, 2007.
The change in minority interest was due to Sunrise having a profit in 20082009 compared to a loss in 2007.$176,000 for 2008. Because our mine expansion is complete, we are no longer capitalizing interest.
Quarter to Date
Coal sales began in February 2007. For the three months ended September 30, 20072009 we sold 304,000673,000 tons at an average price of about $28.50/$44/ton. For the three months ended September 30, 2008 we sold 530,000 tons at an average price of about $33.45/ton.
See above for a discussion of the change inFor 2009 our equity loss in Savoy's income or loss.Savoy was due to lower oil and gas prices and higher operating costs relative to 2008.
Cost of coal sales on a per averaged $25.11/ton basis stayed aboutin 2009 compared to $21 in 2008. We expect the samecost of coal sales to average $23-24/ton for both periods.the remainder of 2009.
See above for a discussion in the changeThe increase in DD&A.&A was due to the significant increase in our coal sales.
See above for a discussion in the change in G&A.
Included in 2009 interest expense for 2007 was $295,000 relateda credit of $116,000 relating to the fair value of our interest rate swap and $130,000swaps; such amount for accretion2008 was a credit of the contract termination obligation. We ceased amortizing such obligation on December 31, 2007.$18,000. No interest was capitalized for either period.
New Accounting Pronouncements
Other than SFAS 160, noneNone of the recent FASB pronouncements had, or will have any material effect on us. In December 2007, the FASB issued SFAS No. 160, Noncontrolling Interests in Consolidated Financial Statements, an amendment of Accounting Research Bulletin No. 51. This statement requires an entity to separately disclose non-controlling interests as a separate component of equity in the balance sheet and clearly identify on the face of the income statement net income related to non-controlling interests. This statement is effective for financial statements issued for fiscal years beginning after December 15, 2008. The adoption of this statement will change how we present our consolidation with Sunrise.
ITEM 4(T). CONTROLS AND PROCEDURES.
We maintain a system of disclosure controls and procedures that are designed for the purposes of ensuring that information required to be disclosed in our SEC reports is recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms, and that such information is accumulated and communicated to our CEO and CFO as appropriate to allow timely decisions regarding required disclosure.
As of the end of the period covered by this report, we carried out an evaluation, under the supervision and with the participation of our CEO and CFO of the effectiveness of the design and operation of our disclosure controls and procedures. Based upon that evaluation, our CEO who is also ourand CFO concluded that our disclosure controls and procedures are effective for the purposes discussed above.
There has been no change in our internal control over financial reporting during the quarter ended September 30, 20082009 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
