Talen Energy Corporation

Good morning and welcome to the Talon Energy second quarter 2023 earnings conference call. All participants will be in a listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star then one on a touch-tone phone. To withdraw your question, please press star then two. Please note this event is being recorded. I would now like to turn the conference over to Ellen Liu, Senior Director of Investor Relations. Please go ahead.

Thank you, Kate, and welcome, everyone, to Talon Energy's second quarter 2023 conference call. Participating on today's call are Mac McFarland, Chief Executive Officer, and Terry Nutt, Chief Financial Officer. They are joined by other Talon senior executives to address questions during the second part of today's call as necessary. I'd like to highlight that we have provided slides on the investor relations section of our website, www.talentenergy.com. These slides provide additional information about our operations and second quarter results. We have also provided information reconciling our non-GAAP financial measures to the most directly comparable GAAP financial measures in our earnings materials. Today, we are making some forward-looking statements based on current expectations. Actual results could differ due to risk factors described in our financial disclosures and other periodic public filings. As a reminder, we have allotted additional time for a question and answer session at the end of our prepared remarks. We ask participants to please limit their questions to one primary and one follow-up. With that, I will now turn the call over to Max.

Great. Thank you, Ellen. Good morning, everyone, and thank you for joining us today. At Talon, we are focused on delivering consistent and predictable free cash flow. Today, Talon reported strong operational and financial performance in the first half of 2023, generating from a diverse fleet anchored by carbon-free nuclear power. With today's release, we are establishing 2023 adjusted EBITDA and adjusted free cash flow guidance, and given our strong first half of the year, the midpoint of our guidance ranges are higher than the last forecasted figures presented on January 27th. On May 17th, Talon emerged from its financial restructuring after successfully raising roughly $2 billion of funded emergence debt, a $700 million undrawn revolver, and $1.4 billion of new equity capital. This, together with the conversion of over $1.4 billion of unsecured debt to common equity, allowed us to emerge with modest leverage and long-dated maturity profile with ample liquidity to run the business. We are and will remain focused on disciplined capital allocation and prioritizing shareholder returns, and we will do so looking to maintain a net leverage ratio of less than three and a half times net debt to EBITDA. In connection with the emergence, we announced management and board changes to support Talon, I was delighted to join Talent at Emergence, and we have since rented out the management team, including the addition of Terry Nutt as Chief Financial Officer. Terry has more than 20 years of experience in the energy industry, including leadership roles and post-reorganization situations, and you'll hear from him later in this call. We also put in place an independent board of directors, each with deep industry expertise, and drawing on this experience in the new management team will allow us to drive value creation for shareholders. Prior to emergence, Tallinn was a private company for over six years. We are now realigning with regular way public company practices, including quarterly financial filings and earnings calls. Tallinn is currently listed on the OTCQX, and we anticipate listing on a major national exchange in the future. Management is focused on this initiative, which could be completed as soon as the end of this year. On August 9th, we simplified the capital structure further by refinancing our non-recourse Lower Mount Bethel and Martins Creek debt through the upsizing of our corporate term loan. The transaction brings the Lower Mount Bethel and Martins Creek generation assets into the talent group, and it frees up previously trapped cash flows that were amortizing the project-level term loan. Overall, this simplifies our capital structure and extends our debt maturity profile further. Additionally, on August 10th, Talon reached an agreement with Riverstone to acquire its roughly 14% interest in Cumulus Digital Holdings and to retire its 3.1 million warrants in Talon Energy for a total cash consideration of $60 million. By doing so, we are eliminating $49 million of liabilities associated with these warrants and their potential common equity dilution risk. We are also eliminating including all of Riverstone's equity and governance interest in Cumulus Digital and its economic rights in related intercompany PPA agreements. This transaction is expected to close in September and again further simplifies the ownership structure of Talent and Cumulus Digital, and it enables increased flexibility as the company continues to unlock value across its platform. Turning now to our results, We performed reliably and safely. We are proud of our safety record with an OSHA total recordable incident rate of 0.6 on a year-to-date basis, and we continue to emphasize safety across the fleet. Our TRIR is one of the best among peers. Our fleet ran well, generating 13.5 terawatt hours with an equivalent forced outage factor of 2.6% in the first half of the year. Approximately 60% of that generation was carbon-free, from our Susquehanna nuclear facility. Furthermore, our ERCOT plants performed consistently and profitably during the Texas summer heat wave. This strong operational foundation and a robust commercial strategy delivered $774 million of adjusted EBITDA year-to-date. And after funding our maintenance capital expenditures, we generated $464 million of adjusted free cash flow on a year-to-date basis. I'd like to take this opportunity to recognize and thank all of our employees across the fleet. They have worked safely to deliver excellent operational results from Montana to Texas to the Mid-Atlantic. Without their efforts and resolve, none of this would have been possible. While the majority of our generation is already produced through zero carbon nuclear and lower carbon gas fired facilities, we are reducing the carbon profile of our wholly owned coal fleet through the conversion to lower carbon fuels. The 1.5 gigawatt Montour gas conversion is nearly complete, and final testing will conclude this quarter. Montour Unit 2 became fully operational on natural gas in early August, and Unit 1 will be fully operational on gas by the end of August. The Wagner Unit 3 coal-to-oil conversion is also well underway, with expected completion before year end. As an update on Cumulus, we are near full electrification on substation three, which will provide fully redundant power to phase one of our data center campus. Going forward, we will have minimal growth investment in Cumulus data, as we need only $5 million or so of incremental spend for the final transformer that will give us an electrical infrastructure capability for up to 240 megawatts of data centers. As Terry and I have been on the road meeting with investors, many have asked about our plans for Cumulus Data and when we will announce a deal. The answer is, frankly, when we have the right deal. Talent has invested significant capital in Cumulus, and we are keenly focused on realizing the value of these prior investments through a sale or joint venture. The data center market is very active because of increased demand from AI and low availability of data center capacity. And we are uniquely positioned with a ready-to-go shell, abundant zero-carbon power, the ability to offer attractive long-term rates relative to other tariff rates, and a scalable campus with the potential capacity for up to one gigawatt of data centers. With that, I'll now turn the call over to Terry. Terry?

Thank you, Mac, and good morning to everyone on the call. Moving to financial results. During the second quarter of 2023, Talon continued to build on its strong first quarter financial results to deliver $774 million in year-to-date adjusted EBITDA. We achieved one of our best first half of the year performances since 2018, driven primarily by higher energy margins realized through our disciplined hedging strategy. Our commercial team took advantage of elevated forward pricing in 2022 to lock in 2023 power prices across our fleet, which resulted in strong revenues through realized hedge gains during periods of less favorable pricing in the first half of 2023. For the second quarter of 2023, Talon reported adjusted EBITDA of $114 million and adjusted free cash flow of negative $30 million. Once again, earnings for the quarter benefited from realized hedging gains that offset lower real-time power prices. Below average temperatures in the PJM market during the quarter resulted in lower demand for cooling needs, which contributed to reduced power load when compared to the second quarter of 2022. That said, Talon did benefit from a slight offset from our ERCOT generation fleet due to higher ERCOT spark spreads during the period. Those plants have performed well and continue to perform well during the current heat wave in Texas. Turning to adjusted free cash flow, for the second quarter, we did operate under our legacy capital structure for over half of the quarter until emerging from restructuring on May 17th. This included incurring interest expense on our prior capital structure for 47 days. At emergence, we used approximately $1.1 billion of cash on the balance sheet to pay off debt and claims, exiting with $170 million of unrestricted cash and a fully undrawn $700 million revolver. Since completing our restructuring on May 17th, we have achieved strong operating and financial performance and have made substantial progress on our strategic realignment to a regular way public company. As the next step in that process, we're establishing 2023 financial guidance ranges for adjusted EBITDA and adjusted free cash flow today. With higher expected midpoints, than the 2023 EBITDA and free cash flow previously disclosed in January of this year. The range for 2023 adjusted EBITDA is 1.07 billion to 1.245 billion. And the range for adjusted free cash flow is 550 million to 595 million. Further, as we continue to reintroduce talent to the investing public, we anticipate providing 2024 guidance during our Q3 earnings call. Moving on, I'd like to discuss current gas and power market dynamics briefly before providing an update on our hedging activities. During the last nine months, tight domestic and international natural gas supply and demand conditions have reversed due to several factors. Those factors include a milder than normal 2022 to 2023 winter, both domestically and abroad, and substantial year-on-year growth in North American gas production. These factors have driven down domestic and international gas pricing relative to the elevated pricing seen in 2021 and 2022. PJM Ford power price dynamics have reflected the underlying drivers of the natural gas market. With the added impact of the recent announcement around the Mountain Valley Pipeline project becoming much more likely, We believe that that project will relieve some of the scarcity premium normally seen in winter pricing in PJM gas markets. The ERCOT forward power market has also been impacted by gas market dynamics, but we've seen added scarcity premium values and an expansion in spark spreads in forward prices due to elevated demand conditions from the prolonged summer heat wave that we're currently experiencing. Now for a brief update on our risk management activities. As of June 30th, Talon has hedged approximately 64% of its expected generation volumes for the second half of 2023 and 76% of expected generation in 2024. The 2024 positions do include the impact of the production tax credit on our nuclear fleet. Talon's hedging program is a key component of the company's comprehensive fiscal policy and supports the objective of locking in future earnings and cash flows. It is important to note that while our hedge percentages for the balance of this year are at the low end of our previously targeted range of 60 to 80 percent, the overall gross margin at risk during this period is relatively low, and that is reflected in our 2023 guidance range. Finally, I want to provide a brief update on our nuclear fuel supply activities. Over the last few months, we have executed on several measures. including eliminating all of our exposure to Russian-related uranium suppliers and further hedging our uranium and uranium conversion positions. As of now, we have hedged 100% of our fuel through the 2025 fuel load, as well as all of our conversion and fabrication needs through 2029. Turning now to the balance sheet, as Mack noted earlier, on August 9th, Talent successfully refinanced our non-recourse lower Mount Bethel Martin's Creek subsidiary debt through upsizing our existing term loan B that matures in 2030. This simplifies our capital structure, reducing the number of credit facilities and eliminating non-recourse debt related to our generation fleet. It also moves a high-quality set of operating assets into our primary credit structure. Breeze-up cash flow is produced from these assets for broader utilization, and clears all debt maturities until 2028. We view this transaction as an endorsement by the capital markets of our performance, strengths, and strategic focus. We saw robust demand from new and existing investors that allowed us to tighten pricing relative to our emergence debt that was raised back in May. As Matt noted earlier, we will maintain a strong balance sheet and utilize our free cash flow strategically to achieve the highest returns for our stakeholders. This includes the deployment of a net leverage target of less than three and a half times net debt to EBITDA, along with maintaining ample liquidity. As of August 11th, Talent had total available liquidity of approximately $840 million, comprised of $140 million of unrestricted cash and a fully undrawn revolving credit facility of $700 million. With that, I'll now turn the call back over to Matt.

Great. Thanks, Terry. To reiterate our value position, first, Talon offers diverse and stable cash flows with limited non-maintenance CapEx going forward. Our capital investments in the data center campus are largely complete. The Montour conversion is nearly complete, and the Wagner conversion will be completed by end of year. Additionally, Talon owns the industry-leading carbon-free Susquehanna nuclear plant, backed by the nuclear production tax credits. Our gas and peaking fleet is well positioned to capture upside from market dynamics in ERCOT and PJM. Our zero carbon digital infrastructure campus is optimally positioned for monetization and value creation. And we have a strong balance sheet, as Terry mentioned, underpinned by modest leverage and ample liquidity. We look forward to engaging with our stakeholders at multiple upcoming industry events. and we will be holding an investor day at the Susquehanna Nuclear Site and Cumulus Digital Campus on October 24th. Look for additional information on this event in the near future, but please save the date. Thank you for your interest and talent for joining us on the call today. We will now open the line for questions, and I'll turn it back to the operator, Kate.

We will now begin the question and answer session. To ask a question, you may press star then one on your touch-tone phone. If you're using a speakerphone, please pick up your handset before pressing the key. To withdraw from the question queue, please press star then two. As a reminder, we ask that you limit your questions to one primary and one follow-up. The first question is from Julian Dumoulin-Smith of Bank of America. Please go ahead.

Hey, good morning, team. Thank you guys very much for the time, and congratulations again on everything. Appreciate it. Hey, look, I just wanted to kick in here on the JV or strategic efforts you have going on the data center front. I mean, look, you said you're waiting for the best deal here. Just setting expectations, what could that deal or what's your latest expectation on what that would look like structure-wise? And any initial expectations on how you would think about the financial ramifications that, again, knowing that there's numerous caveats likely embedded?

Good morning, Julian. It's Mac. How are you? I hope you're well. Look, you're asking a question about commercial negotiations that are ongoing, and so it's difficult for us to get into those. I think what we've said is that we're open to multiple different structures, whether it be a sale or a JV, whichever we find to be the most economic. When it comes to the financial implications of those As we've said right now, we, and as I included in my remarks, we have limited growth CapEx going forward, and that includes Cumulus. We have to buy one additional transformer, which we're in the process of doing for around $5 million, as I mentioned. And once that's done, we have the ability for up to 200, we have the electrical ability for up to 240 megawatts. And we have a building that is a 50 to 65 megawatt shell building. So in either structure, what we're looking to do is find the right JV partner by which to deploy capital with or an outright sale that uses that electrical infrastructure and hopefully has line of sight to the additional electrical infrastructure that would get us to one gigawatt.

Yeah, indeed. Fair enough. All right. I know it's still coming here. And then if I can, just following up on the uranium commentary and the procurement cycle, How do you think about that 25 to 29 procurement decision here? And obviously nicely done on what you've layered in already. But I'm just curious, given what you know about the marketplace, availability of fuel, et cetera, how do you think about just setting expectations financially? And also just, you know, how do you think about that procurement itself on filling in through the decades?

So one thing, I think Terry highlighted it, and I'll have him jump in as well, but what we did is we've locked up conversion because there's a potential bottleneck by the end of the 2020s here, going into 29 and 30. And as we said, we've got our position hedged for the next several fuel loads and hedged 100% through conversion and fabrication through the end of the decade. We thought that that was a prudent measure to do. I will tell you that the last forecast we provided of CapEx is out there. It's the 127 refresh. It's highlighted in one of the charts in the back about the amount of CapEx that's being spent. And what we've been able to do is to hedge within or below those numbers. And so we are tracking, as we've said before, we have a $22, the 2022 All-in cost of Susquehanna was $22, and if you looked at that profile, we show that we're adding about a dollar a megawatt hour because of fuel costs over time each year, and we're still on that trajectory.

Awesome. Excellent. Glad to hear that. Thank you, guys, and speak to you soon. Thanks, Julian.

The next question is from Angie Dorosinski of Seaport Research Partners. Please go ahead.

Thank you. So maybe just finishing up on the nuclear fuel. So you mentioned conversion and fabrication, but it seems like the enrichment is the real bottleneck. Have you locked in the enrichment capacity?

So we've locked in all of our conversion and all of our enrichment. The main piece that we have still outstanding is we have a modest piece of physical commodity left in the near term. We don't think that that's an area of the market that is a huge concern right now. It's really the enrichment and conversion that's very tight.

Yeah. And we have the commodity locked in through the 2026 fuel load, by the way. The other thing, the other step that I should have mentioned earlier that we've done is we have eliminated all exposure to Russia as well through several of the transactions that we've completed.

Okay. So moving on to capital allocation, so you mentioned that you have very limited non-maintenance CapEx going forward, and I understand that 23 is for now a peak earnings year, so there is a degradation in earnings going forward. But what is the plan how you would allocate any excess cash above that 3.5 times net debt to EBITDA?

Yeah, well, I think what we've stated is that, and you're right, Angie, which is that the non-maintenance part of our capital program is behind us after 2023. So in other words, all of our growth capex will have been spent, and that was in the conversion projects, Wagner, Montour, et cetera, as well as all of the infrastructure that was needed at digital at this point for Cumulus. And so what we've said is that going forward, provided that we can maintain the liquidity position that we have, the net debt to EBITDA of less than three and a half times, we are going to prioritize shareholder returns.

Okay. Because I was just wondering, I mean, you know, how – when you look at your existing portfolio, do you think you have sufficient scale as a public company? I mean – you know, power generation, as you know, is a business of economies of scale. And I'm just wondering how you see the current size of your portfolio.

Yeah, well, we're roughly 12 and a half gigawatts. And I think that, you know, we generate approximately 40 terawatt hours a year. So I think it is of scale. I think that there's an opportunity in the space to be a public company that can attract investors. I think we've seen it both from our non-deal roadshows where we've got interest from Obviously, we meet with our existing shareholders, but we've met with a lot of new shareholders. I think we continue to see public appetite for the credit, as well as Terry mentioned, our lower Mount Bethel refinancing into the corporate term loan and the upsizing of the corporate term loan was received very positively. So we do think that there's an opportunity in the space as a public company.

Okay. And lastly, post-restructuring, you don't have any electric retail. And I'm just wondering how you see that business basically as a way to hedge your generation output maybe.

Yeah, I think that – good question there. The retail business, you know, look, there's fairly robust margins for residential in ERCOT. CNI – is often described as an efficient way to hedge megawatts in a low credit, if you will, or with limited credit support. And that's the benefit because the margins aren't necessarily that strong in the CNI business relative to Texas retail. But if you look at where we are and look at, as Terry mentioned, the hedge position, and we can address that in 2024 being at 76%, and that's because we included the production tax credit And if you look at the production tax credit, it provides us a way to hedge the downside, very credit efficient, you know, with a backstop being, you know, the federal government through the production tax credit. So we like our position. We don't feel that there's a need necessarily to add retail at this point.

The next question is from Kevin Kwong of J.P. Morgan. Please go ahead.

Great. Thanks for answering my question. And I just wanted to kind of focus on the capacity market. I know it's a smaller and smaller part of the story now, but I just wanted to see next milestones, what you're most focused on. I noticed that some of your assumptions in the January materials, you have a little bit of an uptick in pricing there. So I just wanted to see what your assumptions are overall and expectations.

Yeah, we haven't, Kevin, it's Mac. We have not provided assumptions because we have, like Terry said, we're going to provide guidance, which is very typical for the industry with third quarter earnings. That's at least our expectation at this point in time. Right now, with the auction being postponed, we're not necessarily providing guidance on what we think the capacity clears will be in the out years.

Okay, that's fair. Maybe then we just move on to... some of the coal assets in the portfolio. I know it's a smaller part of your portfolio, but given that Brandon Shores is undergoing retirement, how should we think about maybe the longer-term viability of some of your minority-owned fleet there? Any opportunities with the remainder of that portfolio?

Yeah, well, we have a stated objective to, out of the non-holy-owned fleet, coal to be out of that towards the mid part of this decade. Obviously, Brandon Shores is retiring, Wagner's been converted, Brunner's been converted, Montour's been converted, and all of which will be running off of gas or oil going forward. Brandon's a bit of a different situation as we've provided a notice of suspension of operations, but it's electrically constrained in the BGE territory, the Baltimore territory, and so PJM has suggested that the unit is still necessary for the next several years. We're working our way through that right now with PJM. We want to be constructive there, but also, you know, we were under a formalized consent decree with their, I guess it's a formalized agreement with Sierra Club to, not a consent decree, but an agreement with Sierra Club to shut down in 2025. and we're making good on that right now, but PJM is saying that it's necessary. So we are focused on being out of coal at those units. Those conversions are the ones that I've mentioned, and they'll be done here and will be out sometime in the next several years, completely out. Okay. We still have that – We still have the minority positions in Keystone, Connemaw, and we're the operator of Coal Strip in Montana, but those are jointly owned facilities, and there's no plans right now to convert them.

Got it. Okay. And then my last question, if I may, just on this kind of dovetails from Angie's question a little bit as well, but we do see a fair amount of free cash flow forecasted so far. And I know you guys are targeting three and a half times net leverage. Just any consideration on debt reduction? I know you kind of get a little bit closer to that three and a half times marker, maybe in 24, 25 timeframe. Are you guys considering debt reduction at all or just mainly focused on managing EBITDA at this point?

Hey, Kevin, it's Terry. So when we think about debt reduction, we obviously think about it in the same manner with our overall cost of capital. And when we look across the debt stack right now and for where the debt's actually been trading, I don't think there's any immediate reductions that we see in sight. Now, that being said, there are some things that we'll continue to look at as we move forward. But when we go out and do a debt transaction, we're going to take a real hard look at our cost of equity and our cost of debt and be very disciplined about how we do it.

Great. Thanks very much. Look forward to seeing you guys at the investor day. Thanks.

Thanks, Kevin.

The next question is from Steve Fleischman of Wolf Research. Please go ahead.

Yeah. Hi. Good morning. Thanks for the investor call. So just the the potential options on the Cumulus plans. Any sense on timeline for that? Is that something that maybe could be done by the investor day that you're hosting?

Morning, Steve. And I think thanks for the question. I'm kidding, Steve. It's a question that's always at the top of mind for investors. And we just have not, because it's commercial negotiations, we have not put a timeframe on it, nor have we said which we have a preferred structure. And we're just going to leave it at that. It's really M&A. And while we kind of lean in and talk about that, we're open to multiple different structures. That's about as far as we're willing to go at this point in time. I will tell you, we are... um, we are focused on it. Um, and, uh, it'll get done when it, once it gets done, but these are, you know, this is, um, I think it's a great opportunity to create value, uh, for talent energy, um, and, and unlocking that value that has been invested in. Um, but it's going to take time because it's a, you know, it's going to take a bit of time to, uh, You know, you would imagine that there's formal contracts, there's commercial negotiations ahead of that. There's a lot that needs to be done in order to finalize.

Okay. Understood. And then just on the debt to EBITDA target, just how should we think about that relative to kind of hedged EBITDA versus, you know, market EBITDA as hedges roll off? particularly if they end up being above market. Just how are you thinking about managing that?

So, Steve, I think a couple of things with respect to how we'll manage that going forward. Obviously, we'll continue to deploy our hedging program. And as we've mentioned, the prompt 12 months, we'll do 60% to 80% of hedging. And then we'll be 40% to 60% in months 13 through 24. That'll help us maintain our overall margin and overall EBITDA at the end of the day. And so, you know, you'll see that as we continue to move forward. Now, one benefit that we do have is obviously with the implementation of the production tax credits, that provides us an implicit hedge within the nuclear asset. And the benefit that we get from that is it acts as a floor. And so when we do see price opportunities that are above the sort of $44 range for the production tax credit, we'll utilize that opportunity to capture upside for the overall value. So that's how we'll look at our hedging strategy as we move forward and continue to maintain that leverage ratio.

And we're in that position, by the way, in 2024. So when we look at it and state the 76% hedge, Terry mentioned this, that's assuming the PTC. It's a put option, but it's effectively... a delta of one it's underlying because of where prices are next year so that's in that 76 percent obviously uh there is upside if markets were to trend up from there because we have not necessarily sold away the upside okay so the 76 percent includes the ptc as kind of yeah just think of it this way steve it includes the ptc as if it sold megawatts at those dollars

Got it. But obviously, you still have upside capture.

So let's say that PJM went to $55. We would have exposure to that $10.

Got it. And of the 76%, how much would you say is captured by PTC part of it in terms of the hedging? Is that the most of it, I assume, or a big piece of it?

I'd say probably 30% to 40%.

Thanks so much. All right. Thanks, Steve. Thanks, Steve.

And thanks, everyone, for joining. We appreciate your interest and look forward to seeing everybody at the October 24th Investor Day.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.