Atlantic Power Corporation
Q2 2015 Earnings Call Transcript

Published: 11 Aug 2015

[Operator:]

Good morning, and welcome to the Atlantic Power Second Quarter 2015 Earnings Conference Call. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Amanda Wagemaker, Investor Relations Associate. Please go ahead, ma'am.

[Amanda Wagemaker:]

Welcome, and thank you for joining us this morning. Please note that we have provided slides to accompany today's call and webcast, which can be found in the Investor Relations section of our website, www.atlanticpower.com. This call will be available for replay on our website for a period of 3 months. Our results for the three and six months ended June 30, 2015, were issued by press release yesterday afternoon and are available on our website and on EDGAR and SEDAR. Financial figures that we'll be presenting are stated in U.S. dollars unless otherwise noted. The financial results in yesterday's press release and the matters we will be discussing today include both GAAP and non-GAAP measures. GAAP to non-GAAP reconciliation information for our historical results is appended to the press release and quarterly report on Form 10-Q, each of which can be found in the Investor Relations section of our website. We have not provided a reconciliation of forward-looking non-GAAP measures to the directly comparable GAAP measures because not all of the information necessary for a quantitative reconciliation is available to the company without unreasonable efforts, primarily as a result of the variability and difficulty in making accurate forecasts and projections. We also have not reconciled non-GAAP financial measures relating to individual projects, projects in discontinued operations or the APLP projects to the directly comparable GAAP measures, due to the difficulty in making the relevant adjustments on an individual project basis. Before we begin, let me remind everyone that this conference call may contain forward-looking statements. These statements are not guarantees of future performance and involve certain risks and uncertainties that are more fully described in our various securities filings. Actual results may differ materially from such forward-looking statements. Now let me turn the call over to Jim Moore, President and CEO of Atlantic Power.

[Jim Moore:]

Good morning, and thank you for joining the call today. With me are Terry Ronan, our CFO; and Dan Rorabaugh, our Senior Vice President of Asset Management as well as several other members of the Atlantic Power management team. In keeping with our servant leadership philosophy and our operating plant focused orientation, Dan will speak first about the performance of our plants this quarter and provide an update on our optimization program. Terry will then review our second quarter financial results and discuss 2015 guidance. And I will wrap up the call with thoughts on how we are positioning the company for the long term. Now I will turn it over to Dan.

[Dan Rorabaugh:]

Thanks, Jim and good morning everyone. Turning first to our operating performance for the second quarter on Slide 4. Both our availability factor and generation levels were relatively flat with the second quarter of last year. There were several factors that accounted for this. We completely a scheduled major outage at our Manchief peaker in Colorado this quarter. This was an overhaul of the gas turbine that’s done every five to seven years. We expense the costs associated with this type of outage. Although the outage had an impact on our financial results as Terry will discuss, it was in line with our expectations. The outage also reduced the availability factor and generation although it wasn’t during a high demand period of the year. Lower water flows at Curtis Palmer and Mamquam during the quarter produced generation and financial results – I am sorry -- reduced generation and financial results relative to both expectations and year ago results. We have made up some of the shortfall at Curtis Palmer since the beginning of June but we expect Mamquam to continue to be below expectations in the second half of the year due to a record low snowpack in the West. We've experienced reduced dispatch at Selkirk more so than expected. Mild weather, low demand and weak pricing have made this a difficult market environment for a merchant plant. We also experienced reduced dispatch at Chambers due to unfavorable pricing. On the positive side, waste heat production in Ontario was 140% higher in the second quarter than the second quarter a year ago excluding Tunis from the comparison. On a year-to-date basis, waste heat is up 62%. It is unusual that we’re seeing waste heat displayed in the year as we generally only see it account stock [ph] during the summer months. All of our Ontario projects have benefited with the most significant benefits realized by Kapuskasing and Nipigon. Slide 5 recaps our operational performance for the first six months of this year. Our availability factor improved to 93.7% from 91.5% in the year ago period but generation decreased 5.1%. This improved availability was mainly a function of fewer outages in the first quarter of this year as opposed to the above normal level of outages in the first quarter of 2014. The decrease in generation was driven primarily by some of the same factors that affected our results for the quarter with the most significant drivers being Tunis and Selkirk. Turning to Slide 6. On our third quarter call we expect to provide an update on the results of our 2013 and 2014 investments which totaled $18 million. The most significant of these were the upgrades of the two turbines at Curtis Palmer, the power phase project at Morris and the once through steam generator or OTSG upgrade at Nipigon. We’ve been targeting a cash return of $4 million to $8 million in 2015 from these and other investments that we’ve made. We still expect to be in that range although one variable has been the amount of waste heat at Nipigon which has reduced the need to run the duct burners that we put in last year. Although waste heat provides high margins and is very positive for us, the extend period of waste heat this year implies that the return on our investment in Nipigon may be lower-than-expected this year, although we don't expect that to be an ongoing situation as waste heat isn’t typically at these levels in the late spring and summer. This is a project with a lease of nine year life. And other variable has been a relatively low flow of water at Curtis Palmer. The two upgraded turbines have been performing well and producing more power than the turbines they replaced would have but less than our pro forma projections. As at Nipigon, we expect flows to revert to normal for this long life upgrade and provide strong returns on our investment, consistent with our initial expectations. Turning to Slide 7. I will provide an update on this year's projects. We still plan to invest a total of approximately $10 million this year with the majority of the projects at Morris, Nipigon and Mamquam. At Morris, we expect to invest about $7 million this year in three separate projects. One, a replacement of the purified water production system with a safer, more efficient system which we expect will be completed late this year. Two, an upgrade of one of the boilers to add fast start capability which is expected to improve reliability of stream delivery for our customer and which we also expect will be done this year. And three, upgrades to certain gas turbine components during the next turbine overhaul either this fall or next spring that will allow increased output from the turbines. At Nipigon, we’re installing a feedwater booster pump to further increase steam and electricity generation following the OTSG replacement and upgrade that we completed last year. The project is currently being commissioned and tested and we expect to have results to report on our third quarter call. At Mamquam, we expect to start work later this summer to improve the project efficiency by permitting smoother water flow. We also continue to expect an annual cash benefit of at least $10 million in 2016 from the $28 million investment we will have made in 2013 through 2015. Lastly, I'll make a brief comment on PPAs. We continue to work on potential early extensions or renewals of PPAs expiring in 2018 and later. We’re focused on those projects where we see opportunities to add value for the customer as well as ourselves. We are optimistic that at least one of these will come to fruition later this year but we cannot provide assurance of that. Now I’ll turn it over to Terry.

[Terry Ronan:]

Thanks, Dan and good morning everyone. Slide 8 presents a summary of our financial results for the second quarter and first six months of 2015. Before discussing these in greater detail, I would remind you that the wind businesses were included in the discontinued operations beginning in the first quarter of this year. The results of these businesses are excluded from project adjusted EBITDA in our adjusted cash flow metrics. But under GAAP they are included in cash flows from operating activities. Table on Slide 8 also shows you the results of discontinued operations. As you can see, the wind businesses were down for the second quarter and the year to date both in terms of project adjusted EBITDA and operating cash flow as a result of low wind production. Turning to Slide 9. We reported $43.9 million of project adjusted EBITDA from continuing operations in the second quarter, down approximately $14 million from $57.7 million a year ago. The decline was mostly attributable to a scheduled outage at Manchief for periodic major overhaul of the gas turbine which accounts for 9 million, the PPA expirations at Tunis and Selkirk along with the unfavorable market conditions for Selkirk to operate as a merchant facility which together accounted for another 5 million and lower water flows at Curtis Palmer and Mamquam which reduced results by 4 million. On the positive side, we had a $3 million increase in Orlando due to higher generation and lower gas cost and a $3 million reduction in expenses in our unallocated corporate segment associated with development and reduced employee compensation. Slide 10 presents our results for the first six months of 2015. Project adjusted EBITDA decreased approximately $12 million to $102.5 million from $114.6 million. The drivers of the reduction were similar to those affecting the second-quarter results

[Jim Moore:]

Thanks, Terry. On my call in February, I outlined our priorities for the company. In May, I provided the progress report. Terry has told of our continued progress in strengthening our balance sheet, reducing our interest expense and improving our corporate debt maturity profile. Today I’d like to talk about how we believe those steps have created value for shareholders and how we are planning to position the company for the long term. On Slide 19, risk reduction. First, we’ve made good progress in lowering the company's financial risk. High leverage and commodity price volatility could be a very risky combination. For us commodity price risk is mostly attributable to expiring PPAs. Approximately 32% of our anticipated project adjusted EBITDA this year is attributable to projects with PPAs that are scheduled to expire in the next five years. We’ve been focused on reducing our risk by getting the balance sheet and maturity profile in better shape and working on extensions of our PPAs. I will talk more about PPAs in a minute. With regard to the balance sheet, as Terry indicated, we've reduced debt significantly. Although some of that was accomplished by asset sales for which we gave up the associated EBITDA, I would point out that we sold those assets at what we considered to be attractive valuations and in a very timely fashion. Our credit metrics have improved as a result and pro forma for the wind sale and redemption of our 9% notes, we're now at six times consolidated debt to adjusted EBITDA, down from the 7 times previously. We expect to see further improvement through continued amortization of our term loan and project debt which creates equity value, just like paying down the mortgage on your home does. We expect to be within our target range of 5 to 5.7 times consolidated debt to adjusted EBITDA in the near future. Balance sheet strength is critical to enduring the cycles that are inherent in a commodity business. In terms of risk for the company from the pending shareholder actions, we were pleased to received favorable decisions in Massachusetts earlier this year and in Ontario in July. Both of these rulings are under appeal and we will continue to defend them vigorously. I will talk about how we think about the external growth in a moment but at present we’re focused on organic opportunities to grow free cash flow per share. We think that these opportunities are compelling and relatively low risk. For example, overhead reductions. We reduced our overhead costs by $26 million, including $19 million through G&A and another $7 million for development from 2013 to the expected level for 2016. These savings have been a meaningful contributor to our cash flow generation this year. At some point we’re likely to increase our development acquisition expense which is close to 0 currently. But we will view that as a strategic investment in future growth. We will be disciplined on any spending. Interest rate reduction. As Terry mentioned, the work we have done on our balance sheet has resulted in a $65 million reduction in our cash interest payments, about $47 million of this was accomplished by selling the wind assets which was accretive to our free cash flow. Going forward we expect another $4 million annually of interest savings from amortization of the term loan and project debt which would benefit our free cash flow further. Investments in the fleet. As Dan mentioned, we’ve made $18 million of investments in the fleet the past two years and we expect to make another $10 million of these investments this year. We expect the cumulative investment of $28 million to generate $10 million of cash flow beginning in 2016. That’s a far higher return than what we see as available from external growth and we believe we can achieve it while taking considerably less risk. Slide 21 on PPA expirations. It’s a difficult market in which we do PPAs because power prices are low and there is not much appetite for long-term PPAs amongst utilities, other than for renewable power. However PPA expirations also represent an opportunity for us. We have a terrific team working on PPA extensions and renewals. We are positioning our balance sheet to endure down markets to allow us to hand [ph] our merchant assets that don’t provide good returns in low-price energy markets so that we could benefit from those same assets in up markets. In addition, in our discussions to renew PPAs, we’re seeing potential opportunities to make bolt-on investments at decent scale that would not only support the PPA renewals but would also provide attractive returns on those incremental investments. We hope to be able to discuss this in more detail with you on our next earnings call. In the meantime we believe that the cost reductions that we have achieved allow us to be patient, disciplined in seeking those PPA renewals. Slide 22 on capital allocation. We expect to have $90 million to $105 million of adjusted cash flow from operating activities this year. Of this amount, we expect to use approximately $70 million to $75 million for mandatory amortization of our debt. Companies can do one or more of five things with their discretionary cash flow. One, buy back equity; two, make discretionary purchases of debt; three, pay common dividends; four, make discretionary investments in the business, and five, invest externally or make acquisitions. We have been returning capital to shareholders in the form of an $11 million annual cash dividend. We've also been making significant investments in our fleet which since 2013 will total $28 million by the end of this year. We've also made discretionary purchases of debt totaling $33 million since December 2014. We see investment opportunities in our balance sheet as well as our fleet, including these potential bolt-on investments related to PPA extensions which we will believe have a good risk-adjusted return and in aggregate exceed our available cash flow. Meanwhile the external market is frothy due to the low yield environment and the stress for yield, long life assets with contracts are highly sought after. We see market expectations for 9% returns but some transactions look like 5% to 7% IRRs over 30 years. By contrast, our internal planned investments have been made a cash on cash returns of 20% and higher. On Slide 23, we talk about external growth. With so much internal opportunity at superior returns and given the size of our business, we simply don't need to chase the market. We will remain focused on maximizing intrinsic value per share rather than focusing on growing the absolute size of the business. We believe someday markets will flip and we will be very focused on bargains externally. That is not the situation today. We're tracking some very smart value investors who understand doing what is less popular contrary in investing and focus on intrinsic value per share, that’s a good fit for us. Capital efficient development. When we do pursue external development in the future, we will do so while maintaining a tight focus on development costs and taking a very disciplined and rationale approach to evaluating potential investments, whether they are development projects or acquisitions. In my previous two positions as IPP CEO we managed to develop and grow a large fleet of combined cycle gas turbines and a wind portfolio in cost-effective and capital efficient ways. We are likely to focus on capital light opportunities, probably of a smaller size that are under the radar of larger companies, but which could be meaningful for a company of our size. In terms of acquisitions, the asset market is frothy right now. If and when asset valuations become more interesting to us, we think mergers could be more appropriate than acquisitions for cash given our balance sheet with the ideal candidate being an acquisition of under-valued assets for stock. We do think there could be opportunities created by strategic financial investors divesting smaller pieces of our portfolio that are not a good fit. However we would consider such a transaction only if we’re accretive to free cash flow per share on a near-term basis. To the extent we consider such transactions in the future we will be disciplined about if and when to issue shares. Our main source of opportunity is our size combined with the volatility of the sector, we are one of the smallest public IPPs. We could therefore focus on the unpopular and the smaller opportunities that would want to follow market sentiment or would be too small to move the needle for bigger players. The power sector is cyclical and volatile. Over the last three decades, we’ve seen markets get very excited about QF facilities, that merchant gas CCGT and renewable energy several times over. The current focus is now on long term contracted assets that support yield plays. During this long period we've seen collapses in asset pricing from time to time. The best money has been made by being contrarian and mindful of all cycles. As a Canadian company, we try to play by the Gretzky rule. Go where the path is going, not where it is today. We’re sometimes asked by analysts and investors whether we would consider additional asset sales, either to further reduce debt or to provide a source of funds for growth. We were very pleased with our wind transaction. It was accretive to free cash flow per share as we used the equity proceeds to pay down our most expensive debt and we saved $28 million of annual interest expense. Distributions from the wind projects were expected to be $26 million this year but they were significantly lower than expected in the first half of the year due to low wind production year to date. Our Hydro assets, for example, are also highly valued in the current market but we believe at this time any transaction would be highly dilutive to free cash flow as the after-tax proceeds would have to be applied to pay down debt at 5%, a much lower cost than the high yield notes. A spin of the Hydro assets to shareholders, on the other hand, would be tax efficient but would not generate any cash for debt reduction, and would result in too much smaller public companies with high leverage and too public overheads. So we don’t see additional asset sales as likely in the near-term and we’re not actively pursuing any. Of course we will listen to any proposal that’s highly compelling. Our analysis is based on the current landscape and may of course change. Moving to Slide 25, and conclusions. The last few quarters we focused on intrinsic value per share in our capital allocation as we acted decisively to monetize our most popular assets at compelling valuations, reduce our overhead costs significantly, pay down a substantial amount of debt and reduce our interest expense concomitantly. We've also been investing in our fleet at compelling returns. With a focus on improved efficiency and margins we’re building a culture of servant leadership and we’re upgrading our team and focused on executing well. Going forward we believe our smaller scale will allow us to capitalize on opportunities that will have better returns than larger or more popular assets. We are playing a long game. We will stay focused on intrinsic value per share. The first phase of the plan is to fix the business. We’re seeing good results on that front. The second phase of the plan is to grow the business. We would like to build a much larger business but we will do so in a patient, discipline and owner oriented manner. We believe we have ample organic growth opportunities at attractive return levels and we have a management team that has a track record of spotting opportunity and hitting it hard when it emerges externally. We won’t promise high levels of sustainable growth on a smooth basis. Some of our major new shareholders understand and support our approach to value creation. We appreciate their investment and commitment. As you may have seen by the amount of insider share purchases last quarter which were done at an average price of $3.09 we are committed to acting like partners, not managers. Let me conclude by saying we have some terrific shareholders, including roughly 62% who are retail shareholders. We have terrific employees, approximately 315 running our plants and our business here in Dedham. As your fellow shareholder and as an employee of the company, when I look at the transformation of this business in the last seven months it is really a big deal, to quote Vice President Biden in part. Our business is in a much better place than it was at the start of the year. That concludes my prepared remarks. We are now pleased to take any questions you may have.

[Operator:]

[Operator Instructions] Our first question is from Nelson Ng of RBC Capital.

[Nelson Ng:]

Just a quick question on outages, are there any scheduled outages we should be aware of in the second half of the year?

[Dan Rorabaugh:]

No, most of the – the outage season is largely done now.

[Nelson Ng:]

And then just moving on to my next question, in terms of your guidance APLP project adjusted EBITDA has not changed in terms of the range but I think you mentioned that the expected debt amortization has increased. So is it fair to assume that the APLP EBITDA is trending at the higher end of guidance or are you accelerating the debt repayment for other reasons?

[Terry Ronan:]

Well, no, I mean the debt amortization is some kind of lumpy, it’s not exactly formulaic, there’s working capital changes in there. We feel confident that we’re going to – we didn’t need to change the range of the guidance for APLP, despite the fact that there may be a little bit more amortization on the term loan B.

[Nelson Ng:]

And just on the convertible debt, I know you guys mentioned that you're looking to re-profile the debt. I think in the past you mentioned potentially upsizing the APLP loan to take out some of the converts. Have you made progress on this and is this your – is this the most likely scenario and if not, what are some other options you are looking at?

[Jim Moore:]

Well I think what we’ve talked about, Nelson, is three approaches that we’re considering; refinancing the debt prior to maturity with another convert, seeking an extension of the maturity dates for which we probably have to pay a fee and maybe adjust the interest rate and perhaps the convertible terms or as you mentioned upsizing the term loan and using the proceeds to take out one or more of the convertible issues. We are looking at all three of those approaches. They all have their pluses and minuses. I think that the term loan B market remains strong based on what we see. Ultimately it may be a combination of one or more of these three items that I have mentioned but we’re certainly taking a hard look at the upsized opportunity just given where the bank market is.

[Nelson Ng:]

And then a quick question on the PPA extensions. So can you provide a bit more color in terms of – I think you guys mentioned bolt on investments related to PPA extensions -- so which facilities are you referring to?

[Jim Moore:]

Well I don't know that we want to get into specific of those right now because they will depend on the PPA extensions themselves. We can talk about that more probably in Q3 we expect to have more to say.

[Nelson Ng:]

If it’s not related to Kapuskasing and North Bay, those ones have 2017 PPA expirations. I was just wondering what your expectations are for those facilities and if you’re expecting a similar outcome with that – as with Tunis?

[Jim Moore:]

Right now everything is on hold in Ontario. At the beginning of this year the OEFC and OP being emerged and the first thing they did was to suspend all negotiations of PPAs and they launched a market study that’s now expected I believe in October. It’s been slipping through the year. So for right now there are no negotiations and for right now there's not much transparency in the direction they are going. We are actively participating through groups like APRO to be part of the process but it's really going to depend on what the government view is of the market going forward.

[Nelson Ng:]

And then I have one last question, I think Jim mentioned that Hydro sale would crystallize large cash taxes. Can you guys provide some commentary on your tax pools in the US? I thought you had pretty decent tax pools in the U.S. and would those tax pools not be available to offset any gains in the event of a hydro sale?

[Jim Moore:]

Well we do have some tax pools or NOLs available. But they are pretty specific around different segments. Some of those would apply to a hypothetical hydro sale without getting into numbers the basis of the Hydro assets is pretty low. So it would very likely given the current market exceed those NOLs that we have available in that particular segment.

[Operator:]

Our next question is from Ben Pham with BMO.

[Ben Pham:]

I just wanted to go back to your commentary about Ontario and I am just wondering what your expectations are for the nuclear facilities with the referred program, and I am pretty aware of the government’s stats but I am just about wonderful your own internal expectations toward.

[Jim Moore:]

I mean we’ve seen the schedule, frankly it’s unusual for nuclear refurbishment schedules to go exactly on time and on budget. So we’re really prepared for them to watch slip and that would create in our opinion more opportunity, more and earlier need for generation capacity up in northern Ontario.

[Ben Pham:]

And maybe just in my line of questioning equity and in California what are your expectations there just needed the backing kind of the decade with the supply demand thought side of things and are partially – has that changed your outlook since that has come out?

[Jim Moore:]

I mean, the clean power plan is largely aimed at coal plants near as I can tell, but what’s in happening in California we are actually – our plants are in a good position to help with the mandates that exist for green house gas emission reductions in the local area, we are currently SPG&E put out an RFO that’s due at this end of the month that we’re preparing to respond to, that would fit for our three San Diego facilities.

[Ben Pham:]

And just to clarify like, when does those California facilities when you get towards the end of the decade. You do look to re-contract or some merchant markets, like would you still require some additional capital to extend the life of those facilities or continue running those facilities?

[Jim Moore:]

That’s certainly one of the configurations we are looking at, it could go a couple of ways, it could be the existing facilities, perhaps just differently, therefore creating reduced emissions, or it could be that, there could be some additional investments and increase the opportunity there under extended contracts.

[Operator:]

Our next question is from Clarence Mauwi of Allen Bastion [ph].

[Unidentified Analyst:]

I just have two questions. Will the extended oil and natural gas prices affect your company directly if we have extended lower prices?

[Jim Moore:]

I don’t see oil being a big factor from our perspective. Natural gas, it varies in some cases, we have long-term contracts where we've locked in prices that could affect us that way and others -- and others, low gas prices can help, it’s really a mixed bag, on the particular plan you are looking at.

[Unidentified Analyst:]

So low natural gas prices, should be probably a little advantageous do you think?

[Jim Moore:]

I think it’s a mixed bag, as I said.

[Unidentified Analyst:]

How does the Canadian dollar, the low Canadian dollar affect your guys right rate.

[Jim Moore:]

Well, always we do have Canadian operations and from a project adjusted EBITDA perspective when you translate that into US dollars it hurts. What we talked about in the past without even though with the end of the lower US is strong as it is versus the Canadian dollar. We also have three of our core converts denominated in Canadian dollars. Our medium term notes are denominated in Canadian million dollars, our preferred stock dividends are in Canadian dollars and our common dividends are in Canadian dollars. So until the point in time in time, it really wants in the bottom line by the EBITDA side, whenever everything watches through you want through on debt and interest expense fees, you pretty have end up even now that pretty going forward much end up heaven though that could change going forward as we continue to reshape the balance sheet depending on, we continue to updates in the balance sheet but I would say through 2016 -- in our 2015 excuse me, it’s a watch.

[Unidentified Analyst:]

So if there was a change – if the Canadian dollar would get stronger would probably help us right?

[Jim Moore:]

Well I mean again your EBITDA and if we are looking at just this year, your EBITDA would allow up as the Canadian dollars strengthen. But so it your debt service requirements the form of the trust that so the watch that way again until at least through this year that may change as Mike said as we continue to reshape the balance sheet and the composition of our death structure.

[Operator:]

Our next question is from Dan Aberdeen of Hyperave [ph].

[Unidentified Analyst:]

Going back to your on addressing the convertibles you listed three options. Have you looked at or considered the fourth which would be instead approaching the term loan market at Atlantic Power purchases at APLP?

[Jim Moore:]

We are looking at all of those options. I didn’t break that out separately but that's something that is part of what we’re looking at, something potentially at the top of the house at the corporate level and it will all depend on what potential terms that could be, what it looks from a pricing perspective but indeed that’s something that’s on the list. End of Q&A

[Operator:]

This concludes our question and answer session. I’d like to turn the conference back over to management for any closing remarks.

[Jim Moore:]

Okay. Thank you for calling in today and we look forward to updating you next quarter.

[Operator:]

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