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Executives Mike Bernstein – Chief Executive Officer Mike Smerdon – Chief Financial Officer Aaron Boles – Senior Vice President, Communications & Investor Relations Analysts Sean Steuart – TD Securities Rupert Merer – National Bank Eric Tang – BMO Capital Markets Bill Cabel – Desjardins Securities Capstone Infrastructure Corporation ( OTCPK:MCQPF ) Q2 2015 Earnings Conference Call August 11, 2015 8:30 AM ET Operator Welcome to the Capstone Infrastructure Second Quarter 2015 Conference Call and Webcast. As a reminder, all participants are in a listen-only mode and the conference is being recorded. After the presentation there will be an opportunity to ask questions. [Operator Instructions]. At this time, I’d like to turn the conference over to Aaron Boles, Senior Vice President, Communications and Investor Relations. Please go ahead sir. Aaron Boles Thank you. Good morning everyone. Thank you for joining us to discuss Capstone Infrastructure Corporation’s financial results for the second quarter of 2015 ended June 30. Today’s call will be hosted by Michael Bernstein, Chief Executive Officer. Also on the call is Michael Smerdon, Chief Financial Officer. Our News Release was issued after market closed yesterday and is available on our website at www.capstoneinfrastructure.com . Today’s conference call is being webcast live with accompanying slides and will be archived on our website along with a transcript of this event. Following management’s remarks we will hold a Q&A session. During that session I’d like to ask that you limit your questions to two before re-entering the queue, so that we can ensure everyone has a chance to participate. And before we begin, I’d like to remind everyone that during the course of this conference call we may make various forward-looking statements that involve known and unknown risks and uncertainties that may cause actual results to differ materially. For information about these risks and uncertainties, I refer you to the MD&A and our Quarterly Report and to our most recent annual information form dated March 24, 2015. And with that, I’ll turn the call over to Mike Bernstein. Mike Bernstein Right, thank you Aaron. Good morning everyone and welcome to Capstone’s quarterly conference call. The second quarter of 2015 was challenging financially, but saw Capstone advance its corporate strategy on three major fronts: growth, operation and Bristol Water’s regulatory review. On this morning’s call we’ll go through each of these areas and our CFO, Mike Smerdon will provide a financial update on the quarter, while lower than normal natural conditions affected output at our wind, hydro and solar assets. We’ll also take your questions later on the call. On the growth side we commissioned the 25-megawatt Goulais wind facility in Ontario in May, which was the third project to achieve COD within 9 months, joining Skyway 8, Saint-Philemon. This facility was build in partnership with the Batchewana First Nation of Ojibways which holds a 49% in the asset. Having strong relationships with Canada’s Aboriginal groups has become increasingly important for successful power development in this country. Organic growth is a central part of our strategy to create long term value for shareholders. As we and others have noted, valuations for operating core assets have escalated in recent years, driving down the potential return for an acquisition. In this environment Capstone is focusing on development. In the second quarter this year we received the final two renewable energy approvals for our five Ontario based wind projects. One of those projects is wholly owned by Capstone, while the others were being developed with the contemplation of partnering. At this point we anticipate having an increased ownership stake of 75%, which could be as much as 100%. This would add between 12 and 24 megawatts of incremental new generating capacity for a total 64 net megawatts. Our team is already fully engaged in developing these projects, so this would simplify the process and enable us to benefit from a larger investment and attractive projects. We anticipate construction on the interior projects to begin in the third quarter of 2015. In addition, our pipeline includes a 10 megawatt Riverhurst site in Saskatchewan, which we expect to commission in 2017. In terms of operations, Cardinal completed major refurbishment and life extension project on schedule in the second quarter. The plant is now a fully functioning cycling facility and was first dispatched to supply power to the Ontario grid in June. Since then Cardinal has been dispatched several more times in response to peak demand periods, usually triggered by hot summer weather. Turning to regulatory matters, the most active period of the UK competition market facility review of Bristol Water’s AMP6 business plan occurred during the second quarter. Subsequent to quarter end, on July 10 the CMA released its provisional findings. Bristol Water responded to those finding and written submissions on July 27 and had hearings on August 4. We were encouraged by the CMAs report in certain areas. On the issue of operating expenses Bristol Water was provisionally allotted an addition 28 million pounds to run the business, which we view as a more appropriate number that the regulator Ofwat had grated. In terms of enhancement capital expenditure, the CMA provisionally reduced the number by $8 million, while simultaneously removing projects that Bristol Water believed would have cost around 25 million pounds. Essentially Bristol Water has less to do and more money to do it with. The net results of the changes to OpEx enhancement CapEx is a gain of about $45 million, which represents half of the difference between Bristol Water’s proposed business plan and Ofwat’s final determination if the Cheddar 2 reservoir is omitted. On that subject, the CMA provisionally determined that a new reservoir isn’t required at this time, which is unfortunate but not unreasonable. The timing for a new reservoir would be necessary is contingent on a potential new power plant, population growth and the effects of climate change. It’s a consensus view that a new reservoir will eventually be built and could be mandated as soon as the subsequent seven regulatory periods. For cost of capital the CMA largely agreed with Bristol Water’s position and provisionally have grown a small company premium, embedded debt cost and removed an unusual customer benefit test. The cost of capital was provisionally raised to 3.65%, which was in the middle of the range established to the CMAs analysis and reflects current interest rates. We believe the numbers should be at the higher end of the range that the CMA considered and there maybe some room for movement on that issue. Finally, on the pay-as-you-go ratio which significantly affects the rates Bristol Water collects, we were disappointed in provisional findings and believe the current rates are still too low; however, the CMA noted in its report that it didn’t focus on this area for the preliminary findings. Bristol Water has since highlighted pay-as-you-go as a central issue, both in its submissions and during the hearings and response to the provisional findings. The CMA has been encouraged to take a much closer look at this area. The final evaluation is expected by September 3. The CMA can seek an expansion if necessary to complete its review. We remain optimistic that the supplementary testimony delivered at the August 4 hearing, coupled with written submissions will result in an improved outcome that will best serve the needs of customers, protect the integrity of the system and place Bristol Water on a more equal footing to its peers in the UK. It bears repeating that even with the provisional findings as they are initially presented, Bristol Water represents an investment in long term value and one that has grown in value since we acquired the business in 2011. Before I turn things over to Mike Smerdon to discuss Capstone’s financial performance, I’ll note that our results year-to-date have trended to plan. Quarterly results were somewhat lower than expected and were affected by a set of specific factors as Mike will cover. This was an unusual combination of circumstances that should not be viewed as the new normal. We expect cash flows to improve in the quarters ahead. I’ll now turn it over to Mike. Mike Smerdon Thanks Mike and good morning everyone. As Mike mentioned, a distinct set of dynamics influenced Capstone’s key financial metrics in the second quarter. Revenue of $81.4 million for the second quarter was 24% lower in the same period in 2014. This was the result of several factors, including the economics of the new Cardinal contract which was expected when we signed the new agreement in March of 2014. Bristol Water operating under Ofwat’s final determination that is now contesting resulting in a 14% real reduction in rates which took effect in the quarter. This was somewhat offset by favorable foreign currency translation. Weather conductions also had a negative year-over-year impact. Poor wind conditions reduced production in most of our wind facilities, persistent dry conditions on the west coast has lowered production at the seashell hydro facility and cloud cover in the spring, effected output at Amherstburg Solar Park. These natural elements compounded what is traditionally a lower production quarter for our company. In addition recalibered how powerful prices led to reduced revenue at Whitecourt. These revenue declines were partially mitigated by the new capacity added since Q2 of 2014, which includes Skyway 8 and Saint-Philémon and Goulais. Total expenses in the businesses fell 22% in the quarter compared to 2014 to $43.7 million. The drivers of this result were reduced operating expenses largely as a result of lower power production at Cardinal. This was partially offset by higher project development costs in the quarter as we continue to make progress on our wind projects. Adjusted EBITDA came in 27% lower than in the same period last year at $28.8 million, reflecting the lower revenue figures. Turning to adjusted funds from operation, this is an area that must be put into context and merits an explanation. AFFO in the quarter was $900,000 in what is typically one of our weakest quarters due to seasonal factors. The results this year were lower than the second quarter of 2014, primarily because of Cardinal’s new contact, but also because of some issues that we do not expect to reoccur. First, Capstone and our two broker partners agreed with the Bristol Water Board to differ declaring a dividend while the CMA review is in process. Of course the amount of dividends available from Bristol Water is contingent on the CMA outcome. However, based on the previous three years we would normally receive a $2 million dividend from Bristol Water during this period. Second, while two wind projects were commissioned in the first half of 2015 and have generated revenue and accumulated cash, this has not yet been distributed out of the projects, so it is not in our reported AFFO. We expect funds from Saint-Philémon to start flowing to Capstone this quarter and from Goulai in the fourth quarter. On our run rate basis we would approximately $1.5 million per quarter in dividends combined from these projects. Third, as we’ve already mentioned, production across our solar, wind and hydro assets was 9% below historical norms because of poor resources. Even though Q2 is traditionally one of our slower quarters, these unusual weather conditions had a further downward impact on AFFO of about $1.4 million. In total, these specific factors created a drag of approximately $5 million on the quarterly AFFO and in Capstone’s corresponding dividend payout ratio. Nevertheless, on a year-to-date basis, AFFO is slightly ahead of internal expectations and our ability to fund Capstone’s dividend is based on our annual planning and our forecast numbers. Therefore we are still tracking to our plan for 2015. Looking at our financial position, Capstone had unrestricted cash and cash equivalence of $51.2 million at the end of the second quarter, which includes $38.5 million from the power segment and $6.8 million from Bristol Water. Cash and equivalents available for general corporate purposes stood at $22.6 million along with an additional $24.2 million in undrawn corporate credit capacity. At the midpoint of 2015 we affirm our outlook of adjusted EBITDA of between $115 million and $125 million for the year. We have planned responsibly to insure Capstone has the resources and financial flexibility necessary to fund its current growth opportunities, operations and the dividend. The company’s long term debt at quarter end was $926 million, including debt at corporate and our proportion of share of consolidated debt of the power assets, as well as Bristol Water. This represents a debt to capitalization ratio of approximately 74%. As has consistently been the case, Capstone’s outstanding debt is predominately fixed rate on length to inflation. It is largely secured at the operating business level; it fully amortizes over the PPA terms and is non-recourse to corporate. On that front we recently completed the refinancing of Amherstburg Solar Park on attractive terms subsequent to quarter end. The new long term loan carries a fixed interest rate of 3.49% and it fully amortizes over the remainder of the Amherstburg PTA, which expires in 2031. This refinancing will have a positive impact on Capstone’s dividend payout ratio, because we will gain higher annual after debt service cash flows from the asset. It also serves as a reminder that Capstone has a high quarter portfolio of well managed, contracted power facilities in Canada. It’s these assets along with the build out of our wind projects and our return to normal dividends from Bristol Water which form the basis of our operations and we will provide the necessary cash flows to return our payout ratio to our 70% to 80% target. I will now hand things back to Mike. Mike Bernstein All right, thanks Mike. Bristol Water commanded a fair amount of attention from Capstone’s management team in the second quarter as we worked with Bristol’s team to put the best case forward before the CMA makes its final determination. However, while the regulatory review of Bristol Water has proceeded, we’ve been active in perusing organic growth. In addition to the sixth contracted wind projects mentioned earlier, we are participating in the Ontario Large Renewable Procurement. Last December Capstone was announced as a qualified application under the LRP and can bid for up to 38 megawatts of solar and up to 130 megawatts of wind. The LRP is now in the RFP stage and proposals must be submitted by September 1. Our development team has recently helped public meetings to gauge community support for possible expansion of our Erie Shores Wind Farm and meeting regarding a potential solar park near St. Thomas, Ontario. Capstone has also recently submitted a proposal for energy storage technology under Ontario’s Energy Storage Procurement. We appreciate that the protracted regulatory processes of Bristol Water has created a period of uncertainty for Capstone and our shareholders. They CMA will soon issue its filed determination and will have a clear picture of how the next 4.5 years will unfold and how this asset fits into the larger picture for Capstone. Regardless of the CMA outcome, all of our scenarios indicate that there’s still a fundamental disconnect between the value of our assets and Capstone share price. We look forward to updating the market once we have that determination in hand. At the end of the second quarter Capstone is tracking to plan for 2015. Our organic development projects are being completed, our operating portfolio is performing well, but still subject to the natural elements and we look forward to moving ahead with our growth strategy with more certainty for our company very soon. Thank you for your continued support and we will be now happy to take your questions. Question-and-Answer Session Operator Thank you [Operator Instructions]. First question today comes from Sean Steuart of TD Securities. Please go ahead. Sean Steuart Thanks, good morning guys. A couple of questions. I guess worst case scenario; if you assume no change from the CMA provisional findings, can you give us your perspective on what dividends if any you will be able to pull out of Bristol Water over this regulatory period. Mike Smerdon It’s a little too early to say Sean. I mean we would expect dividends out of Bristol Water in the later years in the AMP, although, I mean there is still a lot of variables in play in terms of what will the final outcome of the CMA be, what will the financing structure of Bristol Water be for the current AMP. So as you can appreciate, all of those things will have an impact on the dividends that end up getting paid out. So it’s still too early to say and our focus right now is on making sure that the CMA have all of the information they need in order to come to the right answer for Bristol Water. Sean Steuart And is there an ongoing dialog? I know you had I guess the formal rebuttal in early August. I gather you are continuing to submit written documentation. Are they just in decision making mode or is the dialog ongoing? Mike Bernstein What’s happened since the 10 th of July is that there was a fairly robust response. I think it was totally 200 pages sent on July 27. We then had all testimony on the force and that was a full day session for both ourselves and Ofwat and then last Friday we provided supplementary responses to questions that came up to during the all hearing, as well as any additional responses that came up through the transcript and from Ofwat’s proposal. So there is if you will, nothing official between now and the end, although there is always the opportunity which we expect for clarifying questions that may come from the CMA or additional information if they require it. So there maybe some more information, but right now it is us responding to the CMA. We’ve handed over if you will all of the information that we think they need to come to as Mike described, the right decision for Bristol. Sean Steuart Okay, and then last question from me; you touched on potentially I guess some refinancing initiatives at Bristol. Can you speak to any other levers you can pull across the rest of the operating platform for refinancing initiatives to bolster liquidity a little bit? Mike Smerdon I mean there are a few financing activities that sort of we have in mind that we previously discussed, that Cardinal is an unlevered asset and we view that as a sort of untapped reserve of capital for redeployment into growth opportunities, so that is something that could come up. It’s still an attractive market for financing long dated, contracted, power assets, particularly here in Canada. There are also some – a couple of the wind projects, the smaller wind projects which have near term debt maturities. It is small, so I’m not concerned about the refinancing risk with that. It’s more of a refinancing opportunity to extend out the term, extend out the amortization, store it in the PPA periods and get a lower interest rate. Those are the SkyGen and the Skyway 8 assets. In addition, we do have some financing activity coming up on the wind development projects which we’re currently pursuing and we expect to get those financed on attractive terms as we’ve done in the past. Sean Steuart Okay, that’s all I had, thanks guys. Operator The next question comes from Rupert Merer of National Bank. Please go ahead. Rupert Merer Good morning everyone. Can you give us a little more color on your Rim project developments or the next steps for those five projects for the REAs and what’s the timing expected before you will move to construction and look at COD? Mike Smerdon Well, we’re expecting the ERTs for again Alaska and [Indiscernible]. I’m looking at Mike to make sure he corrects me if I get my five projects wrong; that we expect in August. So we’re planning and ready to start construction on those two in September. Then there’ll be a – the last three should be coming on in the fall and I think the last one will probably be Q1, 2016 to the ERT. So then really just want to continue to roll out over the next 12 plus months to have things completed through 2016. Mike Smerdon So in terms of what needs to be done, we have the turbine equipment locked up and scheduled delivery dates all coordinated. The balance of plant tendering is nearing conclusion, so we’ll have our contractor lined up very soon. Again, its six delivery dates and six payments and then the last thing to conclude will be the project financing, which we’ve started and so far so good. These are projects that are progressing with the same level of confidence that the first three did. Rupert Merer Okay. So they are meeting your expectations for cost and potential returns on those projects? Mike Bernstein Yes. I mean right now we’ll have to see, but the interest rates are still tracking below what we originally anticipated. Rupert Merer Okay, great. And secondly, can you give us an update on your claim against the OEFC and what is the expected timing for the next word that we’ll hear on that. Mike Bernstein I’m trying to remember all the details, but the group I think will put in a submission by the end of the month I believe in response to the OEFCs request for their preliminary information and then we expect that probably we’ll drag out if you will, our final decision would be in Q2 or Q3 of 2016. Rupert Merer Okay, that’s all. Thanks very much. Sorry. Mike Smerdon Starting in August we will start to earn the higher level of revenue on the hydro assets, which were part of that claim as well. So there’s two components to the claim. There’s actually reparations for under collected revenue in the past and then there is there higher rates that should apply going forward and the hydro assets will start getting the benefit of those higher rates starting in August. [Cross Talk] Mike Smerdon That one we expect will be probably about $800,000 or so of incremental revenue which really feels like the bottom line annually, so starting in August. Now obviously the OEFC is contesting that, but because the ruling has come down they do have to adhere to the ruling, so we’ll start getting the – there would be higher revenue for starting this month. Rupert Merer Okay, excellent. Thanks for the color. Mike Bernstein You’re welcome. Operator The next question is from Eric Tang of BMO Capital Markets. Please go ahead. Eric Tang Good morning. This is Eric filling in for Ben. Just a modeling question. On those that are for Ontario projects, what’s the CapEx on those? Mike Bernstein On the Ontario projects, the four that we called wind works and the total CapEx is around $170 million and then there’s the fifth one, Grey Clean which was another approximately $60 million. Eric Tang Okay. So would you need equity to finance those projects or…? Mike Bernstein No, we will project finance at the asset level and in the norm these types of projects, the market standard is 80% project debt, 20% equity and some of our equity has already gone in as we’ve continue to develop those projects, so there is still some left to go in, but we have that covered through internal capacity. Eric Tang Okay, thanks. Those are all my questions. Mike Bernstein Thank you, Eric. Operator [Operator Instructions] Our next question comes from [Indiscernible] of RBC Capital Markets. Please go ahead. Unidentified Analyst Hey guys, good morning. Just a couple of quick questions. First of all, sort of assuming that the CMA finalizes the review early next month or whatever, how soon do you think distributions could resume? Mike Bernstein Our plan is that we’d go back to our expected dividends shortly thereafter, so there is – I guess we have the board meetings quarterly, so probably in Q4 we’d love to resume our quarterly and obviously we’d have to work with the board, but hopefully that includes the catch up as well, but that’s what we’re hoping for. Unidentified Analyst Okay, perfect. And regarding your Cardinal facility, so the EBITDA in the Q2, that’s sort of reflective of a run rate or do you expect a different profile during the winter and summer periods? Mike Smerdon It’s a little bit low for a run rate. It should be higher in the summer months when power prices are higher and there’s opportunity to earn market revenue. As Mike mentioned we were dispatched recently. There is not much dispatch activity in our Q2 results. So looking at Q2 it’s a bit low for a run rate, but we still expect EBITDA for Cardinal to be in that sort of $8 million to $10 million per year. Unidentified Analyst Okay, thank you. That will be it. Mike Smerdon Thank you. Operator The next question comes from Bill Cabel of Desjardins Securities. Please go ahead. Bill Cabel Hey guys, just a little confused here. I heard you just say that you expect the Bristol Water distribution up to the corporate level could be back on or you hope to have that back flowing in Q4. So I mean it sounds like no distribution for Q3, but you could have a catch-up. But then when I kind of think back to Sean’s question, maybe I misheard it, but was there not some element of a potential for there not being distributions at the early stage of this AMP period. I’m sorry, I’m just a little confused as to… Mike Bernstein Sean’s question was if there is no change to the provisional findings from the CMA. It’s a sort of hypothetical. I think the way – the second question on Bristol water dividends was based on what we expect, so we do expect that the CMA will come back with revisions. As we’ve said before, in their provisional findings they didn’t put a lot of time into the pay-as-you-go ratio. It was naturally one of the last things that you looked at, so it’s understandable they didn’t spend a lot of time looking at pay-as-you-go since they were still provisional on the top tax, which is the sort of the big item that we first have to figure out before you can turn your mind to pay-as-you-go. So now the discussion is turning to pay-as-you-go. We are hopeful of an improved result on the pay-as-you-go, which obviously changes the current cash flows at Bristol Water. Mike Smerdon And then to give a bit of more color, this TMA provisional findings with the keeping the pay-as-you-go at exactly the same level that Ofwat had last December, which is essentially the same level that we had in our business plan when we were proposing 540 million pounds, which included Cheddar. They are aware that their current business plan at 429 is a very different revenue mix profile or project profile, a lot less capital type projects, so they are aware of that, that the current business plan has changed significantly from last December, which is what the pay-as-you-go ratio was based on. Bill Cabel But can you help me understand what that risk is, because that’s – I mean in my model that’s about a third of your distributable cash. Not quiet, but… Mike Bernstein Maybe if you can just rephrase your question so we can understand exactly… Bill Cabel Like how confident are you that the regulatory body will change the pay-as-you-go ratio enough that you can continue to receive distributions from Bristol? Mike Bernstein The way we look at it, there is a right payout ratio for Bristol Water. The right payout for Bristol Water is above what was used by Ofwat and what was used for deployment in findings. The way we look at it, the right payout ratio you can triangulate in a bunch of different ways, by looking at how much the mix of operating cost to maintenance CapEx is part of top tax. You can look at it based on industry average; you can look at it based on how bills can pay our peers. Based on all of those different ways of looking at it, the right payout ratio for Bristol Water is in the 60%, north of 60% range. Mike Smerdon And that would allow us to pay the dividend that we’re expecting and I will tell a fourth one, which is if you look at regulatory president and how they look at pay-as-you – well they want to call that pay-as-you-go, but if they would have looked at that type of metric in the past, all of those as Mike say triangulate to a number that would provide us the dividend that we’re expecting and presumably the ones that’s consistent with your model. So right now we have significant amount of rate based growth, which is quite high, but that’s not the right balance. So the overall question is, how confident are we that they will adjust the pay-as-you-go ratio? We are very confident, because there’s four different ways of looking at it. They should increase it by a reasonable amount. Bill Cabel Okay, perhaps we’ll follow up after the call. Thanks. Mike Smerdon Okay, thanks. Operator There’s a follow up question from [Indiscernible] of RBC Capital Markets. Please go ahead. Unidentified Analyst Hey guys, yes just another quick question about the facilities you guys are building on. I saw you guys are putting in bids for 38 and 130 megawatts of wind. Can you give us a little bit of flavor on these access locations, competitive advantage, sort of like an expansion of an existing facility or is it going to be net new facilities, that kind of stuff. Mike Bernstein So the quick clarification is we’re allowed to bid up to those amounts. So we’re just finalizing the size. In the case of the wind it would be Erie Shore. I think one of our advantages is that we’re very accepted by the community and that’s worth a lot of points and therefore it’s not just about price. The Ontario LRP includes points for aboriginal involvement, as well as community support, so we are working as we mentioned with an aboriginal group to participate and we do have strong local support for Erie Shore. So if you will that would be adjacent to the existing facility and therefore there are benefits there. Projects size would be significantly less than the 130, but we haven’t decided what the final amount would be where we are optimizing based on the wind and the land leases. In the case of the solar project we are proposing to build it at the Ford facility, which was closed down at St. Thomas Ontario. So we are in front of council, I think next week or so, where we have a community outreach program, so to respond to community questions. So we are not quite there yet in having the community to support, but hopefully they will view us as a good neighbor and contributor to the economic benefits for the region. So from an advantage perspective it’s a good site. It’s close to transmission and again, we are looking to partner with an Aboriginal group. Unidentified Analyst Okay, perfect. Thanks so much. Mike Bernstein You’re welcome. Operator There are no further questions at this time. I will now pass the call back over to the presenters for closing comments. Mike Bernstein Okay, well thank you everyone. I wish all of you a good end of the summer and we look forward to updating you when we hear back from the CMA and provide that clarity that everyone is looking for. Thank you. Operator This concludes today’s conference call. You may now disconnect your lines. Thank you for participating and have a pleasant day. Scalper1 News
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