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Ormat Technologies’ (ORA) CEO Isaac Angel on Q1 2016 Results – Earnings Call Transcript

Ormat Technologies, Inc. (NYSE: ORA ) Q1 2016 Earnings Conference Call May 05, 2016 09:00 AM ET Executives Rob Fink – Managing Director, Hayden Investor Relations Isaac Angel – Chief Executive Officer Doron Blachar – Chief Financial Officer Analysts Paul Coster – JPMorgan Operator Good morning, and welcome to the Ormat Technologies, Incorporated First Quarter 2016 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Mr. Rob Fink. Please go ahead. Rob Fink Thank you, operator. Hosting the call today are Isaac Angel, Chief Executive Officer; Doron Blachar, Chief Financial Officer; and Smadar Lavi, Vice President of Corporate Finance and Investor Relations. Before beginning, we would like to remind you that the information provided during this call may contain forward-looking statements relating to current expectations, estimates, forecasts, and projections about future events that are forward looking as defined in the Private Securities Litigation Reform Act of 1995. These forward-looking statements generally relate to the company’s plans, objectives, and expectations for future operation and are based on management’s current estimates, projections, future results, or trends. Actual future results may differ materially from those projected as a result of certain risks and uncertainties. For a discussion of such risks and uncertainties, please see Risk Factors as described in Ormat’s Annual Report on Form 10-K filed with the SEC. In addition, during the call we will present non-GAAP financial measures such as EBITDA and adjusted EBITDA. Reconciliations to the most directly comparable GAAP measures and management’s reason for presenting such information is set forth in the press release that was issued last night, as well as in the slides posted on our website. Because these measures are not calculated in accordance with U.S. GAAP, they should not be considered in isolation from the financial statement prepared in accordance with GAAP. Before I turn the call over to management, I would like to remind everyone that the slide presentation accompanying this call may be accessed on the Company’s website, at ormat.com, under the Events & Presentations link that’s found on the Investor Relations tab. With all that said, I would now like to turn the call over to Isaac. Isaac, the call is yours. Isaac Angel Thank you, Rob, and good morning, everyone. Thank you for joining us today for the presentation of our first quarter 2016 results and our outlook for the remainder of the year. Starting with slide 4, the first quarter was a great start to the year for Ormat. We executed well, delivering strong revenue and profitability, and our focus on improving our operational and manufacturing efficiency is the main driver for margin expansion and improved results. Both our product segment and electricity segment delivered improved results year after year. Our electricity segment delivered a 20% increase, reaching $108 million, due to higher electricity generation and new expansions coming on line. Our product segment grew 44%, to $44 million, benefiting from several large contracts signed in the previous years. Overall, total revenue grew 26%, to $152 million, which demonstrates strong growth as we overcome the impact of lower commodity prices which continues to affect a portion of our revenue in our electricity segment. In addition, we achieved high gross margin levels in both segments of our business, supporting significant increases in our overall profitability. This performance is due primarily to two factors: first, our balanced business model being vertically integrated; and second, our methodical efforts to improve operational efficiency. We have been focused on efficiency and operational excellence in every aspect of our business, and that effort is reflected in our numbers. I will elaborate on the progress being made and our plans for the future after Doron reviews the financial results. Doron? Doron Blachar Thank you, Isaac, and good morning, everyone. Let me start by providing an overview of our financial results for the three months ended March 31, 2016. Starting with slide 6, for the first quarter of 2016 total revenue increased 26.1%, to $151.6 million, compared to $120.2 million in the first quarter of 2015. Moving to slide 7, revenues in the electricity segment increased 19.9%, to $107.9 million, in the first quarter of 2016, up from $90 million in the first quarter of last year. Slide 8, revenues in the product segment were $43.7 million, an increase of 44.4%, compared to $30.3 million in the first quarter of 2015. Moving to slide 9, gross margin in the first quarter of 2016 increased to 42.1%, from 36.6% in the first quarter of 2015. Our electricity segment gross margin increased to 41%, due largely to new expansions coming on line, improved efficiency at the plant level, and also the transition to a new fixed-rate PPA for our Heber 1 power plant. Part of the increase in gross margin this quarter is driven by timing of operating expenses. We expect a lighter second quarter in the electricity segment with higher expenses that will result in lower margins, on average, in the rest of the year. Our product segment generated 45% gross margin, a particularly strong level for this segment of our business. It was mainly due to the different product mix and different margins in the various sales contracts, improvements made at our manufacturing facility which enables us to shorten lead time, as well as reduction in commodity prices that reduced the cost of raw material in subcontracting. We expect our gross margin in the product segment during 2016 to be higher than normal. The margin should normalize in 2017. Turning to slide 10, operating income for the first quarter of 2016 increased to $50.5 million, compared to $29.9 million in the first quarter of 2015, representing 69.3% increase. Operating income attributable to our electricity segment was $34.8 million, compared to $24 million in the first quarter of 2015, representing a 45.2% increase. Operating income of the product segment was $15.8 million, compared to $5.9 million in the first quarter of 2015, representing 168% increase. Moving to slide 11, net income attributable to the company’s stockholders for the first quarter of 2016 was $29.3 million, or $0.59 per diluted share, compared to $10 million, or $0.21 per diluted share, in the first quarter of 2015. Let me spend a moment speaking on our hedging strategy that is designed to mitigate the impact of changes in commodity prices. We continued to make progress in reducing our exposure to these fluctuations. In December of 2015, the Heber 1 contract was switched to a fixed-rate price, which mitigate our exposure and reduce the portfolio exposed to natural gas prices to approximately 90 megawatts and less than 10% of 2016 expected electricity revenue. Recently, we reduced our economic exposure to fluctuation in the price of oil and natural gas until the end of 2016, by entering into a derivative transaction. We recognized a net loss for this transaction of $0.1 million in the first quarter of 2016, which is recorded within foreign currency translation and transaction gains or losses, compared to a net gain of $0.3 million in the first quarter of 2015 that was recognized in the electricity segment revenue. Please turn to slide 12, adjusted EBITDA. Adjusted EBITDA for the first quarter of 2016 was $80.2 million, compared to $65.3 million in the same period last year, which represents a 22.8% increase. Reconciliation of the EBITDA and adjusted EBITDA is described on the appendix slide. Turning to slide 13, cash and cash equivalents as of March 31, 2016, were $148.5 million. We generated $27 million in cash from operating activities and invested $31 million in CapEx. The accompanying slide breaks down the use of cash during the quarter. Our long-term debt as of March 31, 2016, and the payment schedules are presented on slide 14 of the presentation. The average cost of debt for the company stands at 5.9%. On May 4, 2016, Ormat’s Board of Directors approved payment of a quarterly dividend of $0.07 per share for the first quarter. The dividend will be paid on May 24, 2016, to shareholders of record as of closing of business on May 18, 2016. In addition, the Company expects to pay a quarterly dividend of $0.07 per share in the next two quarters. This concludes my financial overview. I would like now to turn the call to Isaac for an operational and business update. Isaac? Isaac Angel Thank you very much, Doron. Starting with slide 16, for an update on operations. In the first quarter, we delivered strong results that demonstrate that we are making solid progress on our multiyear strategic plan. Moving to slide 17, we continue to make improvement in all aspects of our value chain. Specifically, we are focused on reducing manufacturing lead time, improving procurement to lower our material cost, and improving management control. This process translates into a significant improvement in gross margin and adjusted EBITDA margins. Turning to slide 18, another goal was to expand our electricity generation, both organically and inorganically. Electricity generation during the quarter was 1.4 million megawatt hours, an increase of 16.4% compared to the last year. This increase was due to commencement of the second phase of Don Campbell and McGinness Hills, power plants in 2015, as well as Plant 4 of the Olkaria III complex in Kenya which come on line in January this year. Beyond expansion, we continue to make plant-level adjustments designed to optimize our electricity generations. These adjustments include the elimination of older and less efficient components and modifying output based on the underlying resource. The goal is to improve profitability, and we are making meaningful process here, as well. In addition, we are also working to monetize the Don Campbell plant and further strengthen our balance sheet as part of our joint venture with Northleaf Capital Partners. Currently, we are conducting the required power generation tests under the agreement to determine the final terms for closing. Following the closing, Ormat Nevada will contribute Don Campbell 2 to ORPD, and Northleaf will buy their interest share. We expect to close this in the second quarter of 2016. Turning to slide 19, another part of our expansion strategy involves targeted acquisitions. We recently signed definitive agreements to acquire gradually 85% of a geothermal plant in the island of Guadalupe. We expect to close this acquisition during the second quarter. This acquisition will be immediately accretive to Ormat CPS. Turning to slide 20, for an update on projects under construction. We plan to add 160 to 190 megawatts by the end of 2018 by bringing new plants on line, expanding existing plants, as well as adding capacity from the recent acquisitions. The expansion plan includes the Platanares geothermal project in Honduras, which is currently under construction, and we expect to reach commercial operation by the end of 2017. We also initiated development efforts in two projects in Nevada. Tungsten Mountain and Dixie Meadows are each expected to generate 25 to 35 megawatts once they come online in 2017 or 2018. While the drilling activity is ongoing in both projects, we are making progress towards securing PPAs. We believe that these projects may qualify for the production tax credit. In Sarulla, Indonesia, engineering and procurement for the first and second phases has been substantially completed, but it’s still in progress for the third phase. Construction for the first phase is in progress, with major activities related to mechanical and electrical equipment installation. The infrastructure work for the second phase is in progress. Major equipment, including Ormat’s OECs and Toshiba’s steam turbines, for the first phase has arrived at the site and currently installed. The drilling of production and injection wells is also in progress for all three phases. The project is still experiencing delays, mainly in field development of the second phase and third phases and cost overruns. With respect to Ormat’s role as a supplier, all contractual milestones under the supply agreement were achieved and main shipment of the second phase is on its way to the site. Manufacturing of third phase equipment is progressing as planned. The consortium expects that the first phase of operations to commence towards the end of 2016, and the remaining two phases of operations are scheduled to commence within the 18 months thereafter. The projects I just described, as well as additional projects under various stages of development, are expected to support our expansion by the end of 2018. Besides the investment in new projects, we are continuing our exploration and business development activities to support future growth. On slide 21, let me briefly discuss the recent agreement with Alevo. On March 30, 2016, Ormat signed an agreement with a subsidiary of Alevo Group S.A., a leading provider of energy storage systems, to jointly build, own, and operate the Rabbit Hill Energy Storage Project, which is located in Georgetown, Texas. The storage market is one of the most developing, growing, and exciting areas in the energy industry today, and this agreement moves us for the first time into the energy storage arena. We view this market as key to our long-term growth plan, as it helps us to further diversify revenues and support our position as a leader in the renewable energy industry. Under the terms of the agreement, Ormat will own and fund the majority of the Rabbit Hill Energy Storage Project and will provide engineering, construction services, and balance of plant equipment. Alevo will provide its innovative GridBank inorganic lithium ion energy storage system in conjunction with the power conversion systems. In addition, Alevo will provide ongoing management, operations, and maintenance services for the life of the project. We do not expect this first entry into the storage market to generate material revenues for Ormat. However, we do believe this collaboration will allow us to make significant progress towards our expansion in this field. We continue to actively explore opportunities in this area and remain focused on building relationships and collaboration with established technology providers. We believe that such collaboration can leverage our experience, relationships, and project management, and other capabilities. If you could please turn to slide 22, you would see that our CapEx requirement for the balance of 2016 stands at approximately $245 million. We plan to invest a total of approximately $75 million in capital expenditures on new projects under construction and enhancements. And additional approximately $170 million are budgeted for exploration activities, development of new projects, investment in new activities that reflects expenditure under the new strategic plan, and maintenance CapEx for operating projects. In addition, $51 million will be required for debt repayment. Turning to slide 23, for an update on our product segment. Our backlog as of May 4, 2016, stands at approximately $214 million. Moving to slide 24, for a regulatory update. We shared with you the tremendous efforts Ormat’s team is investing in order to accelerate growth of the electricity segment to increase its portion in the future. In addition to shortening the manufacturing construction lead time, we are also investing efforts to shorten the development process. One of the hurdles in the geothermal development is obtaining key permitting in order to test prospect viability. We have been supporting and lobbying the geothermal components of Senator Dean Heller’s Geothermal Exploration Opportunity Act to simplify geothermal exploration review process in the future. Under the Energy Policy Modernization Act of 2015, which passed the U.S. Senate on April 2016, an agreement was reached to approve 29 amendments, including Senator Heller’s Public Land Renewable Energy Development Act, which streamlines permitting for renewable energy projects on federal land. If the bill will pass the House unchanged, it will be significant achievement in improving ability to assess potential geothermal resources faster than before and, by that, to accelerate the development process. Turning to slide 25, for 2016 guidance. We are reiterating our 2016 full-year guidance. For the year, we expect total revenue to be between $620 million and $640 million. We expect revenue in our electricity segment to be between $410 million and $420 million. For the product segment, we expect revenues to be between $210 million and $220 million. We expect 2016 adjusted EBITDA to be between $300 million and $310 million. I’m very pleased with our performance. The first quarter represents a strong start to what we believe will be another great year for Ormat. And that concludes our remarks for today, and I thank you very much for continued support. Operator? Question-and-Answer Session Operator [Operator Instructions]. The first question comes from Paul Coster from JPMorgan. Please go ahead. Paul Coster Yes, thanks, few quick questions. First up, you’ve made tremendous progress in the electricity segment in terms of improving the yield of the existing assets. How far are we, though, from sort of the point of diminishing returns in terms of that focus? Isaac Angel Hi, Paul. Thanks very much. What was the last part of your question? Paul Coster I’m just wondering have you got to the point of having realized the efficiencies at this point, do you still have further opportunities ahead? Isaac Angel Paul, as we explained last year, this is going to be a very long journey, and we barely touched only part of the efficiencies that we have planned. We’re working on a [indiscernible] basis, and we still have a long way to go until we will actually finish all the efficiencies that we are planning to do. Paul Coster Okay. The backlog is continuing to come down. Is there anything being added in to backlog? Or, are we just simply depleting it as a result of the Sarulla project? Isaac Angel First of all, you realize that the $256 million Sarulla project is a very large project and, obviously, it affects the backlog. On the other hand, as I said last conference call, we are making a tremendous effort, and we are in the middle of a journey to increase our electricity segment which will continue to grow faster than in the past. But if we are looking forward, I would not be worried about the backlog. And there is also another thing that you should take into consideration. We decreased seriously our delivery time, for something like from 20 months to less than 12 months, which means that projects that we are signing which used to be for the year after, now they are kicking in within the next 12 months, which makes a difference in the calculation of the backlog. Paul Coster So, in other words, you’re expecting backlog to plateau soon and maybe even start rebuilding? Does that sound – is it possible that would happen within the 2016 timeline? Isaac Angel I’m writing this down, Paul, and I hope it’s going to happen. Paul Coster Okay. My last question is oil and gas prices have actually ticked up a bit recently. Is there any way in which you might start to capture the benefit of a positive inflection in prices before the point at which you move as many of these projects as possible to a fixed rate? Isaac Angel We still have about one-third of our exposure in oil and two-thirds in natural gas, which is barely moving. On the one-third which is going up, it is not something that’s going to change in the near future, which is our Puna power plant, and we hope we are going to catch the increase. And maybe Doron would like to add here something. Doron Blachar Hi, Paul. We took a different approach to the hedging due to the very, very low prices at the beginning of the year. So, we actually are able to enjoy some of the increase in the oil prices, not all of it, but some of it. And on the gas, if the gas prices are relatively stable to the beginning of the year, there isn’t much change. But as prices goes up, it gives a potentially better performance next year with the higher prices on the oil and natural gas prices. Paul Coster Very good. Thank you so much. Isaac Angel Thank you Paul. Operator [Operator Instructions]. This concludes our question-and-answer session. I would like to turn the conference back over to Mr. Isaac Angel for any closing remarks. Paul Coster Okay. Thanks a lot operator. Thank you very much for your continued support during the year, and we are very optimistic, management here in Ormat. And see you next conference call. Operator The conference has now concluded. Thank you for attending today’s presentation. You may now disconnect. Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. 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Portfolio Construction In The Age Of Extraordinary Monetary Policy: Part I

Why This Series? This will be the beginning of a multi-article series that seeks to assess the Fed’s monetary policy and its effect on markets, and thus how we should invest going forward. My objective in writing this series is to make the case for why the traditional models of asset allocation will not provide the same results going forward as they have in the past, and thus a new approach is necessary. I form this conclusion by analyzing the data, and exploring the economic environment that investors find themselves in, as well as the unprecedented level of global central bank action and how this will affect the process of portfolio construction to meet the goals of the future. The series will have a particular focus on engineering the best portfolio possible by incorporating cutting edge academic research into the portfolio construction process. The series will consist of five pieces which together represent an in-depth discussion about the Fed, the economy, and how to invest in the new normal. The 2008 Financial Crisis and The Fed’s Response The 2008 financial crisis was the worst since the Great Depression of 1929, and by some measures, it was worse. In 2008, the S&P 500 fell by over 37.02% as the financial crisis took hold, figures four, five, and six below illustrate the take no prisoners effect of a violent market drop. The crisis was caused by a combination of government induced lending to unqualified borrowers, brought on by the community reinvestment act (12 U.S.C. 2901), as well as Wall Street speculation on real estate prices. Wall Street banks packaged Mortgage Backed Securities (MBS) rated AAA with subprime debt in various groups called tranches. These tranches of debt, then went bad when the subprime loans were deemed worthless. Wall Street packaged Collateralized Debt Obligations (CDO), which are pools of securities packaged together for sale to investors. The senior tranches of this debt are generally safer and have higher credit quality, while junior tranches are generally made up of riskier securities with higher yields. The challenge during the crisis was that Wall Street was packaging these CDOs with more and more risky debt and less and less of the AAA debt. On top of this, they created securities known as Synthetic CDOs, which use derivatives and other securities to obtain their investment goals without owning the assets of a CDO. The following chart depicts the creation of a Synthetic CDO in detail. Source: Financial Crisis Inquiry Commission When these junior tranches went bad, the House of Cards came down and brought trillions in consumer real estate and equity market wealth with it. Banks were most seriously hit with billions in worthless securities on the books. In response, the government took action to combine failing banks to create even larger financial institutions, and initiated new regulations under Dodd-Frank. The reality, however, is that this bill does little to increase the safety of our financial institutions, and only provides the illusion of safety with increased capital requirements. A Quantitative Analysis of Risk In conducting a quantitative analysis of the risks within financial services firms, there are multiple avenues to be considered. In terms of fair value accounting, IFRS 13 and FASB 157 are the two methodological statements for application. As we are going to focus the analysis on U.S. banks, I will limit the scope of this writing to U.S. GAAP application, and leave concerns from IFRS out of the discussion. Currently, U.S. GAAP only requires netting of derivatives exposure, providing investors with only a part of the overall exposure of any financial institution. Two additional pieces are required to more accurately understand the risks from derivative securities. First is the PFE, the potential future exposure, largely calculated through counter party risk. The second piece is the CVA (Credit Value Adjustment), this adjusts for the deterioration in credit quality of counter parties. It is important to note, however, that the CVA has no standardized method of calculation, adding another layer of uncertainty in arriving at a dependable quantifiable value of the derivatives exposure. (For additional exploration-Ernst & Young laid out this point well in this piece .) One additional layer of exposure is found in the Level 3 section of the valuation hierarchy. According to FASB 157, assets can be valued according to a hierarchy. Level 1 represents securities where readily available markets are available, and thus observable pricing exists. Level 2 are securities where inputs are observable either directly or indirectly, such as in markets that are thinly traded or where observable inputs can be estimated based on the prices of similar assets. Level 3 assets are assets where no observable market prices are available. In such a scenario, banks are allowed to use various methodologies to determine the prices of these assets. In my opinion, the challenge with these Level 3 values is that they are given a certain value simply because the banks say that is what they are worth. With no observable inputs, it is hard to put much confidence in the stated prices of these assets without a more dependable model for price discovery. It is important to note that the challenges with Level 3 assets extend beyond the world of bank balance sheets. The May 4, 2015 issue of Barron’s includes a very interesting exploration of the subject on page 31, as it relates to bond mutual fund financial statements. The article discusses a specific fund currently under investigation, but also deals with the issues of Level 3 securities on the books of many mutual funds. The story quotes the independent auditor of the specific fund in question in its most recent annual report as stating the following in relation to Level 3 assets: “These estimated values may differ significantly from the values that would have been used had a ready market for the investments existed, and the differences could be material.” The article also warns investors that during a crisis many assets classified as Level 2 can quickly become Level 3. I would echo this view in relation to bank balance sheets, as we learned during 2008 many of these arcane securities buried deep within bank balance sheets may carry a material variance between stated value and real market value.” Analyzing Level 3 in the Largest Banks Bank of America (NYSE: BAC ) As you can see from this analysis from page 241 of Bank of America’s annual report (2014), Level 3 assets represent 3.37% of the total assets after netting. The company is holding over 1,592,332M in total Level 1, 2, and 3 assets before netting with Level 2 making up 86.7%. I give BAC management a great deal of credit for maintaining a low value of Level 3 assets, but I believe the high value of Level 2 assets may expose investors to unquantifiable, and possibly material risks, in a financial crisis as there is no way of knowing how much of Level 2 would become Level 3 in such a scenario. Additionally, according to the OCC’s Quarterly Report on Bank Trading and Derivatives Activities for the 4th quarter of 2014 , BAC had total credit to capital exposure of 93%, and 85% as of the fourth quarter of 2015. Wells Fargo (NYSE: WFC ) Note 17 and Table 65 of the 2014 Annual Report, illustrates an exposure of 2% for investors to Level 3 securities. WFC is holding the majority of its assets at level 2, representing 94% of assets after netting. Additionally, according to the 4th quarter OCC report on Bank Trading and Derivatives Activities, WFC has total credit to capital of 22%, and 31% for the fourth quarter of 2015. JPMorgan Chase (NYSE: JPM ) Page 163 of the Annual Report indicates total Level 3 assets as a percentage of total assets measured at fair value of over 7.2%, which appears to be rather high when compared to peers. Additionally, according to the 4th quarter OCC report on Bank Trading and Derivatives Activities, JPM has total credit to capital of 177%, and 209% for the fourth quarter 2015. Note 3 of JPM’s annual report lays out the detail for fair value accounting for the firm. Citigroup (NYSE: C ) Page 262 of the 2014 Annual Report shows total Level 3 exposure of 2.42%. Additionally, Citi had a credit to capital ratio in 2014 of 172%, and 166% in the fourth quarter of 2015. Before netting exposure, Citi is holding close to a trillion dollars in derivatives at $892,760M. After netting of $824,803M occurs, this number is reduced to $67,957M, and this total includes Levels 1, 2, and 3 securities. The total Level 3 exposure after netting is $11,269M which is 16.58% of the net exposure of $67,957M, and 2.42% of total investments in Levels 1, 2, and 3 of $302,901M. What would be worrisome to me if I were a Citi shareholder is that the vast majority of the assets in the hierarchy are recorded in Level 2. The question is how much of Level 2 would become Level 3 in a crisis? It is important to note that many of these risks are mainly material to the investment thesis if we were to have another financial crisis. Level 3 assets are not a day-to-day concern for investors, generally speaking. That being said, they would be material should another crisis befall us. As nothing has been done to address the root cause of too big to fail, we now have larger financial institutions with more complex securities on the books, and another financial crisis may be inevitable. The Fed Response to the Crisis The Federal Reserve acted quickly instituting, what could be best characterized as an unprecedented experiment in monetary policy. The Fed put these extraordinary monetary policy measures in place to unfreeze markets and induce risk taking in the economy. They did this by implementing a combination of Large Scale Asset Purchases (LSAP) as well as Zero Interest Rate Policy (ZIRP). The combination of these policies were introduced to drive down the risk premium for long-term bonds (BRP), and drive up the risk premium for equities (ERP). While Ben Bernanke , the Fed Chair at the time defends his actions in monetary policy, the effects of these policies, which I will explore in the next article, are muddled at best and a down right failure at worst. The Fed’s objective in instituting this monetary policy was to drive up the prices of equity securities with the hopes of creating a real wealth effect. At the same time, the Fed hoped to induce risk taking in the real economy by driving down interest rates. The idea was that the two-fold effect of driving down interest rates to the zero lower bound, and inducing a rising equity market would allow us to avoid the negative effects of the great depression. But many question whether this was simply a mechanism to delay rather than avoid the worst of the financial crisis. In part II, we will discuss the implications of these policies on asset prices. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. Additional disclosure: This article is for informational purposes only and is not an offer to buy or sell any security. It is not intended to be financial advice, and it is not financial advice. Before acting on any information contained herein, be sure to consult your own financial advisor.

Empire District Electric’s (EDE) CEO Brad Beecher on Q1 2016 Results – Earnings Call Transcript

Empire District Electric Co. (NYSE: EDE ) Q1 2016 Earnings Conference Call April 29, 2016, 1:00 pm ET Executives Dale Harrington – Secretary & Director, IR Brad Beecher – President & CEO Laurie Delano – VP, Finance & CFO Analysts Paul Ridzon – KeyBanc Brian Russo – Ladenburg Thalmann Michael Goldenberg – Luminus Management Operator Good day and welcome to the Empire District Electric Company First Quarter 2016 Earnings Conference Call and Webcast. All participants will be in a listen-only mode. [Operator Instructions]. After today’s presentation, there will be an opportunity to ask questions. [Operator Instructions]. Please note this event is being recorded. I would now like to turn the conference over to Mr. Dale Harrington, Secretary and Director of Investor Relations. Please go ahead. Dale Harrington Thank you, Emily, and good afternoon everyone and welcome to the Empire District Electric Company’s first quarter 2016 earnings conference call. Our Press Release announcing first quarter and 12-months ended March 31, 2016 results was issued yesterday morning. The Press Release and a live webcast of this call, including our accompanying slide presentation are available on our website at www.empiredistrict.com. And a replay of the call will be available on our website through July 29 of 2016. Joining me today are Brad Beecher, President and Chief Executive Officer and Laurie Delano, Vice President, Finance and Chief Financial Officer. In a few moments, Brad and Laurie will be providing an overview of our first quarter and 12-month ended results as well as some highlights on other key matters. But before we begin, I’ll remind you that our discussion today includes forward-looking statements and the use of non-GAAP financial measures. Slide 2 of our slide deck and the disclosure in our SEC filings present a list of some of the risks and other factors that could cause further results to differ materially from our expectations. So let me caution you though that these lists are not exhaustive and the statements made in our discussion today are subject to risks and uncertainties that are difficult to predict. Our SEC filings are available upon request or may be obtained from our website or from the SEC. I would also direct you to our earnings Press Release for further information on why we believe the presentation of estimated earnings per share impact of individual items and the presentation of gross margin, each of which are non-GAAP presentations, is beneficial for investors in understanding our financial results. And with that, I’ll now turn the call over to our CEO, Brad Beecher. Brad Beecher Thank you, Dale. Good afternoon, everyone and thank you for joining us. Today we will discuss matters from the Board of Directors and Annual Shareholders Meetings, as well as our financial results for the first quarter and 12-months ended period March 31, 2016. We will also provide an update on the proposed merger and other recent company activities. During our annual meeting of shareholders held yesterday, three directors were reelected to serve three-year terms, Ross Hartley, Herb Schmidt, and Jim Sullivan. And other business shareholders ratified the appointment of PricewaterhouseCoopers LLP as Empire’s independent registered public accounting firm for the fiscal year ending December 31, 2016. Shareholders also approved a non-binding advisor proposal regarding compensation of our named executive officers. During the meeting yesterday, the board declared a quarterly dividend of $0.26 per share payable June 15, 2016, for shareholders of record as of June 1. On Slide 3, of our presentation, we provided some highlights of the quarter and 12-months ended period; we will discuss these more throughout the call. Yesterday we reported first quarter 2016 earnings of $14 million or $0.32 per share inclusive of merger-related costs. This compares to the same period in 2015 when the earnings were $14.6 million or $0.34 per share. For the 12-month ending period March 31, 2016, earnings were $56 million or $1.28 per share inclusive of merger costs. This compares to 12-months earnings of $60.8 million or $1.40 per share for the same period last year. As you can see from the slide it’s been a mild quarter for weather. In terms of heating degree days the 2015/2016 winter season was the warmest in the past 30 years, the first quarter ranks as the sixth warmest in the last 30 years, it was a great, it was great weather for enjoying the outdoors but not great for energy sales. During the quarter, we announced Empire had reached an agreement and planed a merger with Liberty Utilities, the U.S. subsidiary of Algonquin Power and Utilities Corporation. Algonquin Power and Utilities is a North American diversified generation transmission and distribution utility company, they are based in Oakville, Ontario, and their stock is traded on the Toronto Stock Exchange. Liberty Utilities is a growing utility operator that has been in business in the U.S. for over 15 years. They operate electric, natural gas, water, and waste water utilities across the broad geographic areas stretching from California to New Hampshire. Empire will be delivering Central’s region with Jolpin serving as the corporate headquarters. The Central region will include 340,000 customers in Missouri, Kansas, Arkansas, Oklahoma, Iowa, Illinois, and Texas. The transaction will provide greater scale, geographic diversity, and growth opportunities for both organizations. As a reminder, Empire shareholders will receive $34 for each share of stock owned at the close of the transaction. This represents a 50% premium over the unaffected price of $22.65 on December 10, 2015. On Slide 4, we provided a tentative timeline of the approval process and transaction closing. Merger applications were filed with state and federal regulatory agencies on March 16. We expect to receive an order from FERC approving the merger any day. In Oklahoma, the hearing was held on April 27 and Oklahoma Administrative Law Judge has recommended approval and order is expected within 60 days. Procedural schedules are being established in Missouri, Kansas, and Arkansas. We anticipate approvals in place for transaction close in the first quarter of 2017. Shareholder approval is also required for the transaction. We have set May 2, 2016, as the record date for determining eligibility to vote on their agreement and planned merger. We expect to hold a Special Shareholders Meeting on June 16, 2016, to conduct the vote. A final proxy and voting instructions will be mailed to shareholders next week. Last week, we began joint meetings at the senior management level to initiate the transition and integration planning process. As we work to fulfill the conditions to close the merger we remain focused on business as usual at Empire. Moving onto Slide 5, Riverton combined cycle is nearing completion of in-service testing. The project is on schedule and on budget. As of March 31, approximately $163.3 million has been spent on the project against a total budget of $165 million to $175 million. The Riverton project is the first large frame combined cycle generating unit in the State of Kansas and will be among the most efficient natural gas units in the country. This projects completes our multiyear compliance plan for the Mercury and air toxic standard. We continue to prosecute the Missouri rate case which is primarily related to the cost recovery of the Riverton project. Slide 6, is a reminder of the key aspects of this case filed October 16, 2015. The case seeks an increase in annual revenues of $33.4 million or about 7.3%. The procedural schedule provides for a true up of expenditures incurred through March 31, 2016, assuming a Riverton 12 combined cycle end service date of June 1, 2016. Evidentiary hearings are slated for May 31 in Jefferson City. As you can see from the projected timeline on Slide 7, we will experience a period of lag between the in-service state of the Riverton project and the time new customer rates are effective which we expect to be late September of this year. A corresponding rate filing has been made in our Oklahoma jurisdiction; we expect to file rate cases in Kansas by the end of the third quarter, and in Arkansas, no later than the end of the year. For 2016, we expect earnings to be within a weather-normalized range of a $1.26 to $1.44 including estimated merger transaction fees. We estimate total fees of $15 million to $17 million with approximately 50% of the fees payable in 2016 and included in the guidance range. As of April 1, 2016, we have received the applications for just over $10 million in rebates for private solar installations. As of the end of the quarter, we had processed 467 solar rebate applications and have recorded a regulatory asset of approximately $6.2 million on our books. These rebate costs will be collected from other Missouri electric customers and future charges. On the legislative front, we continue to support legislation in Missouri to update our century old regulatory framework. Senate Bill 1028 allows timely recovery of utilities prudently incurred operating cost while offering important consumer protection such as earnings caps, revenue caps, and performance standards. We believe that Senate Bill 1028 offers a balance long-term solution that will benefit both Empire customers and shareholders all while retaining the strong oversight of the Missouri Public Service Commission. We will continue to work to move this important legislation forward in the final two weeks of the Missouri legislative session. I will now turn the call to Laurie to provide additional details of our financials. Laurie Delano Thank you, Brad, and good afternoon everyone. As we review our first quarter 2016 earnings per share results, the financial affirmation I will discuss will supplement our press release that we issued yesterday, and as always our earnings per share numbers referenced throughout the call are provided on an after-tax estimated basis. As we noted in our press release yesterday the Missouri customer rate increase that went into effect in July 2015 was the primary driver of increased margin compared to the prior year quarter. The mild fourth quarter 2015 weather continued to spill over into the first quarter of 2016 driving the 7.5% decrease in our electric segment sales. This mild winter weather largely offset the impact of higher customer rates from an earnings per share standpoint. And as we also noted on our press release in the first quarter we paid approximately $4.2 million in merger-related costs which reduced earnings an estimated $0.06 per share minus the mild weather and the merger cost impacts, results were pretty much on track with our expectations. Slide 8, shows the detail of changes that impacted earnings per share quarter-over-quarter. Consolidated gross margin increased $1.8 million lifting earnings by $0.03 per share. Increased electric customer rates of about $7.7 million net of an estimated $1.9 million decrease in Missouri-based fuel recovery, increased revenue $5.8 million quarter-over-quarter this added an estimated $0.11 per share to margin. As mentioned previously, this increase was almost entirely offset by the impact of the mild winter weather and other volumetric factors which decreased revenue by about $10.5 million negatively impacting margin by about $0.10 per share when compared to the first quarter last year. Positive customer growth contributed about a penny to earnings per share and other items including the content and timing of our fuel deferral and recovery mechanisms combined to add another estimated $0.02 per share to margin when compared to the first quarter of 2015. Mild weather also impacted our gas segment retail sales quarter-over-quarter resulting in a decrease in gas segment margin of about a penny per share. We estimate the net impact of the mild winter weather reduced margin about $0.06 to $0.08 per share for the quarter when compared to normal weather. Continuing on with Slide 8, consolidated operating and maintenance expenses remained relatively flat compared to the 2015 quarter combining to raise earnings per share about a penny. And as mentioned previously, the most significant expense item during the period was the previously mentioned $4.2 million in merger cost which reduced earnings per share about $0.06. Exclusive of the $0.06 per share negative impact resulting from the merger cost, our first quarter earnings would have been $0.38 per share. Moving on to our 12-months ended results, Slide 9 provides a roll forward to our $1.28 per share earnings for the period ended March 2016. As Brad mentioned earlier, our net income decreased about $4.8 million or $0.12 per share compared to the year ago period. Slide 9 details the breakdown of the various components. Consolidated margin increased about $12.7 million or an estimated $0.18 per share when comparing the two periods. Electric rates were again the most significant positive margin driver during the period adding an estimated $0.26 per share. The impact of mild weather and other volumetric factors combined to reduce electric on-system sales about 2.7% decreasing margin an estimated $0.15 per share. Increases in customer growth added about $0.02 per share. Other items again including the content and timing of our various fuel deferral and recovery mechanism combined to add an estimated $0.08 per share to margin when compared to the 2015 period. The mild weather also continued to impact our gas segment reducing margin an estimated $0.03 per share period over period. Our total on-system electric sales for the 12-months ended March 2016 were 4.84 million megawatt hours versus 4.97 million megawatt hours in the 12-months period ending March 2015. This is near our weather-normalized annual expected sales level of approximately 5 million megawatt hours. Slide 9 also details the — shows the details of increases in operating and maintenance expense items which combined to decrease earnings per share by $0.05. A planned maintenance outage of our state line combined cycle plan, increases in production maintenance expense at a number of our other generation plants, and our previously discussed Riverton 12 maintenance contract which became effective January 1 of 2015, combined to decrease earnings around $0.05 per share. As you may recall, we did not begin recovering that Riverton maintenance contract and customer rates until our rate increase effective last year in July. Increased labor cost driven by increased executive stock-compensation valuations reduced earnings about $0.04 per share. Other smaller cost increases and decreases combined to add another $0.04 per share to earnings bringing the total O&M impact to the $0.05 per share reduction. Again the merger cost of approximately $4.5 million in that 12-month ending period reduced period over period earnings at an estimated $0.06. Increased depreciation and other taxes reduced earnings an estimated $0.08 and $0.03 per share respectively. Interest expense reduced earnings per share about $0.05 period over period due primarily to the $60 million privately placed first mortgage on financing that we did in August 2015. As Brad mentioned earlier, and as Slide 10 illustrates, our full-year 2016 weather-normalized earnings guidance range which we revised on February 2016 of this year remains unchanged at $1.26 to $1.44 per share. As a reminder, at the time we revised our guidance range we advised that we estimated full-year earnings to be $0.10 to $0.12 per share lower than our original full-year guidance range of $1.38 to $1.54 that we provided on February 4. We continue to expect to incur total merger costs of approximately $15 million to $17 million, half of which would be payable in ’16, with the other half in 2017, assuming a 2017 closing date. Now as I mentioned earlier we have already paid $4.2 million of those costs in 2016. On our balance sheet, we have $104 million in retained earnings and we had $19 million of short-term debt outstanding at the end of March. On Slide 11, we have updated our trailing 12-months return on equity charge. As you can see on the slide at the end of March our return on equity was approximately 6.9%. With that, I will now turn the call back over to Brad. Brad Beecher Thank you, Laurie. At Empire, we strive for continuous improvement and innovation, I’m proud to report our efforts were recently recognized by the Edison Electric Institute when they announced that we were among a small group of utilities chosen as the finalist for the Edison award. The award recognizes our work in developing an innovative modular transmission, structured design, and construction process. The design speeds construction, lowers cost, and reduces outage sign during coal replacement projects. With that, I will now turn the call back to the operator for your questions. Question-and-Answer Session Operator Thank you. We will now begin the question-and-answer session. [Operator Instructions]. Our first question is from Paul Ridzon of KeyBanc. Please go ahead. Paul Ridzon Good afternoon. How are you? Laurie Delano We’re fine Paul, thank you. How are you? Paul Ridzon Fine, thank you. Just hoping to get an update on where the proposed I think its Senate Bill 1028 stands? Brad Beecher Well that’s going to be the question of this day, Paul. There is only two weeks left in the session, but so we’ve got a lot of work to do and a short amount of time to do it. Senate Bill 1028 is currently on the informal Senate calendar which means it can be called up at any time. That said it’s going to be difficult for 1028 to move through the remaining process and house process in two weeks. So if Senate Bill 1028 is going to move forward or you will likely see it attach to another House Bill that might be moving through the Senate. As you probably heard we have had the third filibuster in the Senate here this week on voter ID and so it’s just going to be — so we are still working hard and we still think it’s got to shot but it’s going to be a difficult process. Paul Ridzon Thank you for that update. And Laurie, I had a question, when you talked about gross margin there was new rates net $5.8 million and then weather was $10.5 million headwind but net-net there was gross margin actually went up and you referenced in the release some fuel deferrals, is that where the delta is and is that a timing issue? Laurie Delano That’s where the delta is. So if you will recall in our last rate case fuel was rebased pretty significantly as part of the rate reduction and rates that were set. And so the way we think about that is our revenue reduction is net of that fuel rebate, but that fuel rebate doesn’t impact margin. So let me get to my notes here. So when we say that we had increased electric customer rates of $7.7 million for the quarter, net of the estimated $1.9 million decrease in Missouri-based fuel recovery that $1.9 million in Missouri-based fuel recovery is a loss to margin. So in our estimation the $7.7 million is really the impact of margins. Paul Ridzon Okay. Laurie Delano Does that make sense? Paul Ridzon So as we go through the year are there a few deferrals going to kind of reverse and may be make another quarter weaker? Laurie Delano No it’s a dollar for dollar increase in revenue and increase in fuel. So as we compare the two periods, period over period we’re identifying the new rates that came in at the gross amount which would be the $7.7 million and then we’re identifying how much of that fuel base recovery brought revenues and fuel both down together to get to our net revenue change. Paul Ridzon Of $5.8 million? Laurie Delano Yes, so again the $5.8 million reflects the increased cost less the fuel decrease. But that fuel decrease is not only decreasing revenues, it’s also decreasing fuel cost. Paul Ridzon Okay. Thank you very much. Laurie Delano Hope that made sense. Paul Ridzon Yes. Operator Our next question is from Brian Russo of Ladenburg Thalmann. Please go ahead. Brian Russo Yes hello. Laurie Delano Hi Brian. Brian Russo You mentioned the Missouri Legislature ends in two weeks, what’s the exact date that it concludes? Brad Beecher It’s Friday, May 13, I believe. Brian Russo Okay. And when does the legislature resume again I guess in 2017? Brad Beecher I don’t know that exact date but it’s again — it’s in 2017. Brian Russo Okay. And is there any sort of some statutory deadline in which Missouri would have to rule on the merger once procedural schedule is set? Brad Beecher We went through this a little bit Brian on our merger call. But the way it stands in Oklahoma once they have the hearing which they have, they have 60 days in order to issue an order, in Kansas they have 300 days from the time the merger application was filed, so 300 days from March 16, in Arkansas and Missouri, there is no prescribed statutory timeframe that they have to act. Brian Russo Okay, got it. And you mentioned that SB 1028 is on the informal calendar and it could be heard anytime. So if there is not, it’s not when it was put on the calendar prior along with a lot of other proposed legislation, so there is no particular order in which it will be heard, it can be heard at anytime? Brad Beecher As we said, right now, it can be heard at anytime. They have rolled — they have used the term roll to the calendar and anyway Senate Bill 1028 is on the informal calendar and either it or an energy-related House Bill could be that it’s passed through the House could be called up at anytime. Brian Russo Okay. And then I’m just curious the Riverton lag seems like it’s related to depreciation. Are there any O&M savings for the gas conversion that you guys will retain until you should include this rate case and new rates going to affect? Laurie Delano Nothing significant, Brian. Brian Russo Okay. Brad Beecher If we shift the coal units down really in ‘14 and ‘15 and so any reductions in O&M have already been in the rearview mirror. Operator Our next question is from Michael Goldenberg of Luminus Management. Please go ahead. Michael Goldenberg Hi I wanted to continue the discussion about the merger approvals. So as it stands right now which one do you think will be the most complicated or complex, which of the state will be the most involved? Brad Beecher As we said right now Missouri, Arkansas, and Kansas, are kind of all at the same stage we’re getting data request in all the states now, they all take you through a full process. So we have a few more interveners in Missouri than we do in the other states. If you think that’s going to add complexity but generally speaking all three of them are going to through the same type of process. Michael Goldenberg So you said Missouri, Kansas and I’m sorry. Brad Beecher Arkansas. Michael Goldenberg And what? Brad Beecher Arkansas were those three. Michael Goldenberg Arkansas, okay. Now in terms of in Kansas is the one with 300 days and Missouri has no statutory deadline right? Brad Beecher That is correct. Michael Goldenberg Do both Kansas and Missouri have a specific schedule of events posted somewhere? Brad Beecher So in Missouri we have field a proposed procedural schedule and Laurie can range you the dates here but the commission is not rolled on it. Laurie Delano So what the proposed schedule says is for technical conferences on May 16 and 17 and then June 1, with rebuttal testimony on July 6, serve rebuttal on July 22, and order witnesses, order cross examination on July 28, physician statements August 4, with the hearing occurring on August 15 to 17 and again that is just proposed that has not been approved yet. Michael Goldenberg But basically July, August will be the hard and heavy times of this, so to speak? Brad Beecher Right and I think that’s the way you need to think about Arkansas, Kansas and Missouri as we said here today it is the summer especially late summer is going to be full of hearings. And then hopefully that will give commissions about 90 days to make decisions and hopefully get us orders by December so that we can close in the first quarter. Michael Goldenberg When you think about interveners, is it the usual cash [indiscernible] consumer advocates comes out of that, oh, I want money, I want fixed rates stuff like that. Is it that kind of a millet that we see in every merger proceeding or is that something that we need? Brad Beecher So in Kansas and Arkansas the interveners are the typical AG consumer advocate or staff, in Missouri in addition to that we have some of our industrial consumers in the City of Jolpin which are typical interveners in our rate case and then we have a couple other folks that have groups that have intervened one of them being Empire’s retirees who have interest in retiree healthcare. Michael Goldenberg Okay. Is it too early to discuss strategy and kind of what you learned from recent merger proceedings? Brad Beecher We filed direct testimony, so a lot of the strategy is laid in that direct testimony. We filed joint testimony with Common Council with Liberty. And I think reflecting to 99 on why we didn’t get approval on 99 the big ticket items that have kind of been taken off the table as Algonquin is not asking for premium recovery, they are not asking for recovery of transition cost and they are not proposing any staff reductions and those are the big ticket items that have caused a lot of things in the past and so Algonquin took all of those off the table in their initial filings. Operator [Operator Instructions]. Showing no additional questions, this concludes our question-and-answer session. I would like to turn the conference back over to Brad Beecher for any closing remarks. Brad Beecher Thank you. Before we close, I will remind you that as we work diligently to achieve the conditions necessary to successfully close the merger with Liberty Utilities, our mantra will be business as usual. Rest assured we will continue to stay focused on the business at hand providing safe, reliable energy for our customers and attractive return for our shareholders and a rewarding environment for our employees. One last note, Laurie, Dale, and I will be at the AGA Financial Conference May 16 and 17 in Florida. We hope to see many of you there. Thank you for joining us today and have a great weekend. Operator The conference is now concluded. Thank you for attending today’s presentation. You may now disconnect. Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) 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