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Innergex Renewable Energy’s (INGXF) CEO Michel Letellier on Q4 2015 Results – Earnings Call Transcript

Innergex Renewable Energy Inc. ( OTC:INGXF ) Q4 2015 Earnings Conference Call February 25, 2016 10:00 AM ET Operator Good morning, ladies and gentlemen. Thank you for standing by. Welcome to Innergex Renewable Energy’s Conference Call and Webcast for its 2015 Year End Results and 2016 Objectives. [Operator Instructions] I would like to remind everyone that this conference call and webcast is being recorded today, Thursday, February 25, 2016 at 10 a.m. Eastern Time. I will now turn the conference over to Martine Benmouyal, Senior Advisor, Communications. Please go ahead. Martine Benmouyal Good morning, ladies and gentlemen. If you haven’t done so already and would like to access the webcast, please go to our website at www.innergex.com. I am here today with Mr. Michel Letellier, President and CEO of Innergex, and Mr. Jean Perron, Chief Financial Officer. Please note that the presentations will be in English. However, you are welcome to address your questions either in French or in English. I would also like to point out that journalists are invited to call us afterwards if they wish to further address any question. In a minute, Mr. Perron will provide some details on our financial results for the year ended December 31, 2015. Mr. Letellier will then provide an overview of our operating activities in 2015 and our objectives for 2016. We will then open the Q&A session with both senior executives. The financial statements and the MD&A have been filed on SEDAR and are readily available via the Internet. You may also access the press release, financial statements and the MD&A on the Innergex website in the Investor section. During this presentation we will refer to financial measures such as adjusted EBITDA, free cash flow and payout ratios that are not recognized measures according to International Financial Reporting Standards, the IFRS, as they do not have a standardized meaning. Please be advised that this conference call and webcast will contain forward-looking information that reflects the corporation’s expectations with respect to future results or developments. For explanation concerning the principle assumptions used by the corporation to derive this forward-looking information and the principle risks and uncertainties that could cause actual results to differ materially from those anticipated, I invite you to consult the first pages of the webcast presentation, as well as Innergex’s Annual Information Form. I now turn the conference to Mr. Perron. Jean Perron Thank you, Martine. Good morning. The quarterly results for Q4 2015 show production of 94% of long-term average due mainly to below average water flows and wind resources. Production for the year stands at 98% of the long-term average. Revenues for the quarter were $12 million lower than in 2014 mainly due to last year where the production was under 20% of long-term average. Revenues for the year were $5.1 million higher than last year. The increase is attributable mainly to the full year contribution of the SM-1 hydroelectric facility acquired in June 2014 and to the higher wind regimes in Québec, partially offset by lower water flows in British Columbia. Adjusted EBITDA for the quarter was $9.9 million lower compared to Q4 2014 for the reasons explained above. Adjusted EBITDA for the year was $4.2 million higher than in 2014. The increase is mainly due to the higher revenues. Finance costs for the quarter were slightly lower than in Q4 2014, while for the year they are down $3.4 million compared to last year mainly due to the lower inflation compensation interest. During the quarter $51.7 million impairment was recognized on the prospective projects acquired from Cloudworks in 2011. This impairment is due to the lack of visibility on the future RFP following the construction of sites and the decrease in demand that was expected from the construction of new LNGs planned that have been postponed. Innergex servicing the ownership of the license and may eventually develop them in the future. During the year, a total of $1.1 billion of financing was completed and we do not need any additional liquidity to complete the construction of the forward projects, an amount of $180 million remains unused and available on our revolving corporate credit margin of $425 million. During the quarter, we bought back 400,000 shares and for the year a total of 1,190,000 shares at an average price of $10.36. During the year, we also issued a new $100 million convertible debenture at the 4.25% interest rate and convertibles at $15 per share, which is less dilutive than the former convertible debenture that was bearing interest rate of 5.75% and convertible at $10.65 per share and that was partially redeemed from the proceeds of the new debenture. Overall, the slightly below average quarter combined with a very strong first quarter allowed us to be very close to production in various targets for the year, while our operating expenses were lower than expected. As a result, free cash flow for the year reached $74.4 million, compared to $67.7 million in 2014 and our payout ratio improved to 86% from 88% last year. Since the beginning of 2016, our production has been above the long-term average mainly at our hydroelectric facilities in British Columbia. We remain confident in our ability to reach our long-term average production figures year-over-year. This concludes my review of the results. I will be happy to answer your questions later on during the call. And I will turn it back to Michel? Michel Letellier Thank you, Jean. Good morning, everybody. As a little bit of a tradition that we have established in the last two years, this presentation we would like to come back to what we have said in report cards for 2015 and give you what we have actually accomplished give you a little bit of a perspective on our objectives of 2016, give you our run-rate of 2017, and give you a little bit of an overview on our strategy for the next few years. And then we will have the question period. So, if we come back a little bit on what we said in 2015, we said that we wanted to increase the production and revenue by approximately 3% to 5%. We did manage to increase the revenue by 2%, even if the long-term average was a little bit weaker, as Jean mentioned. We did a little bit better on the EBITDA. We have increased 2% our EBITDA. And we have managed to keep our payout ratio at 86%, so, so far, so good. Objectives on the development, that’s where we had a big year in 2017. As you remember, we have the project of Upper Lillooet, Boulder, Big Silver and Tretheway under construction in BC. And we wanted to start the construction on Mesgi’g Ugju’s’n, the 150 megawatt wind farm in Québec. So, I am happy to report and we have a tab in the next page to give you the more – a little bit of more detail. But in a nutshell, we have managed to put the Tretheway on COD a little bit in advance and under budget by $8 million. We have started the construction on Mesgi’g Ugju’s’n project and we have overall facility reduced the construction budget by $28 million. So, if you include the $8 million saving in Tretheway, we are down to $36 million savings over a little bit over $1 billion of projects. I am pretty proud of the team there. So, if you flip on the next page, you see the project, the actual cost now forecast for the COD. And we have moved the COD a little bit in Boulder, in Upper Lillooet due mainly on the last summer fire. We have lost a few months there in the peak of the summer. So, we are managing to have Upper Lillooet and Boulder now moved a little bit further in 2017 instead of the last quarter of 2016. Mind you that Boulder and Upper Lillooet are in a remote area, where the intakes are fairly high in altitude. So, winter revenue for these projects are not big. So, our goal is to make sure that we will be in COD for the spring time, where we get the majority of the revenue. In terms of more specific costs, Boulder and Upper Lillooet have been a little bit more of a challenge, given the tunnel. So we have increased the budget and we think it’s fairly conservative by $17 million. On the other hand, Big Silver has proven to be, I would guess – I would say a very – I wouldn’t say easy project, but we didn’t have any issue with the tunnel. And most of the civil work has been done already. So we are forecasting a reduction in cost by $10 million. And Mesgi’g Ugju’s’n have – we have finalized all the construction. We have also finalized the financing. So we are now very comfortable with a reduction of $35 million. So again, all-in-all I think that I am very proud of the team to have managed a $1 billion of construction and being able to have a reduction of $36 million on their budget, so very happy on that. Financing was also a big year, if you remember last year. We had a project finance I guess portfolio of about $1 billion to be done in 2017. We managed to do all of those with at least favorable – a little bit more favorable terms, conditions. The team has been also very creative in their ability to negotiate with long-term lender to structure the reimbursement of the amortization, so very interesting financing there. We also have issue the convertible debenture of $100 million to replace the old one with more favorable terms. So that’s another plus. We did also the refinancing on Umbata Falls. So all-in-all, we managed to do a little bit more than $1 billion worth of project finance in 2015. So right now as mentioned by Jean, we don’t have any more financing to do. So every project under construction has now the equity and the financing in place with fixed term and fully amortized over the initial terms of the EPA, so quite a good achievement there too. Now, if we are talking about the growth opportunity, we said that we wanted to participate in the Ontario market. We have managed to deposit or to supply – not supply but to file two projects in the RFP with 100% of the points. I don’t know if you are familiar with the Ontario RFP. But there is a possibility of discount in your price submitted to the authority by about 40% if you have 100% of the points that the – and its social acceptance and the advancements of the project. So I am happy to report that we managed to have 100% of the points on both projects that we have submitted. So we will know a little bit later on in March if we are a winner there or not. And we also have signed a Memorandum of Understanding with the Federal Electricity Commission of Mexico, which is the equivalent of Hydro- Québec and/or BC Hydro in Mexico, to develop in cooperation a small hydro opportunity. So we are starting to initiate this meeting and opportunity. So I am quite positive on that outcome as well. Also we said that we wanted to expand internationally or to look outside Canada and to consolidate our leadership in Canada. So I am happy to report that we did another acquisition in BC. We acquired Walden North electricity facility. It’s a 16-megawatt facility, not far from our own portfolio. So we are quite happy to have been able to achieve that. And we are pursuing acquisition opportunities in France and Mexico. We are making very good progress over there. Both teams are very present in France and in Mexico. And we are still very positive on our possibility over there. Now, what we are hoping to do in 2016, we want to grow our production by 6% or 8%, grow our revenue by 9% or 11% and grow our EBITDA between 7% and 9% and obviously trying to maintain our payout ratio below 100%. We want to make sure that we also advance our construction of the three hydro facilities in BC. We want to put Big Silver and Mesgi’g Ugju’s’n project in service by the end of the year. And obviously we want to make sure that we keep on track on Boulder and Upper Lillooet construction. We also want to finalize the negotiation with Hydro-Québec regarding Saint-Paulin and Windsor PPA. And in terms of growth opportunity, we want to make sure that we are still present in Canada when there is opportunity in Canada. We reaffirm our willingness to work in Mexico and France. We want to realize at least one acquisition in one of those two markets. And we are looking into other markets, mainly the U.S. and possibly the Peru market for small hydro. We are maintaining our run rate for 2017. That run rate doesn’t include any acquisition or future development that we could have, except from the projects that we are under construction right now. So our free cash flow, we are maintaining $105 million free cash flow for 2017 and the growth of the installed capacity will go from 708, our net capacity, to about 895. That doesn’t include the acquisition of Walden or any other facilities. So I am very confident about those numbers to 2017. Now the overview of our strategy for 2016 in the next few years, we would like to again reaffirm our commitment to remain exclusively in renewable energy. We want to maintain a very healthy diversification of energy sources. We want to consolidate our leadership position in Canada. So that means that if there is opportunity in Canada, we will be there. We want to develop an international presence in target markets, as we mentioned Mexico, France and possibly the U.S. and Peru markets are still under our focus. Still again, you know us. We want to focus on high quality assets. We want to maintain a low risk business model, maintain a long-term outlook. This is very important for us. We want to focus on partnership, especially with First Nation in Canada. I think that has been a very good tool for us to develop. Maintain our discipline of acquisition that means that we want to make acquisitions that are accretive to cash flow. So in summary, I am very proud of the evolution of Innergex, from the transition following the merger of the Income Fund and the company. We have as a team, being able and patient, focused on delivering both the growth and overcoming our high payout ratio, which was the heritage of the Income Fund. We have managed to build a very strong, long-term cash flow that are based on a great diversified portfolio of assets, all under long-term PPA. With a majority of these projects being project financed with long-term and fixed rate and that are fully amortized over the first life of the EPA. We have secured the sustainability of our dividend. And finally, we will have a significant amount of free cash flow in 2017. We now have the tools to focus on growing for the future. In a nutshell, we are willing and able to deliver on our strategy. So thank you. And we will take the questions. Martine Benmouyal This concludes our presentation. We now invite you to ask your questions. Question-and-Answer Session Operator Thank you. Ladies and gentlemen, we will now conduct the question-and-answer session. [Operator Instructions] And your first question comes from Nelson Ng with RBC Capital Markets. Your line is now open. Nelson Ng Great, thanks. Good morning, everyone. Michel Letellier Hey, good morning, Nelson. Nelson Ng A quick question on the delay in the timing of construction for Upper Lillooet and Boulder Creek like was it entirely due to the forest fires last summer or did the incidents in Upper Lillooet in November contribute to the delay as well? Michel Letellier The incident that you are mentioning very unfortunate incident had delayed about 10 days as well. So, it’s a little bit of a both. We had managed to have a force majeure by BC Hydro for 95 days – 90 days, which is basically the main – if you add up those 10 days, which is mainly the delay. Also the consequences of the fire having burned all the trees and the brushes along the slope had increased also some avalanche risk. So, we have lost a few days on that aspect as well. So, it’s all related to the fire mainly and also the very sad incident, that we had last fall, yes. Nelson Ng I see. So, in terms of the cost increase, was any of like the roughly $17 million cost increase, was any of that related to the delay or was that purely just on technical items? Michel Letellier It’s a little bit of mix. Mind you that it’s still – I think it’s still conservative. What we are doing is that we have kept the risk of the geology on the tunnel. So that means that we have fixed prices for the type of rock that we encounter during the construction, but it depends on a mix of quality of the rocks. We have basically four classes, 1, 2, 3 and 4. And depending on the quality of the rocks, we get to have a different pricing. So, I think that we have been a little bit conservative and rightly so, because we don’t know what’s in front of us in the tunnel, but I think that it’s basically the tunnels that are driving the cost, the overruns. Nelson Ng Okay. So, pushing out construction doesn’t really cause much of an increase? And I guess kind of related to that and if there are any cost increases, would that be recoverable through insurance? Michel Letellier Yes. Well, the delays are bringing some cost, but we are thinking – and we are discussing with the insurance. And hence, the insurance are basically covering all of those delay costs. So, that’s why we are not – and I was not referring to the $17 million being related to delays, because we think it’s – basically it’s a flow-through in terms of cost with the insurance. Nelson Ng I see. Okay. So there would be some costs, but like you said, it’s a flow-through. So, it’s not included in the increase? Michel Letellier No. Nelson Ng Okay. And then kind of more big picture in terms of I guess opportunities and project developments. So, like is it fair to say that like in the absence of an acquisition, was it fair to say that there won’t be – given the kind of lead time to procure projects, there probably won’t be any kind of new projects commissioned either in the second half of 2017 or even 2018 and potentially even early 2019? Would there be a period where there will be like no new projects contributing new revenues? Michel Letellier Well, Greenfield project, because in acquisition we can acquire existing facility or facilities that are just ready for construction. If it’s wind or solar, you can take sometimes only 1 year to build a wind or a solar facility, so that’s also part of our strategy. As I mentioned, always in the past we love to have a good balance between existing facility, facility under construction, facilities that are just at the very late stage of development and permitting are almost ready to build. So, that’s what we are looking into when we are looking into acquisition or a little platform or partner with existing developers, both in France or in Mexico. So, those are the targets. And Nelson, we may see some other projects coming in, in late 2017 or ‘18. Obviously, those would have to be acquisition of projects that are already under development. Nelson Ng I see. Okay. Just one last question, like obviously I think in the past you mentioned that you guys are looking at French wind acquisition as probably one of your priorities, but I guess given that Alberta and Saskatchewan now want to go green and the U.S. extended their renewable tax credits like what are your priorities and also geographies? Michel Letellier Well, obviously Canada is always top priority when there is opportunity. We have been very successful over the years in Canada. Canada is our own turf. There is no exchange rate issue. So, Canada is definitely a place that we want to be present. Alberta is a little bit more complicated. We don’t know exactly what will be the way that they are going to pay for the electricity. So, it’s still a little bit of an unknown. Saskatchewan is definitely of interest for us. There is New Brunswick as well who is having a small call. And Ontario has reaffirmed their willingness to extend the LRP II. So, we will be focusing on Canada. The U.S. is maybe a little bit more, I would say, not necessarily open in terms that there is always competition in the U.S., so in other market, but the yield co has been definitely been challenged in their business models. So, suddenly there is maybe a little bit more room for the Canadian company to participate in the U.S. market. Nelson Ng I see. Thanks. Thanks, Michel. Those are all my questions. Michel Letellier Thank you. Operator Your next question comes from Sean Steuart with TD Securities. Please go ahead. Sean Steuart Thanks. Good morning, everyone. Few questions. There was mention in the MD&A of a 200 megawatt block, wind block, given to the Innu First Nation and I gather you are exploring options to potentially partner with them. Can you give any context on developments there? Michel Letellier Yes, it’s like I said, I mean, I have been very careful to talk about active RFPs in development. So yes, we are interested definitely in the 200 megawatt Innu RFP or development, but it’s competitive. It’s under development right now. So, I won’t comment more, but definitely we are interested. Sean Steuart Okay. And with respect to the MOU in Mexico, wondering if you can give any insight on how everything is progressing there, where you are in terms of specific project development, any more detail you can provide in Mexico? Michel Letellier Yes. We are very, very active in Mexico. We have been meeting with CFE. Right now, the focus on both CFE and ourselves is the first RFP in Mexico. The prequalification for RFP have been happening. So, we are there. We hope to participate in that RFP. So, I guess that CFE is also focused on that first RFP. The date is sometimes late March to deposit the projects. So everybody, I guess the industry is really focused on that right now in Mexico. But we have been meeting with CFE on small hydro development. CFE has the ability to do its own project and not necessarily take all the supply from future RFPs. So, the small hydro project that we would like to do are on that basis is direct negotiation with CFE under potential partnership to build small hydro that will be used for supplying CFE-owned electricity. Sean Steuart Okay, thanks for that detail. And then lastly, any insight you can give on I guess potential resolution around the Québec PPA arbitration process from your perspective? Michel Letellier Alright. It’s tough to call. It’s – the arbitration is ongoing right now. I think that the arbitration – some arbitration are actually happening. I think that the conclusion should be somewhere late fall this year. So we are still hopeful that the arbitration conclusion on a few projects will bring value to the price of electricity. I think that we have a good case, the industry has a good case to come back to the avoided costs. Those projects – what we call the [indiscernible], the pricing was based on the avoided costs of electricity by Hydro- Québec. So we are hopeful that that notion will be retained by the arbitrator. Sean Steuart Okay, that’s all I had. Thanks Michel. Michel Letellier It’s my pleasure. Operator Your next question comes from Rupert Merer with National Bank. Your line is now open. Rupert Merer Hi, good morning everyone. Michel Letellier Hi Rupert. Rupert Merer So we had a dividend increase this quarter and some share buybacks, can you talk a little about how you are thinking about capital allocation, how regularly are you going to review the dividend and how you are going to look at share buybacks going forward? Michel Letellier Well, I think that again that policy or declaring a dividend is the responsibility of the Board. But as we discussed that strategy yesterday, I think that what we want to establish is the sustainability of the dividend and the foreseeable growth of the dividend. We are cautious, as I guess you gather from our development and the type of project that we are doing. So I think that what is important for us is to be able to say that our dividend is sustainable and we want to grow it sustainably. We are going to generate more cash flow in 2017. We will have a payout ratio that is going to be a lot lower than where we are experiencing right now. So again, always the decision between increasing the dividend and making that cash flow to work. We are very confident on what we are seeing abroad and eventually to Canada, to be able to make good investment and good use of that free cash flow. So whenever we are going to have some ability to invest and create value for the company, I think that will be the priority. But I think that the investors have to be rewarded on their patience with us. And creating – increasing the dividend slowly, but surely is probably what we are going to do. Rupert Merer Okay, great. Thanks for that. And then quickly then what was your outlook for Q1, can you talk about how it’s shaping up, given what you can see so far in the quarter? Michel Letellier Well, BC is probably doing the best of the best. It’s raining in lower elevation and we are capturing the rain. And it’s – there is a ton of snow in higher evolutions. So in BC we are well above 100% right now of our long-term average for the year-to-date on all our facilities. The wind in Québec is okay, a little bit over in February, but it was a little bit lower in January. So we are very close to our long-term average in the wind. And the hydro in Québec is also very good and in Ontario as well. So only the solar doesn’t have the full radiation right now. But that’s not so bad. But it’s still very close also to [indiscernible]. So far, the first quarter looks very, very strong. Rupert Merer Okay, excellent. Thank you very much. Michel Letellier It’s my pleasure. Operator [Operator Instructions] Your next question comes from Ben Pham with BMO Capital Markets. Please go ahead. Ben Pham Thank you. There wasn’t any commentary in the MD&A or even in your prepared remarks on Alberta, where do you guys stand on Alberta with renewables? Michel Letellier Well, I would say that for a change Alberta is now focusing on renewable energy. And I don’t want to go politics on that. It’s just that I think and I said in places in public speeches that especially in Canada, coal cannot produce electricity in Canada anymore. There is no way our country should support coal to produce electricity. And Alberta has close to 5,000 megawatts to 6,000 megawatts of installed capacity in coal. So we are hoping to see that market evolving towards future RFP. Alberta is very lucky to have very good wind resources and to some degree very good solar radiation as well. So I think that Alberta, if they have the willingness, they certainly could see a very dynamic IPP sector to produce renewable energy in Alberta. So if there is a good market and if there is some fair market for us to play, we will definitely love to be present in Alberta. Ben Pham Okay. But you don’t – you are more watching in the background now, rather than setting up offices? Michel Letellier We are yet to see how it’s going to evolve in Alberta. What we – why we haven’t been very active in Alberta is that Alberta never really had a long-term PPA that makes sense for us. So depending on what they are going to put forward, we will be aggressive or not in Alberta. Ben Pham Okay. Michel Letellier So we are – basically we are looking for long-term PPA opportunity, so if the renewable energy is again focused on merchant and some green credit, it will be difficult for us to be very aggressive there. Ben Pham Okay. And my second question, I was just wondering perhaps your thoughts about the benefits of scale as you think about 2020, what are you thinking in terms of your asset base and the growth opportunities beyond then, because it seems like most of your peers, and within the sector outside are touting scale and building scale to position for the next wave, I am just wondering your thoughts on that whole situation? Michel Letellier I think that scale is important, yes. I think that our ability to be creative is also very important and flexible and also is to be present in, I would say some good markets. Especially, I would say that we like Mexico, because Mexico is a growing market. They are growing their electricity consumption. In many other markets like the U.S., the electricity consumption is not going higher. It’s just that they are changing the way they are producing electricity. So hence, it’s making a good opportunity for renewable energy. But Mexico has both. You see the growth and you also see a change towards renewable energy and target portfolio to increase their percentage of renewable energy up to about 35% of their total generation capacity. So I see those markets as being very, very interesting for us. Peru has also some long-term contracts for small hydro. And I think we have good expertise there. So we are interested in Peru, although it’s not a big market. It’s a market where I think our expertise can be put to work. And obviously, Europe is interesting. Is Europe going to be as interesting as Mexico on the long-term, maybe not, because they are not growing that much their electricity consumption base. But to come back to the scale, I think that we can certainly have the ability to make a partnership. We have done and we have proved to be able to be a very good partner, a creative partner that has the ability to bring the win-win situation where we bring sometimes the capital. Sometimes we bring the capacity, the knowledge. So I am not so concerned about the scale, because we will never be big enough. I mean, there is always a bigger guy, a bigger fish in the pond. So, what I am focused more on is our ability, our creativity, to create value for our shareholders. That being said, we are not afraid of growing. We are not afraid of making acquisitions. And I think that one of the strategies to grow in foreign markets is to have maybe a local partner and to partner with maybe pension funds. And we have shown that our ability to do that, I think that we can be a good partner for infrastructure funds or a pension fund to acquire existing assets or to grow development projects. Again, the type of partnership that we have signed with CFE in Mexico is a very good example. I think that we are willing to partner with a big, a very big entity in Mexico that somehow has lost the ability to be nimble to develop smaller hydro. Hence, I think this is a win-win situation where we can bring the knowledge and they can bring the long-term PPA. So, those are the places where I feel we can create more value for our shareholders. Just getting bigger and bigger for the sake of getting big, I don’t think is the solution. Ben Pham Okay, that’s helpful. And maybe just a last cleanup question one of your recent projects you put in is the CPA adjustment and trimming the EBITDA down. Does that impact some of your future projects or is it already in the numbers? Are you going to revisit that in ‘17 timeframe? Michel Letellier Which one, I am sorry, Ben, what you are mentioning, you mean the Québec-based contract or? Ben Pham I think it’s on – it was in the contract that’s the Tretheway, the inflation mechanisms lower than your initial expectations. So, is that incorporated in your future backlog too or are you going to revisit it later? Michel Letellier No. Now, it’s already included in our long-term forecast, but the difference was basically what we had forecast during the construction. During the construction in BC, you have 100% of the CPI during the period of the construction or the development of the project. After that, it’s depending. It’s up to 50%. In some cases, we have 30%. Some places we have 50%. But in this case, I think we had forecasted in the construction about 2.2% of inflation and we had 1.5% or 1.6%. So it’s not a big gap though. Ben Pham Okay, alright. That’s helpful. Thank you very much. Michel Letellier My pleasure. Operator Your next question comes from Jeremy Rosenfield with Industrial Alliance. Please go ahead. Jeremy Rosenfield Thanks. Good morning. Just maybe one cleanup question related to the refinancing of the Stardale debt that I think you announced earlier this week. It looks like you are pulling out some equity from that project and you are also lowering your interest expense, so kind of a win-win. But can you just comment more broadly on what I would call capital recycling or raising debt or refinancing projects and taking out equity potentially using that to finance future acquisitions or future projects as you go forward. What’s your outlook there? Michel Letellier Well, Stardale was not done on a long-term basis with life insurance. So, we had the ability to refinance it with the same Japanese Bank. And at the time, solar and the market was not known and basically the spread also on the credit risk for solar was a little bit higher. And well, we just basically take advantage of now the bank – and especially that Stardale has been performing very well as well. So, the lenders were willing to reduce the spread and make more room for a bigger amount. So, I guess that whenever I can put my hand on long-term financing in a range of less than 5% in the range of 4%, why not? So, whenever we would have the ability to do that, we certainly would rather do that than issuing stock and diluting our shareholders. So, I think that this is probably the cheapest type of capital we can get, especially after-tax when you take into account the deductibility of the interest rate. So, do we have a lot of those possibilities? Not necessarily with the new one, because obviously we have put project finance – brand new project finance, with most of the projects are done with life co. So, there is not a lot of flexibility there. But we still have about 14 unconvert facilities and maybe with Walden, it will be 15. So, there is a little bit of room there definitely to – especially after renewing the existing PPA. So, there is maybe a case to put a portfolio together and issue a long-term bond on those, instead of having the corporate loan. So, that might bring also some more liquidity on that aspect. Jeremy Rosenfield Okay. But you don’t have a specific target in terms of the amount that you could resurface, let’s say? Michel Letellier No, we are trying to stay opportunistic. The long-term bonds are very, very attractive. It keeps amazing me to see the 30-year bond below 2%. So, obviously that makes very cheap long-term money when you have a good project to finance, especially in Canada, but no, Jeremy, we don’t have a specific number. I think we are trying to be just opportunistic. For the time being, we don’t need necessarily a lot of equity. As we mentioned, everything is being fully financed. It’s only acquisitions that would require us to have a little bit more equity. I don’t have a fixed target, Jeremy. Jeremy Rosenfield Okay. And thinking about the acquisitions that you are looking at or the potential acquisitions that you are looking at in terms of financing and expected returns on those acquisitions, do you see yourself being able to earn similar spreads in terms of the return versus the cost of capital on the projects that you are looking at or on the potential acquisitions that you are looking at? Michel Letellier It’s a good question. It’s always paramount and it’s difficult to know where the market is going, right? When the 30 years bond are below 2%, one could wonder what type of return is acceptable or not, but I always said that we look at a portfolio a little bit like any equity investor, you have risk reward formula that we are trying to follow, obviously an existing facility with already financing and long-term PPA are worth more and obviously would generate a little bit less return than a Greenfield project. So, we want to make sure that we keep our global return north of 10%. That’s our perceived cost of capital for our equity. But there is reality, there is competition out there, and we want to make sure that we stay competitive in acquiring a facility. We have looked at a lot of opportunity. We have passed on. We have bid. And I think we will be successful in the near future. One thing that we are willing to use as a tool to increase our return is to partner with pension fund, as we did with SM-1 project, where we had increased the internal rate of return for Innergex by using a little bit of debenture and using a little bit of premium to manage the asset. So, that’s one tool that we have to increase a little bit the internal rate of return for our shareholders at the end of the day and manage more portfolio and being I would say active on the M&A market as well. So, that’s definitely one aspect of the capital structure that we are willing to take in order to make a decent return at the end of the day. Jeremy Rosenfield That makes sense. And maybe since you just mentioned it, in terms of opportunities that you have passed on or that you haven’t closed, is there anything specific that you can point to as reasons why you felt either it wasn’t a good fit for Innergex or why you weren’t successful with those deals? Michel Letellier Well, it’s hard. You know, when you know your business, it means that you know how much it costs to manage it. And sometimes we wonder, because there is maybe people that have a more optimistic view on long-term forecasts. We want to make sure that whenever we are taking risk is that – or risk or we are making an acquisition is that we will not be hearing on the too optimistic side on the long-term forecast. So, I rather accept a lower return, but making sure that we are going to make that return. Another way to say it, one can imagine that they can buy an existing facility at 13% internal rate of return, but it depends on the assumption that one can use. So for us, I don’t want to promise my board or lead my investor to think that we would be able to do a bigger return on a very secure asset. Usually, you could do it in a small acquisition here and there, but usually the market is fairly efficient. And I just want to make sure that we stay focused on being a conservative long-term manager and that whenever we are accepting as a return, it will materialize over time. So that means also that whenever we are going outside, we will want to make sure that we hedge and we would not put the company at risk with the foreign exchange rate. One thing that Innergex doesn’t have right now is foreign exchange exposure. And that sometimes people might underestimate the variability of foreign exchange. We take that very seriously in our analysis. And this is one of the challenges we have whenever we are looking into acquiring something in the States or in France or in Mexico. So again, we are taking our time, but whenever we are doing something, I think that we can sleep well at night. You know that I like to sleep well at night. Jeremy Rosenfield Yes, okay. Thanks, Michel. Excellent. Michel Letellier My pleasure. Operator Mrs. Benmouyal, there are no further questions at this time. Martine Benmouyal We have one more question actually from Mr. Jay Ferguson of Ferguson, Andrews Investment Advisers and it goes as follows. With the dislocation of the yield co market in the U.S., are you looking to buy assets from them such as NYLD, NRG Yield, and SUNE? Michel Letellier That’s a very good question. And I was amazed to see how quick the market realized that yield co promises were hard to deliver and we will stay opportunistic. If there is some good opportunity, definitely the U.S. market is on our radar screen. And I agree that the market seems to have evolved from being a little bit crazy to now being more reasonable in yields. Martine Benmouyal Thank you. Alright, if there are no more questions, I will thank everyone for attending this conference. We appreciate the opportunity to provide an update about our company. Please do not hesitate to contact us if you have any other questions. Operator Ladies and gentlemen, that concludes our conference call and webcast. Please note that a replay of the conference call and webcast will be available on the Innergex website. The press release, financial statements and Management’s Discussion and Analysis are also available on the Innergex website at www.innergex.com in the Investors section. Thank you. You may now disconnect your lines. 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.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited. THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY’S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. 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PNM Resources’ (PNM) CEO Pat Vincent-Collawn on Q4 2015 Earnings Guidance Conference – Call Transcript

Operator Hello, and welcome to the PNM Resources Fourth Quarter 2015 Earnings Conference Call. All participants will be in 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 Jimmie Blotter, Director of Investor Relations. Please go ahead. Jimmie Blotter Thank you, Carrie and thank you everyone for joining us this morning for the PNM Resources fourth quarter 2015 earnings conference call. Please note that the presentation for this conference call and other supporting documents are available on our website at pnmresources.com. Joining me today are PNM Resources Chairman, President and CEO, Pat Vincent-Collawn and Chuck Eldred, our Executive Vice President and Chief Financial Officer as well as several other members of our Executive Management team. Before I turn the call over to Pat, I need to remind you that some of the information provided this morning should be considered forward-looking statements, pursuant to the Private Securities Litigation Reform Act of 1995. We caution you that all of the forward looking statements are based upon current expectations and estimates and that PNM Resources assumes no obligation to update this information. For a detailed discussion of factors affecting PNM Resources results, please refer to our current and future Annual reports on Form 10-K, Quarterly Reports on Form 10-Q, as well as other reports on Form 8-K filed with the SEC. And with that, I will turn the call over to Pat. Pat Vincent-Collawn Thank you, Jimmie. Good morning, everyone. And thank you for joining us as we close out our discussion on 2015 which is a very productive year for the company. We’ll begin the presentation today on slide four with a look at our regulatory and operational achievement over the year. 2015 was to say the least an interesting year. I am very proud that we are able to successfully over several challenges and finished the year on a strong note. Our most significant accomplishment was PNM obtaining final approval for the San Juan Generation Station BART plan. We received that approval two years from when we filed with the commission. Many things were dependant on a positive decision and we are now able to move forward with our comprehensive plan. It is the most cost effective path forward and the best option for our customers who are already seeing lower build as a result of the new core supply agreement. It will also benefit the entire state by minimizing economic impact and providing significant environmental improvements. Ultimately, the position that we and other utilities had regarding the definition of what constitutes the future test year was upheld. The commission revised its definition in a way that agrees with our understanding as the New Mexico Supreme Court has dismissed the appeal. We are also pleased that we were able to settle our first transmission formula rate case. The settlement is awaiting final approval from FERC. In Texas, TNMP successfully implemented two TCOS increases totalling $5.8 million annually. In addition, on January 8th of this year, the staff of the Public Utility Commission of Texas recommended that the Commission approve without changes TNMPs filing for reconciliation regarding its AMS deployment. We anticipate the commission to rule at its open meeting on March 24. We turn to our operational highlights. You always hear me talk about reliability being our customer’s number one priority. I am proud to say that in 2015 PNM delivered strong reliability and was recognized with a ReliabilityOne award for outstanding Midesize Utility. TNMP also continued to deliver excellent reliability despite extreme weathers throughout the year in Texas. As a result of PNMs excellent reliability and focus on customers, in 2015 we continued to improve our J.D. Power customer service ratings. In July and August, PNM achieved its highest scores ever. At the same time, the number of merited complaints with the New Mexico Commission remained at the lowest level in the past five years. That’s especially significant during the rate case year. In 2015, PNM stayed on track with plans to increase generation capacity. We added four new solar facilities totaling 40 megawatts, and the new La Luz 40 megawatt gas peaker is also now online. We are also proud of the fact that once again TNMP received Energy Star’s Market Leader Award for its energy efficiency programs. That’s the 11th consecutive year that TNMP has earned that honour. We continue to move forward with the AMS roll out at TNMP. We’re now at 91% completion. In conjunction with the AMS deployment, we’ve implemented a new outage management system. This will be an important tool in improving response time, reducing outage time and increasing both reliability and customer satisfaction. Let’s now go to slide five for a snapshot of fourth quarter and year end results. As you can see there is a significant difference between our GAAP and ongoing earnings, which is primarily due to a GAAP write off related to the shutdown of units 2 and 3 at the San Juan Generating Station. Our GAAP EPS for fourth quarter 2015 was a loss of $1.15 compared to earnings of $0.24 in the fourth quarter of last year. For the year, GAAP earnings per share were $0.20 compared to $1.45 in 2014. For the fourth quarter, ongoing earnings per share were $0.23 compared to $0.24 from the fourth quarter last year. For the year, ongoing earnings totaled $1.64 up $0.15 from 2014. We are also affirming our 2016 guidance range of $1.55 to $1.76. Couple of quick regulatory updates. We are moving forward with the implementation of our BART plan at San Juan. The SNCR and Balanced Draft equipment are now in full operation on units 1 and 4 and savings from the new coal supply and restructuring agreements are now flowing to our customers and the 40 megawatts of solar that was in our replacement plan is now online. We are also on track with the rate case we filed last August. PNM and the interveners filed Rebuttal testimony this past Monday and the hearing is currently scheduled to run from March 14 to March 25. On January 29, TNMP made its latest TCOS filing requesting an annual increase of $4.3 million. We expect that these rates will go into effect in March. This reflects a $25.8 million increase in transmission rate base over our last filing. I’ll now turn it over to our Chief Financial Officer, Chuck Eldred for a more comprehensive look at the numbers. Chuck Eldred Thank you, Pat and good morning everyone. We continue to make progress towards achieving our goal. The Westmoreland coal contract that became effective February the 1st brings substantial savings to customers. We received approval on the BART and resolution of the future test year definitions under New Mexico Commission in December. We also ended 2015 with an improvement in earnings compared to our revised guidance range. So beginning on slide seven, let’s start by reviewing load of both PNM and TNMP. Both were within the guidance ranges that we had for the year. At PNM, 2015 was down 1.4% compared to 2014. I want to point out the residential loan was flat both for the fourth quarter and for the entire year. Customer growth came in higher than our expectations at 0.8% for fourth quarter and 0.7% for the year. The economy in New Mexico continues to have mixed indicators. The employment growth recently in Albuquerque Metro area has been strong and you can see that even on a 12-month rolling average its moving up with the strongest numbers we have seen in three years. The state overall is not faring as well though. That softness is driven primarily by the low oil and natural gas prices. While we do not serve the regions of the state that produce oil and gas, we do expect the impacts of layoffs and the decrease in state royalty revenues will somewhat soften the economies in our service territory, particularly in Albuquerque metro area in Santa Fe as the state deals with budget shortfalls. We continue to expect 2016 load to be flat to down 2% for the year. Moving to TNMP, load for 2015 was up 2.6% compared to 2014. Customer growth was higher than forecast at 1.5% for Q4 and for the year. The Texas economy continues to be strong but the Houston area in particular is feeling the impact of low oil and natural gas prices. While Houston property is suffering, we are not seeing the economy in our service territory softened. This is because of a couple of factors. We serve many refiners and petrochemical manufacturers who continued to have strong production. Additionally, we see some production movements into the smaller communities outside the Houston Metro area, population movements into the smaller communities outside the Houston area. TNMP serves some of those areas and therefore, we are actually seeing customer increases rather than decreases. For 2016, we continue to expect load to be up 2% to 3%, as refiners and petrochemical manufacturers continue strong production and our service territories near Dallas and Forth Worth continues to have a strong economy. On slide 8, as I said before, we ended the year exceeding the upper end of 2015 guidance range, with the $1.64 consolidated ongoing earnings. All of our segments performed well during the year. PNM came in $0.02 higher than guidance. TNMP at the upper end of the guidance range and Corporate and Other was also $0.01 better than guidance. Now moving to slide 9. Ongoing earnings came in at $0.23 for fourth quarter compared to $0.24 in the fourth quarter 2014. PNM was down $0.03 and TNMP was flat. Corporate and other came in $0.02 better than last year, driven by improvements in interest expense related to the repayment of the $119 million and a 0.0025% debt in May of 2015. On slide 10, let’s look at the drivers for PNM and TNMP. Beginning with PNM, AFUDC improved $0.03 compared to the fourth quarter of 2014. This was caused by higher capital spending and higher quid balances, including the SNCR and balanced draft equipment in San Juan, the construction of the 40 megawatt La Luz gas peaker and 40 megawatts of solar. As we’ve seen through 2015, the half price of the Palo Verde Unit 1 leases contributed $0.03. Weather was an improvement of $0.02 between the quarters, as weather reduced fourth quarter 2014 earnings by $0.01 and improved fourth quarter 2015 by $0.01. The heating degree days for fourth quarter 2015 were not the driver for weather, as they were only 8% higher than last year but 2% below normal. Instead it was our cooling season that extended into October, with temperatures that were warmer than normal and warmer than 2014. We have been migrating to the Palo Verde Unit 3 Nuclear Decommissioning Trust from a shareholder asset to a regulated asset. This involves rebalancing the portfolio to reduce the percentages held in equity investments to better match the regulated assets. As we do this, we have opportunistically captured gains. In addition to that, we change some of our managers which resulted in further rebalancing of the investment portfolios. Together these actions resulted in higher gains of $0.02 compared to fourth quarter 2014. Renewable also improved results by $0.01. We had higher O&M expenses of $0.03 in the quarter, which brings our year-to-date expenses in line with our guidance range. Outage costs were $0.02 higher. This was caused largely by the San Juan Unit 4 outages and saw SNCR and balanced draft equipment. We took $0.02 write-off in fourth quarter 2015 for items on our balance sheet related to the exploration of alternative fuel supply contracts for San Juan. With the completion of the Westmoreland contract, we determine that it was appropriate to write-off these assets. Interest expense was $0.02 higher related to the additional debt that PNM entered into August of 2015. Load was down a $0.01. Transition margins were down a $0.01, compared to fourth quarter 2014. We had two long-term point-to-point contracts expired during the year, which is the primary cause of this change. We also had higher depreciation and property tax expense of $0.01. Finally, we capitalized ANG load on capital projects as lower than it was last year. This is primarily relating to the timing of capital projects At TNMP, rate relief from TCOS filings was up one penny compared to fourth quarter 2014. Weather was down $0.01. Heating degree days were 28% lower than fourth quarter of 2014 and 27% lower than normal. Depreciation and property taxes were also higher by a $0.01. Now turning to slide 11. Before we review the 2016 forecast, I want to mention how the five-year bonus depreciation extension affects us. As you are aware, we have an NOL at PNM for income tax purposes that have been expected to be fully utilized in 2018. The extension of bonus depreciation will cost the NOL to last for a longer period of time, now carrying us into 2019. While the additional deferred tax from bonus depreciation decreases rate base, the NOL increases rate base. As a result, we do not expect to see significant change in our rate base. Looking at 2016, bonus depreciation does not impact our ongoing earnings guidance. We have included our rate base projection on this slide for the expected impact of bonus depreciation and the extension of the NOL. The impact of bonus depreciation does not change our 2016 rate case numbers except the TNMP, which does not have an NOL. However, regardless of rate base change, our EPS expectations for 2016 are ineffective. As a reminder, we expect to update guidance in middle of this year after we resolve the ongoing rate case at PNM. In the appendix to today’s presentation, you will find the 2017 to 2019 potential earnings power slide. This is also been updated for bonus depreciation. As for 2016, PNM does not have a significant change and TNMP’s rate base is reduced from our prior presentation by approximately $50 million in each period. Overall, the changes are not as significant earnings driver for the company. Since the NOL’s expected to be utilized in 2019, bonus depreciation will have an impact in our 2020 rate case. We are currently viewing the capital projections and identifying which projects should be funded. We will provide those updates later this year. Finally on slide 12, we are focused on achieving our strategic goals. We expect to continue delivering above industry average earnings and dividend growth, which is displayed to the potential earnings power of the business and supports our 7% to 9% growth rate. As I wrap up today, I want to express that 2015 ended with good results. We are optimistic about 2016 and we recognize the importance of PNM’s rate case on this year’s financial results and the need to bring it to a good resolution. We also expect to file our 2018 rate case in December of this year. That filing will include the major elements of the BART case. The abandonment of San Juan’s Unit 2 and 3, additional megawatts in San Juan Unit 4 and the inclusion of Palo Verde Unit 3 rates. The rate base valuations for each of these items have already been set for the BART process. Pat, I will turn the call back over to you. Pat Vincent-Collawn Thanks, Chuck. As Chuck said, we are very proud of what we accomplished in 2015. We reached positive conclusions on key regulatory filings. The company delivered another solid financial performance and most importantly, we continued to focus on serving our customers with reliable, affordable and environmentally responsible electricity. Given the challenges and oppositions we faced through this year and continue to face, these achievements confirm that our strategy is sound and our hard work is creating positive results. Going forward, we plan to stay the course and continue to work in the best interest of our customers, the communities we serve, our employees and our shareholders. One more note about our rate case. No one likes rate increases. We understand that and we take it very seriously. This request is driven primarily by capital improvements to our system designed to ensure continued reliability for our customers. As filed, the rate case would increase rates by 14%, but when you consider the customer benefits from the Westmoreland coal contract and other items, the total increase is about 5%. That’s an average of about 1% a year since our last increase. I want to emphasize that it is of great importance that we achieved timely rate recovery in this proceeding and we are confident that we have strong justification for the revenue requirement. As we have been saying all along, given the number of interveners in this case, it is likely that the best way to achieve this will be through litigation. And in closing, I cannot say enough about the tremendous effort of our employees. They are responsible for our ongoing success and progress and they make us proud every day. Operator, let’s now open it up for questions. Question-and-Answer Session Operator We will now begin the question-and-answer session. [Operator Instructions] Our first question comes from Anthony Crowdell of Jefferies. Please go ahead. Anthony Crowdell Good morning. Pat Vincent-Collawn Good morning, Anthony. Anthony Crowdell I have a couple questions. One is I wanted to know, what’s left on your Palo Verde leases after you file for the rate case at the end of this year for new rates in 2018? Chuck Eldred Yeah. Anthony, the leases about 114 megawatts and still remain, but actually extend on half price as a path through to O&M through 2022, 2023. Anthony Crowdell Okay. Great. Since I guess the BART filing in December or maybe even the third quarter call, you had given this, I don’t want to use the word guidance but maybe a rough estimate of the potential loss to the unregulated portion of the San Juan plant would be. Power prices have since maybe taken another downturn. Could you give us an update on what your estimate would be for the unregulated portion of power of San Juan? Chuck Eldred Yeah. Anthony as you know, the 65 megawatts actually doesn’t affect us until the BART implementation in 2018 when we taken on the 65 megawatts. And as you recall in our projections, we use spot prices, real-time prices of the markets. So you are right, prices have decreased considerably since we’ve last talked about it. I think we are around of $0.03 losses and with the additional lower prices, which are close to little less than $30 a megawatt hour is a breakeven in the mid $40 a megawatt. For San Juan 65 megawatt, we are probably additional $0.03 or $0.04. But let me just also comment that as you are aware, with the Westmoreland contract, the financing that we have done through Westmoreland to support the closing of the purchase of the mine that there are some additional earnings that begin to reflect as a result of the financing and the basis spreads between what we were able to financed at PNM versus PNM Resources versus what Westmoreland was charged to reflect more of their credits. That benefit, if you will is roughly around $0.04 or so because it would offset the losses that we would have at the 65 megawatts I just referred to. So, we remain kind of neutral that overall we are on the course that we said we’d be on and we are not really receiving an impact even with the lower prices at the 65. Anthony Crowdell Okay. And just lastly, Pat, I know you had said you think the best way of achieving what you’ve requested in the rate proceeding given the large number of interveners, it looks like you went to dug in their positions was through a litigated decision. Would you comment at all, if there is even a potential for a settlement or it just seems like it’s not really going to happen here? Pat Vincent-Collawn There is always a potential but I think in this case, litigation is probably the best path forward because it’s the most expeditious and the quickest path forward. Anthony Crowdell Great. Thanks for taking my questions. Pat Vincent-Collawn Thank you. Chuck Eldred Thanks. Pat Vincent-Collawn Thanks, Anthony. Operator Our next question comes from Brian Russo of Ladenburg. Please go ahead. Brian Russo Hi. Good morning. Pat Vincent-Collawn Good morning, Brian. Brian Russo You mentioned that when the NOLs runoff at the end of 2019, there will be an impact to your rate base for bonus depreciation in 2020, can you quantify that? Chuck Eldred Yeah. We actually haven’t put out the 2020 rate base at this point. But it pretty much keeps the rate base slightly lower than what we have through 2019, but we haven’t quantified at this point, Brian. So, I’d rather wait till we really run through the numbers and look to see if there is some additional capital funding that we can benefit from the bonus depreciation and additional cash flow and then we will update the number and provide them to you. Brian Russo Well. Maybe I will ask in a different way. In 2016 rate base, hypothetically, if you didn’t have the NOL, what would the impact to your rate base be, if you can answer that? Chuck Eldred 2016? Brian Russo Or 2015. Chuck Eldred I don’t know I have 2015. Let me get — we will just have to get back with you on that. I have got the numbers of 2016. I don’t have 2015 with me. Brian Russo Okay. So could you share with us for the 2016? Chuck Eldred Yeah. 2016, if you would, roughly with the effects, without NOL, the net effect of that looks like it would be about 2.6 to 2.4 about $200 million net. Brian Russo Okay. Thank you very much. Operator [Operator Instructions] Our next question comes from John Allie [ph] of Castleton. Please go ahead. Unidentified Analyst Good morning, guys. Pat Vincent-Collawn Good morning, John. Unidentified Analyst Just two quick questions. You said the litigation is the quickest route, what’s the timeline you guys are thinking for that? And then secondly, do you have any thoughts on the formation of the REIT for your taxes as such? Pat Vincent-Collawn I’ll take the first one and let Chuck take the second one. The hearings John start on the 14th of March and go till the 25th of March. We would hope that the effective date would be close to the beginning of Q3. I think you will know that Q3 is our largest quarter, so therefore having the rates in place early in that quarter makes a big impact which is why we want timely rate increase. So that’s probably the schedule we are looking at. Chuck Eldred Yes John in regards to — we’re watching as everyone else to see what the commission ultimately does with the on proposal reactions relative to how they pursue that going forward. And whether they actually allow that to be approved in the regions formed and with Encore. So we’ll monitor that and if we feel that that decision is made as I’m sure all the AT&T companies in Texas will do the rigor and analysis necessary to see if it makes any sense for our structures to consider that as well. So at this point we’re just on the sideline keeping a close eye on it. Unidentified Analyst All right. Thank you. Chuck Eldred Okay. Operator And this concludes our question and answer session. I would now like to turn the conference back over to Pat Vincent-Collawn for any closing remarks. Pat Vincent-Collawn Thank you. And again thank you all for joining us this morning. We appreciate you joining us on this call to hear about our very successful 2015 and our plans for going forward and we look forward to speaking with you and seeing you all throughout the year. Have a great weekend. Operator The conference has now concluded. Thank you for attending today’s presentation. You may now disconnect your lines. Have a great day. 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.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited. THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY’S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY’S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY’S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS. If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com . Thank you!

El Paso Electric Company’s (EE) CEO Mary Kipp on Q4 2015 Results – Earnings Call Transcript

Operator Good day. And welcome to the El Paso Electric Company Fourth Quarter 2015 Earnings Call. Today’s conference is being recorded. At this time, I would like to turn the conference over to Lisa Budtke. Please go ahead. Lisa Budtke Thank you, Diana. Good morning, everyone. Thank you for joining the El Paso Electric Company fourth quarter 2015 earnings call. My name is Lisa Budtke, and I’m the Director of Treasurer Services and Investor Relations for El Paso Electric. On the call with us today are CEO, Mary Kipp; CFO, Nathan Hirschi; and other members of the senior management. You should have a copy of our press release and today’s presentation. And if you do not, you can obtain them from the website on our Investor Relations page. We currently anticipate that our 2015 Form 10-K will be filed with the Securities and Exchange Commission on or before Monday, February 29, 2016. A replay of today’s call will be available shortly after our call ends, and will run through March 9. The details as they relates to the replay are disclosed in our press release. On Slide 2 of our presentation you will see our Safe Harbor provisions. In summary, our earnings presentation, comments and answers to your questions may include statements that are not historical and that constitute forward looking statement. Such forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause the company’s actual results in future periods to differ materially from the expectations stated here. As the format of this presentation does not permit a full discussion of these risks, please refer to our Form 10-K and other SEC filings for a discussion of risk factors that should be considered. These filings may be obtained upon request from the Company, on our website or from the SEC. The Company cautions that the risk factors discussed in these filings are not exhaustive, and do not undertake to update any forward-looking statement that maybe made from time to time by or on behalf of the Company. At this time, I would like to turn the call over to Mary. Mary Kipp Good morning, everyone. On Slide 3 of the presentation I’ll briefly cover our financial performance in 2015. During the fourth quarter, we were able to record positive earnings of $0.02 per share despite the negative impact resulting from regulatory lag associated with the placement of new assets into service in the first quarter of 2015 without a corresponding increase in revenues. For the year, we reported net income of $81.9 million, or $2.03 per share which was right at the mid point of our guidance range issued during our third quarter earnings call. Also of note on January 28, 2016 the Board of Directors declared a quarterly cash dividend of $0.295 per share payable to shareholders on March 31, 2016. If you now turn to Slide 4 of the presentation, I’d like to point out some of the significant highlights that the company achieved in 2015. As I look back on all of the challenges we faced at 2015, I am extremely proud of the achievements made by the company during a very dynamic year. We began the year by completing construction of the first two generating units at the Montana Power Station. These first two units were completed on schedule and are currently providing enough energy to serve 80,000 homes in our growing service territory. We also completed construction of our new 100,000 square foot Eastside Operation Center in early 2015. The new operation center incorporates green design features which include energy efficiency and water conservation concepts. The operation center will also consolidate many of our El Paso warehousing, fleet, line crew and engineering personnel into one location, allowing us to improve the efficiency of operations, including outage response time. One of the biggest accomplishments in 2015 was the filing of rate cases in both Texas and New Mexico. The cases were necessary to seek recovery of approximately $1.3 billion that has been invested in new electric plant to meet customer growth and grid modernization since June 2009. I am also pleased with the progress of construction on the latest addition to our portfolio of local generation. Construction of Montana units 3 and 4 is on schedule on budget and is progressing well. In 2015, our consistently growing service territory and hotter than normal summer weather combined to create another native peak record of 1,794 megawatts achieved on August 6, 2015. This was the second native peak record achieved by the company during 2015. El Paso Electric has set a new native peak record in 10 out of the last 11 years. I am also pleased that Palo Verde had another stellar year in 2015 increasing its capacity factor to 94%. Palo Verde recorded its highest output ever in 2015 and once again ranks as the nation’s largest power producer for the 24th consecutive year. Also during 2015, the company was able to successfully implement a management transition strategy. Several key management positions were filled from within the company in 2015 which will leave the company well positioned for the future and will enable us to provide the safe and reliable service that our community has grown to know. Also in 2015, our employees’ commitment to excellence and our continued focus on our customers allowed us to maintain favorable customer satisfaction rating. I am also happy to see how the El Paso Electric family came together to benefit the local community last year. Our employees devoted their time and effort by volunteering almost 10,000 hours to our communities. At this time, I’d like to turn to Slide 5 where I will discuss the company’s 2016 objectives. Construction of Montana units 3 and 4 continues as planned. We expect unit 3 to be available for commercial operation in time for our summer peak and we anticipate that unit 4 will be placed into service by the end of this year, which are among our main objectives for 2016. Placing these two generating units into commercial operation by the end of the year is one of the main objectives for the company. Also in 2016, we anticipate further lowering our carbon footprint by becoming a coal free utility. We intend to sell our 7% ownership interest in Four Corners the Units 4 and 5 and associated common facilities to Arizona Public Service Company in July pending regulatory approval. This transaction will not only allow us to become a cleaner utility but it will help limit the company’s financial obligations relating to changing environmental regulations. Our 2016 objectives also include the negotiations of a new collective bargaining agreement with the International Brotherhood of Electrical Workers Local 960, which represent approximately 38% of our local workforce. The current agreement expires in September of this year. We look forward to working with our union to reach a new agreement that allows us to continue to provide our customers with a high level of service. The addition of affordable large scale solar projects to our generation mix has been an objective of the company for several years now. We currently receive over 5% of our total generating capacity from solar resources. As the cost of producing large scale solar continues to decrease, we’ll be exploring the possibilities for expanding this resource. In the near term, our integrated resource plan called for the addition of 8 megawatts of large scale solar to be added to our system by year end. Over the past several years El Paso Electric has consistently ranked near the top for grid reliability as complied by the Public Utility Commission of Texas. And we are confident we will continue on that trend in 2016. In addition, our customer care department has made it a priority to always try to improve upon the good results of recent customer satisfaction surveys. And additional objective that is very important to our company is to continue to improve communication and relationships with all our stakeholders. Last but not least the next round of rate cases will be primarily driven by the need to recover cost for Montana Units 3 and 4. These cases are currently anticipated to be filed in early 2017. If you will now turn to Slide 6, I’ll provide some details on our current rate case filings in Texas. In Texas, we initially filed for an increase in non-fuel base revenues of $71.5 million which was then revised to $63.3 million. The filing also included a requested return on equity of 10.1% and in equity ratio of 49.5%. On January 21, 2016, the company filed a joint motion to abate the procedural schedule for our Texas rate case filings. The joint motion was filed on behalf of the company, the city of El Paso, the Public Utility Commission of Texas Staff, the Office of Public Utility Council and the Texas Industrial Energy Consumers. The motion to abate the procedural schedule was filed in order to facilitate ongoing settlement talks. We continue to work towards a settlement with all parties and we will continue to file weekly updates with the PUCT regarding progress. We anticipate that the company will begin billing customers for the new rates during the second quarter of this year, but pursuant to legislative changes, we have the ability to surcharge customers for new rates relating back to consumption beginning on January 12, 2016. On Slide 7, I’ll provide a brief update of our New Mexico regulatory filing. In New Mexico, our original rate case filing requested a non-fuel base rate increase of $8.6 million, which we subsequently lowered to $6.4 million. Hearings on the merits of the general rate case took place in mid- November. Last week the hearing examiner recommended a $640,000 non-fuel base rate increase. Although we are not in agreement with all the items contained within the hearing examiner’s recommendation, we recognized that this is just another step in the process and look forward to making our case before the full New Mexico Commission. The commission currently is schedule to issue a final order by April 8, 2016 although this deadline maybe extended by the commission up to two months. All parties in the case will be filing exceptions to the hearing examiner’s recommendation in the coming weeks. After which there will be an opportunity for parties to respond to those exceptions. The primary reason for the difference between our request of $6.4 million and the hearing examiner’s recommendation of $640,000 is due to approximately $97.7 million for pension and other post employment benefit liabilities on a total company basis being included as a rate base offset. Another reason for the difference between our ask and the hearing examiner’s recommendation involves return on equity. We’ve requested an ROE of 9.95% and the hearing examiner’s recommended an ROE of 9.6%. These two items comprise a little over 1/2 the difference. Several smaller cost of service items make up the remaining difference. A critical component of the hearing examiner’s recommended decision is that substantially all of our plant in service was deemed reasonable and necessary. The treatment of our pension and other post employment benefit liability as a rate base offset is one of the items to which we will file an exception. Our attorneys and other members of the regulatory team are still evaluating the recommended decision and are identifying all items to which we will accept. We currently anticipate that a final order from the New Mexico Commission could be issued in the second quarter. Also along the regulatory front in New Mexico, we recently participated in hearing regarding the sale and abandonment of our 7% ownership in Units 4 and 5 and related facilities at the Four Corners plant. On February 2, the company filed an opposed joint stipulation reflecting a settlement agreement. We anticipate receiving a final order by the first half of this year. In December 2015, the Federal Energy Regulatory Commission authorized Arizona Public Service Company to purchase our ownership interest in Units 4 and 5 and common facilities of Four Corners. So we anticipate closing this transaction in July of 2016. If you will turn out to Slide 8, our potential timeline for the next round of rate cases has not changed. In New Mexico, the company anticipates filing a rate case in a first quarter of 2017 using an historic test year ended September 30, 2016. Although Montana Power Station unit 4 is not scheduled to be placed into service until December of 2016, precedent in New Mexico allows us to include in rate base plant addition completed within five months of the test year and date. A final order in new rates would then be anticipated to take effect during the first quarter of 2018. Looking at the Texas timeline, we also anticipate filing our rate case in the first quarter of 2017 using an historic test year ended September 30, 2016. Our timeline reflects a potential final order to be issued during the first quarter of 2017. However, due to legislative changes we have the ability to surcharge customers for new rate relating back to consumption beginning on the 155th day after the rate case is filed. This means the effective date for new rates could be applied as early as the third quarter of 2017 even if the schedule for the rate case were to be extended. I’d now like to turn the call over to Nathan who will discuss our financial results. Nathan Hirschi Thank you, Mary. Turning to Slide 9, we list the key earnings drivers for the fourth quarter and the year compared to the prior year. Beginning with the negative drivers for the quarter, earnings were lowered by $0.07 per share due to decreased AFUDC resulting from lower balance of the construction work in process. As we’ve discussed, this was primarily due to the placement of service of Montana Units 1 and 2 and the Eastside Operation Center in the first quarter of 2015. Placing these assets into service also contributed to increase depreciation expense resulting in a $0.03 per share reduction in earnings for the quarter. The impact of regulatory lag associated with placing these assets into service without a corresponding increase in revenue was expected and is the primary reason that we have filed the rating for rate increases in Texas and New Mexico. Increased administration and general expense also decreased earnings per share by $0.04 for the quarter and was primarily due to increased payroll cost and employee incentive compensation as well as increased payroll and benefits cost. Also during the quarter, interest accrued on $150 million senior notes issued in December 2014 negatively impact earnings by $0.02 per share. Earnings also declined during the quarter by $0.02 per share due to decrease deregulated Palo Verde Unit 3 revenues reflecting a decline in the price of natural gas when compared to the same period of last year. On the positive side, net income for the fourth quarter of 2015 compared to the same period last year was positively affected by a decrease in operation and maintenance expense related to our fossil fuel generating units. The decrease in expense was primarily due to decrease maintenance at the Four Corners and Newman plants. The lower level of O&M expense resulted in an increase in earnings of $0.06 per share. However, a planned outage at Four Corners was moved from the fourth quarter of 2015 to the first quarter of 2016. So we will have a corresponding increase in the first quarter. Retail non-fuel base revenues also increased during the fourth quarter primarily driven by an increase in number of customer in a residential customer class and slightly more favorable weather conditions. Non-fuel base revenues increased earnings by $0.02 per share when compared to the same period of 2014. As you can see on the same slide, many of the same drivers then impacted the fourth quarter earnings also serve as drivers for the year-to-date results of $2.03 per share. The earnings drivers that impacted the year-to-date results that were not already mentioned for the fourth quarter were investment and interest income and the Palo Verde performance rewards. Investment and interest income had a positive impact on earnings for the year due to gains resulting from the further diversification and rebalancing of our Palo Verde decommissioning trust portfolio, which increased earnings by $0.07 per share. Palo Verde performance rewards impacted the year negatively by $0.04 per share due to the performance rewards associated with the 2009 to 2012 performance periods being recorded in 2014 with no comparable amount in 2015. As these amounts are normally recorded upon the completion of our Texas fuel reconciliation filings. If you now turn to Slide 10, we have provided a chart to illustrate the weather conditions experienced in our service territory during the past 10 years. The chart includes a comparison of normal weather to the actual weather recorded in our service territory. As you can see heating degree days in 2015 were 10.3% higher than the same period last year but remain 3.6% below the 10 year average. In 2015, cooling degree days were 5.3% higher than the 10 year average and 6.3% higher than 2014, which helped to drive the increase in revenues from our residential customers and primarily impacted our third quarter results. Now turning to Slide 11, we’ve provided a comparative analysis of the changes in retail non-fuel base revenues and megawatt hour sales by customer class for the fourth quarter of 2015 compared to the same period of 2014. During the quarter, total retail non-fuel base revenues increased by $1.4 million pretax, or 1.2% over the same period in 2014. The increase was primarily due to a 2.6% increase in megawatt hour sales to the residential customer class which also recorded a 3% increase in non-fuel base revenues reflecting favorable weather and 1.4% increase in the average number of customer served. As we have provided the same analysis for the year on Slide 12. For the year total retail non-fuel base revenues increased by $14.3 million, pretax were 2.6% over the same period in 2014. Most of this was attributable to increase sales to the residential class, hotter than normal summer weather was largely responsible for the 5.1% increase in residential non-fuel base revenues when compared to the same period in 2014. Now turning to the Slide 13, our cash capital expenditures for 2015 for additions to electric utility plant were $281.5 million. In terms of cash dividends, we paid $47.1 million during the 12 months ended December 31, 2015. On December 31, 2015 we have liquidity of approximately $166 million including a cash balance of $8.1 million and borrowing capacity available to us on our credit facility. As we continue to make progress on our current construction program, we anticipate returning to the debt markets in the first half of 2016 to issue long-term debt. Now turning to Slide 14, I’d like to provide our five years projections of capital expenditures. On this chart you will see that we plan to spend $231 million on construction expenditures in 2016. Over the next five years, we currently anticipate spending approximately $1.1 billion to ensure that we have the generating capacity required to meet our customers’ growing demand for electricity. The projection also includes expanding and updating our transmission and distribution infrastructure. These amounts are subject to revision as we continue to adjust and revise our construction plans. Now turning to Slide 15, I would like to discuss everybody’s rate base projection based on our current construction plan. As Mary mentioned earlier, we anticipate Montana Units 3 and 4 to be placed in commercial operation by the end of 2016. After the completion of these two units, total rate base is expected to grow to approximately $2.1 billion. This amount is an approximation of our rate base at the time of our next rate case filings in 2017. Turning to Slide 16, I would like to wrap up today’s presentation with some comments regarding our 2016 earnings drivers. Once we get further down the road on our rate cases, we will provide specific guidance. For now, we will discuss some key earnings drivers for 2016. As you can see there are several factors that will negatively impact earnings in 2016. Most of the negative drivers are directly related to the regulatory lag which will especially impact the first quarter and in fact could result in negative earnings per share for the first quarter of 2016. The primary components of regulatory lag in 2016 are higher property taxes, lower AFUDC, increased O&M, depreciation expense and interest expense. Other items that are anticipated to negatively impact earnings include a higher effective tax rate, a return to normal weather conditions and a decrease in investment and interest income. The effective tax rate is anticipated to increase to approximately 36% for the next several years due to higher state income taxes and a reduction in the manufacturing credit due to bonus depreciation being extended through 2016. Earnings are anticipated to be positively impacted by rate increases in Texas and New Mexico as well as customer growth. Again just emphasize the point it is possible that we could have negative earnings per share in the first quarter of 2016. At this time, I’d like to turn the call back over to Lisa. Lisa Budtke Thanks, Nathan. Diana, please open the call for questions. Question-and-Answer Session Operator [Operator Instructions] We will go first to Brian Russo of Ladenburg Thalmann. Brian Russo Hi, good morning. Good, thanks. Can you quantify if any the impact to rate case from bonus depreciation? Nathan Hirschi Yes. The bonus depreciation will help us out — will give us about $30 million effect in 2016, and then over the next — until it expires in 2019 it will be about $65 million benefit. So a moderate benefit and it has been factored into that to the rate base charge that we showed on schedule on 15. Brian Russo Okay. So and I apologize but I didn’t — wasn’t — didn’t have time to compare slide 15 with your prior update but there have been some adjustments on that slide. Nathan Hirschi Some adjustments although it’s pretty consistent with what we’ve shown in the past. Brian Russo Okay. So I guess the $65 million is the cash flow benefit. Is there any rate base offset? Nathan Hirschi Yes. That it will both be a cash flow benefit and the rate base offset. But that’s at the end of the four year period. For 2016, it kind of have an offsetting effect, we think we will be in NOL position so it won’t really have that dramatic effect for 2016. It will — we will generate bonus depreciation that we didn’t initially anticipate. Some of that will be offset by some NOLs. So won’t have that dramatic effect. Brian Russo Okay. Understood. And then on the CapEx slide, it looks like there were some upward increases in the annual CapEx. Can you maybe talk about that? Nathan Hirschi Well, yes, it’s very comparable to what we saw last year actually. What we had was we had — what we had last year is relatively high year in 2015, that is $281 million that we expanded this year right. But we added a relatively high year in 2020 when we anticipate building the next two combined cycles. So we ended the year slightly below with the five year projection at $284 million– I am sorry $1.084 billion, which is slightly below what we had in the five year projection last year. But so that stays relatively consistent to what we had last year on a five year basis. Brian Russo Okay. And can you talk about whether normalized load growth in 2015 and kind of what your outlook is? Nathan Hirschi Yes. Well, obviously we had a very good year last year from a revenue perspective and from NOL that was obviously attributable to the very hot summer. If you remember we had — we had 106 days in a row what was over 90 degree. So we had a very nice summer and of the revenue growth we think about half of it was attributable to above average weather. So we think of course we saw solid customer growth which we continue to see at the 1.4% and that’s real positive. And so some of the growth was clearly related to customer growth and they are expanding service territory. And perhaps about $5 million about half of the — $5 million to $6 million about half the growth was revenue — was weather related. Brian Russo All right. And then just with the new legislation and taxes and your ability to capture the rate increase 155 days prior to when rates are effective. How does it kind of like flow through the income statement and it’s kind of like conceptually the margin impact from that. Nathan Hirschi Yes. That’s why the first quarter looks kind of challenging. Although at the day — when we ultimately when we settled the Texas rate case, we will be able to relate back to revenues to usage to January 12. But we won’t record that in the first quarter. We won’t — we don’t have the certainty of the amount of the rate increase or that until we have a final order. So when we have the final order which we anticipate would be likely in the — during the second quarter, that’s when we would pick up the revenue that would relate back and then would be built as a surcharge over perhaps an 18 months period to recover that. So that’s one of the reasons why we have a kind of challenging first quarter that revenue would not — we don’t feel comfortable recording that revenue until the second quarter assuming all the regulatory works out as we had hoped. Brian Russo Okay. So when new rates go into effect you will collect over an 18 months period conceptually rate effective starting in January of 2016. Nathan Hirschi Yes. That’s how we envision it working, yes. Operator Thank you. [Operator Instructions] We will go next to Ben Budish of Jefferies. Ben Budish Hey, good morning, guys. How are you doing? I have a quick question on the Mexico. It looks like with Texas it should be fairly easy to push those rates back to January, is there any kind of sensitivity to like the delay in implementation of rates if –get pushed back into June. Or any guidance on that? Nathan Hirschi Yes. I mean that is one of the issues. We had originally anticipated putting in new rates perhaps April 1 in New Mexico. And as the case continues it will be pushed back a little bit later in the year. We are not sure exactly how quickly it could move pretty — it could move relatively fast from here but it could delay further in the year. We think probably June 30 — June 1 is probably a reasonable day assumption. Mary Kipp And yes because so much of our revenue is dependent on second and third quarters. We are hopeful that we’ll have the new rate in time to take advantage of them during this quarter. Ben Budish Okay, great. And then I saw one of the — obviously the year-over-year drivers below AFUDC. In the release you had mentioned that it was due both to Montana 1 and 2 being put into service and reduction in the rate base, sorry AFUDC rate, is that reduction significant or is that only you are probably looking forward like when 3 and 4 going, I am thinking about the timing and comparing that to one to one end? Nathan Hirschi I am sorry the rate — Ben Budish AFUDC rate, yes. Nathan Hirschi Yes. Now the rate should be relatively constant from what we have now. We just have a more outstanding balance on our short — on our revolving credit facility which kind of drop cause the rate to go down a bit. So you’ll see the rate that we disclose in the 10-K coming up when we file that, that should be pretty close to the rate that we have going forward. Operator [Operator Instructions] And it appears we have no further questions. I’d like to turn the conference back over for additional or closing remarks. Lisa Budtke Thank you, Diana. I just want to thank everyone for joining us on today’s call. And please be safe. Operator Thank you for your participation. That does conclude today’s conference. 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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