Ormat Technologies, Inc. (ORA) Q2 2014 Earnings Report, Transcript and Summary

Good morning, and welcome to the Ormat Technologies Q2 2014 Earnings Conference Call. [Operator Instructions] Please note, this event is being recorded. I would now like to turn the conference over to Rob Fink of KCSA Strategic Communications. Please go ahead.

Thank you, operator. And thank you, everyone, for joining us today. Hosting the call are Isaac Angel, Chief Executive Officer; Doron Blachar, Chief Financial Officer; and Smadar Lavi, Vice President of Corporate Finance and Investor Relations. Before beginning, we would like to remind you that the information provided during this call may contain forward-looking statements relating to the current expectations, estimates, forecasts and projections about future events that are forward-looking, as defined in the Private Securities Litigation Reform Act of 1995. These forward-looking statements generally relate to the company's plans, objectives and expectations for future operations and are based on management's current estimates, projections, future results or trends. Actual future results may differ materially from those projected as a result of certain risks and uncertainties. For a discussion of such risks and uncertainties, please see risk factors as described in Ormat Technologies annual report on Form 10-K filed with the SEC on February 28, 2014. In addition, during the call, we will present non-GAAP financial measures, such as EBITDA and adjusted EBITDA. Reconciliations to the most directly comparable GAAP measures and management's reasons for presenting such information is set forth in the press release that was issued last night, as well as in the slide posted on our website. Before (sic) these measures are not calculated in accordance with U.S. GAAP, they should not be considered in isolation from our financial statements prepared in accordance with GAAP. Before I turn the call over to management, I would like to remind everyone that a slide presentation accompanying this call may be accessed on the company's website at ormat.com, under the IR news and events link that is found on the Investor Relations tab. With all that said, I would now like to turn the call over to Isaac. Isaac, the call is yours.

Thank you, Rob. Good morning, everyone, and thank you for joining us today for the presentation of our second quarter 2014 results and outlook for the near future. I'm excited to be speaking with you today as the CEO for Ormat, a position I officially assumed on July 1, following the close of the second quarter. I've been only -- been a member of Ormat Group for a few months, but it's already apparent to me that I'm surrounded by an exceptional group of dedicated employees with a deep knowledge of the geothermal industry. The strong and accomplished Board of Directors with extensive experience and industry expertise will continue to be an asset to the company and a resource for management going forward. With that said, I would like to start the call with a review of the quarter and half year operation summary. Then I will turn the call over to Doron to review the financial results. I will finish with the business updates before opening the call for Q&A. Starting with Slide 5. We are pleased with the results for the second quarter, which reflect the continued success of our business and contributed to strong financial results in the first half of 2014. Total generation for the second quarter of 2014 was approximately 1 million megawatt hours, which is a decrease of 2.2% from the last year. The decline in generation is primarily the result of scheduled shutdown, due to enhancements at Heber complex, lower generation at direct facilities due to lower load in the gas pipeline and uncontrolled well flow at North Brawley. On the other hand, the generation of Mammoth complex and a multiplant power plant was higher in the second quarter this year compared to the same period last year as a result of enhancements be completed. Moving to Slide 6. We currently have 2 projects that have been fully released for construction: McGinness Hills Phase 2, which is expected to come online by Q1 2015 and Mammoth G3, which is expected to be refurbished by 2015. In addition, construction work has started in Sarulla project in Indonesia, following the financial closing. During the quarter, we completed our scheduled refurbishment of Heber 1 and we are assessing the contribution of the resource and the new equipment to the complex. Additionally, we have 35 prospects in various stages of exploration, or where activity has yet to begin, in the U.S., Chile, Guatemala, New Zealand and Indonesia. In addition to adding capacity, we will continue to seek technical and commercial opportunities to improve existing plans. Slide 7 provides an update on the product segment. Our backlog reached a record of $376 million, which includes $254 million of the Sarulla supply contract, a new contract signed during the second quarter. As a reminder, now that the notice to proceed has been issued, we expect to recognize revenue from the project over the course of the next 3 to 4 years, starting in this quarter of 2014. If you could please now turn to Slide 8, you will see our updated CapEx requirement for the remainder of 2014. We plan to invest a total of $62 million in capital expenditures on new projects under construction or enhancement. An additional $49 million is budgeted for development, exploration activities and capital maintenance for operating projects and investments in machinery and equipment, as well as $41.7 million for debt repayment. The funding of this program will come from cash on hand at the end of the second quarter of 2014, expected cash from operations, unused corporate lines of credit and from expected financing of McGinness Hills Phase 2, which is covered under the existing financing structure for OFC 2 senior secured notes, benefiting from the DOE loan guarantee program. Now, I'd like to turn the call to Doron to review the financial results of the quarter. Doron?

Thank you, Isaac, and good morning, everyone. Let me provide an overview of our financial results for the second quarter of 2014. Starting with Slide 10, total revenue for the second quarter of 2014 were $127.6 million, a 16.4% decrease over revenues of $152.7 million in the second quarter of last year. In our electricity segment, as you can see on Slide 11, revenue grew 4.5% to $91.7 million in the second quarter of 2014, over $87.7 million in the second quarter of 2013. The increase was primarily due to new capacity coming online from Olkaria III complex in Kenya and Don Campbell plant in Nevada, that was somewhat offset by the 2-month shutdown of Heber 1, as part of the scheduled refurbishment project. Based on our policy, we continue to take actions to mitigate the impact of natural gas and oil prices on our electricity segment throughout -- through our hedging activity. We have entered into derivative transaction at a fixed price of $4.07 per MMBtu to reduce our exposure to fluctuations in natural gas prices through December 31, 2014 and $4.95 per MMBtu for the period from January 1, 2015, until 31st of March, 2015. As a result of our hedging activity, for the second quarter of 2014, we recorded a net loss on derivative transactions on oil and natural gas prices of $0.3 million compared to a net gain of $3.6 million during the same period in 2013. Excluding hedging adjustments, electricity revenue increased 9.3% year-over-year. In the product segment on Slide 12, revenue for the second quarter of 2014 was $35.9 million. As guided, performance of the segment this quarter was reason primarily due to timing of revenue recognition, timing of release of notice to proceed of certain projects and different product mix. We expect the second half of 2014 to be stronger than the first half of this year with a strong fourth quarter. Moving to slides 13 and 14. The company's combined gross margin for the second quarter of 2014 was 31.3% and the first half gross margin grew to 34.6%. In the electricity segment, gross margin for the second quarter of 2014 was $24.4 million or 26.6% compared to $29.1 million or 33.1% in the second quarter of 2013. The expected decrease was primarily due to the loss of revenue during the scheduled enhancement at the Heber complex and higher cost related to an uncontrolled well flow in North Brawley. Electricity gross margin in the first half of 2014 grew to 33.3%. In the product segment, gross margin for the second quarter of 2014 was $15.6 million or 43.4% compared to $21.3 million or 32.8% in the second quarter of last year. The increase in product gross margin percentage is mainly attributable to different product mix and margin in various sales contracts and to a $2.5 million reimbursement of cost, out of which $1.5 million related to the cost of goods for the Sarulla project that we received following the financing of the project, which we recorded in previous periods. Moving to Slide 15. Operating income in the second quarter of 2014 was $22.3 million or 17.5% of revenue compared to operating income of $37.9 million or 24.8% of revenue in the same period last year. The decrease was primarily due to the reduction in both electricity and product segment gross margin and an $8.1 million write-off of an unsuccessful exploration activity related to the Wister exploration site in California. Excluding the write-off of the Wister project, operating margin was 23.9% of revenue. Operating income attributable to our electricity segment for the second quarter and first half of 2014 were $9.5 million and $40.4 million, respectively, compared to $22.6 million and $21.3 million for the second and first half of last year. Operating income attributable to our product segment for the second quarter and first half of 2014 was $12.8 million and $24.5 million, respectively, compared to $15.2 million and $24.2 million for the second quarter and first half of 2013. Moving to Slide 16. Interest expense, net of capitalized interest for the second quarter of 2014 was $22.1 million compared to $17.5 million for the second quarter of 2013. This increase was primarily due to a new loan Ormat received from OPIC in 2013, the conversion of OPIC interest loans from floating interest rate to fixed interest rate, and the decrease related to the interest capitalized to our projects. Moving to slide 17. Net income attributable to the company's stockholders for the second quarter of 2014 was $9.1 million or $0.20 per diluted share. Excluding the write-off of the Wister segment, net income reached $17.1 -- $17.2 million or $0.37 per diluted share. For the 6 months ended June 30, 2014, the company reported a net income attributable to the company shareholders of $30.7 million or $0.67 per share compared to $20.1 million or $0.44 per share for the 6 months ended June 30, 2013, an increase of 52.3%. On March 26, 2014, we signed an agreement with RET Holding to sell the Heber Solar project in California for $35.25 million. We received the first payment of $15 million in the first quarter of 2014, with the remainder of the process this quarter. In the second quarter of 2014, we recorded a pretax gain of approximately $7.6 million. As shown in slide 18, adjusted EBITDA for the second quarter of 2014 was $59.7 million compared to $69.7 million for the second quarter of 2013. Adjusted EBITDA for the 6 months ended June 30, 2014 was $130.3 million compared to $115.5 million for the 6 months ended June 30, 2013, an increase of 12.9%. Net cash provided by operating activities was $103.6 million in the 6 months ended June 30, 2014 compared to $20 million in the 6 months ended June 30, 2013. Moving to Slide 19. Cash equivalents as of June 30, 2014 were $80.1 million. The accompanying slide breaks down the use of cash during the quarter. Our long-term debt as of June 30, 2014 and the payment schedule are presented in Slide 20 of the presentation. The average cost of debt stands at 6%. Moving to slide 21. In the project finance front in the Sarulla consortium, in which we hold 12.75% stake, we recently closed a $1.17 billion project finance for the world's largest geothermal project with major banks, including Japan Bank for International Cooperation and the Asian Development Bank. We expect to finance the McGinness Phase 2 project under the OFC 2 senior secured note that we issued under the DOE loan guarantee program. We expect proceeds of $140 million in the second half of 2014. On August 5, 2014, Ormat's Board of Directors approved the payment of a quarterly dividend of $0.05 per share pursuant to the company's dividend policy. This dividend will be paid on August 28, 2014 to shareholders of record, as of closing of business on August 19, 2014. This concludes my financial overview. I would like now to turn the call to Isaac for business update. Isaac?

Turning to slide 23, we outlined our revenue outlook for 2014. For the full year 2014, we reiterate our electricity segment revenues to be between $370 million and $380 million, and product segment revenues to be between $170 million and $180 million. As we guided on the previous 2 calls, we expect the second half of 2014 to be stronger than the first half. With the release of the Sarulla contract, we have a robust product backlog that will carry us not only through the several -- through the next several quarters, but the next few years. In the electricity segment, we expect generation to trend higher as we complete scheduled enhancements at some of our plants. Moving to slide 24. In addition to the internal prospect and improvements plan, there are several domestic legislative development that will further support renewable energy development. On the federal level, there is currently a bill in the U.S. Senate that will extend the ITC and PTC for an additional 2 years, covering plants that begin construction by December 31, 2015. Additionally, about 1 year ago, President Barack Obama announced a new National Climate Action Plan and recently the EPA under Obama's plan released the Clean Power Plan proposal, which, for the first time, cuts carbon pollution from the existing power plants in the United States. The Clean Power Plan will be implemented through a state-federal partnership, under which states identify a path for using either current or new electricity production and pollution control policies to meet the goals of the proposed program, including cutting carbon emission from the power sector by 30% nationwide below 2005 levels by 2030. On the state level, in May, California State Senate approved the proposed geothermal legislations Senate Bill 1139. The bill, if enacted, will require retail sellers to increase their geothermal-powered electricity use by a combined total of 500 megawatts by 2024. This development demonstrates the recognition of the geothermal baseload benefit to the state grid and will support our expansion plan. This important development create a well-established platform for growth. And as a vertically integrated industry leader, we are well positioned to take advantage of strong industry tailwinds. According to the Geothermal Energy Association's annual report, about 500 megawatts of installed power came in line in 2013, of which Ormat is responsible for more than 50%. The increase in 2013 is the largest increase in absolute terms since 1997, bringing the total installed global capacity to just over 12,000 megawatts. Domestically, California, Nevada and Utah, the 3 states in the U.S. with the most robust geothermal resources are ripe for continued development of the significant untapped potential. Meanwhile, local and national governments throughout the world are recognizing the benefit of this clean renewable energy. They are offering incentives to foster its development, many of which have been discussed on previous calls. Today, Ormat remains not only the world's largest pure-play geothermal power producer, but the only one that is vertically integrated. Our engineering, technological advancement and operational superiority has allowed us to grow and develop projects of increasing complexity such as Don Campbell project, for which the company was just awarded the GEA Honors 2014 for developing a new innovative technology, uses low-temperature ORC cycle. In the coming months, I plan to go on the road and meet the investment community, while focusing on Ormat 2014 world plan and strategy plans in the future. With that, I would like to thank you for your support. And at this time, the call is open for questions. Operator, can you please?

[Operator Instructions] Our first question comes from Dan Mannes of Avondale.

I wanted to go back through and talk a little bit about the margins and cost structure in your power business. Obviously, you were pretty clear that last quarter, it was maybe an aberration that margins were very high. But I guess this was a little bit worse than we were expecting. Could you maybe walk us through, maybe, some of the cost increases that were incurred from the first quarter to the second quarter, with maybe some particular attention to North Brawley?

Okay. We had, as you know, we had an uncontrolled flow in North Brawley during the quarter, which cost us about $3.3 million, reducing $1 million we got from the insurance, it's about $2.2 million. And we also lost about $1 million of income from the power plant itself. Furthermore, there were some operational expenses that moved from, as we said on our Q1 conference call, that were moved from Q1 to Q2. And end-to-end, they lowered or decreased our operational margins in Q2. But if you look at combined 6 months, we are on 33%, which are the numbers that are much more representative than the Q2 numbers.

Okay. And just digging a little deeper, when you talk about the expenses that shifted, are you including also any operating costs of Heber? Or are you just talking about sort of annual expenses this year Q2 instead of Q1?

Dan, I'm relating mainly to annual regular expenses of maintenance that shifted, as you know. And I learned to know, during the last 3 months, that in a project company, unfortunately, the power plants are not behaving on quarterly basis, and they excuse themself for that.

But was there -- can you talk, maybe, about any operating costs that were incurred at Heber in the quarter? Or was most of the costs at Heber, both lost revenue as well as CapEx?

Dan, it's Doron. The cost, actually, that shifted between Q1 to Q2, doesn't relate specifically to Heber. These are mainly well field cost that expected them to be in Q1. They didn't happen in Q1, some of them happened in Q2. So Q1 looked a little bit better than what was expected; in Q2, the opposite. But I think as Isaac said, looking at the 6 months' numbers, you can see actually that the numbers are getting back to normal.

Okay. And then lastly, on North Brawley, you mentioned the uncontrolled flow. Was that remedied during the quarter? Can you talk about any root cause analysis? Or is that maybe an ongoing issue that we'll have to see in future quarters?

No, we expect that it's a one-time event and there was a full remedy during the quarter. The well is back on operation already and let's keep our fingers crossed that it's not going to happen again in Brawley or elsewhere. But as you understand, when you are running so many power plants, sometimes it's cost of doing business.

Okay. Just a couple other quick ones and then I'll jump back in queue. It looked like -- outside of Sarulla, it looks like maybe you had another maybe $50 million of new business in the quarter on the product side. Obviously, it sounds like some nice wins. Anything material you can point to in that group or just a lot of small ones or?

If -- I assume you're referring to the backlog, so the backlog last quarter was about $120 million and this quarter, it's $376 million. Actually, if you take -- if you split it between Sarulla $254 million, you get to about $122 million. So actually, we were able to sign new contracts in the same amount of money that we recognized revenue for the quarter.

Right. I was just wondering if there was anything material or notable in what you saw in your...

We will be on the road after this conference call during September, and we will certainly give you much more color on the upcoming product contracts and the ones that we've signed and so on.

Okay. And then just let me close out, one last question. You did take the write-down on Wister this quarter. I think you've been talking about terminating the PPA on Wister for a period of time. Can you talk about, maybe, what brought it to the conclusion now? Because I mean, frankly, I think you've kind of been a little bit cautioned on the timing of Wister for some time. Why take the write-down now versus in a prior period? Or wait on it, given maybe an improving environment in California in terms of geothermal demand?

Look, when we have these exploration sites, there is various work that is done, some of it is drilling wells and others. And others are analyzing models and statistics and information that we get constantly on our exploration sites. And it's a question of one, our exploration team, the resource team comes to the conclusion that they don't see between all of our sites, that this site has the right priority or the ability to come to a full-blown power plant. And if we write it off or not, there are some accounting thresholds that we need to meet. But it's a process that we keep. We keep analyzing exploration sites until we get to a decision. It's not a binary decision every quarter. And we have a very capable exploration team that -- they have a mandate to explore each and every site that we have. And if their conclusion is that we will not be able to pick up this site and go ahead with it, and we don't have a choice, but to take it off.

Makes sense to me.

Our next question comes from Gregg Orrill of Barclays.

Just a couple of questions on Sarulla. Just if there's anything you could help us with in terms of the products revenue being realized, sort of the timing of that and what milestones might be the triggering factors, if it's not obvious?

It's Doron. In the Sarulla project, as we said, we got notice to proceed in Q2. Again based on the accounting guidelines and our policy, we need to reach some threshold in order to start recognizing revenue. We expect to reach this threshold in Q3 and recognize a relatively small amount of revenue from Sarulla. And going forward, starting from Q3 but much stronger in Q4, we will recognize revenue percentage of completion. So Q4 is expected to be higher than Q3 and to start with the normal pace going forward. For Sarulla, as we said earlier, we expect in the range of $35 million of revenue from Sarulla. This is obviously an estimated number since it's based on the number of hours that we will do and the procurement that we build, but we do expect to recognize revenue already starting in Q3.

Okay. Maybe just switching gears. Isaac, I know you mentioned you're going to do some investor outreach balance of the year, but any additional thoughts on repositioning the company, if at all? And -- just interested in your initial impressions.

I'm here only 4.5 weeks and -- but I was here before 3 months in a listening mode. And we are sitting on strategy right now with the new management that's come in place, which consists of Ormat employees, obviously. That is sitting on strategy. But now, the upcoming weeks, our main focus is enhancing our existing assets. We are specifically, and I may use the frame sitting on 3 specific assets, that we want to enhance fast, and we are planning to do that. And later on, it will be some growth strategy. And I will again, as I said, Doron and myself will be on the road during the upcoming months and we'll give you much more details on a bit of shifting of strategy in this aspect.

Our next question comes from JinMing Liu of Ardour Capital.

First is on the -- just a quick question on North Brawley. So what is the financial situation of that facility? Is that running at EBITDA positive right now or you're still losing money?

It's Doron. The plant was expected to do this year somewhat positive EBITDA. However, with the uncontrolled flow that we had, which, actually, had on one hand an additional cost, that we expect to receive most of them back from the insurance, but also have the reduced revenue. So we assume that this year, it will have a negative EBITDA.

But if we exclude all this one-time thing, the power plant itself should be running at the EBITDA positive, right?

Our position that excluding this event, it should have been slightly positive.

Okay. Good to hear. Switch to Sarulla project. What kind of product margins we should expect? Is that in the low 20% or much higher, like in what we achieved in the second quarter?

In the Sarulla project, you should assume somewhere in the high 20s, similar to our regular contract. Usually, what we try to do in the project, we will start with a range of between 25% to 30%, having some contingencies. And as we move ahead with the project, assuming we are able to manage the contingency, we will sometimes see margins going up. Not always, but sometimes. So as a basic strategical project, somewhere between 25% to 30%.

Jim, this is Isaac. You should realize that it pretty much depends on the product mix that we have in a certain quarter. Because if we can get synergies from the other projects, obviously, we will have a bit more margin and if we don't have synergies in a certain period or quarter, then those synergies not existing, it will be a bit lower.

Okay, that's helpful.

This concludes our question-and-answer session. The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.