Ormat Technologies, Inc. (ORA) Q2 2018 Earnings Report, Transcript and Summary

Good morning, and welcome to the Ormat Technologies' Second Quarter 2018 Earnings Conference Call. All participants will be in listen-only mode. 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 Jeff Fink. Please go ahead.

Thank you, Danielle. Hosting the call today are, Isaac Angel, Chief Executive Officer; and Doron Blachar, Chief Financial Officer; and Smadar Lavi, Vice President of Corporate Finance and Investor Relations. Before beginning, we would like to remind you that the information provided during this call may contain forward-looking statements relating to current expectations, estimates, forecast, 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 and 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 Technology’s Annual Report on Form 10-K filed with the SEC. In addition, during the call, we will present non-GAAP financial measures, such as adjusted EBITDA and adjusted net income. Reconciliations to the most directly comparable GAAP measures and management reasons for presenting such information is set forth in the press release that was issued last night, as well as in the slides posted on our website. Because these measures are not calculated in accordance with U.S. GAAP, they should not be considered in isolation from the financial statements prepared in accordance with U.S. 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 Presentation link that’s found on the Investor Relations tab. With all that said, I would now like to turn the call over to Isaac Angel. Isaac, the call is yours.

Thank you, Jeff and good morning everyone. Thank you for joining us today. Starting with slide five. This was certainly an eventful quarter for Ormat and I'm proud of the way to we responded to a significant challenge and delivered another solid quarter. Our performance, overcoming a volcanic eruption, which forced the shutdown of our Puna plant in Hawaii is additional evidence of the strength of our Electricity segment. As you know, in the second quarter, we added to our operating portfolio the three operating assets of U.S. Geothermal. All three plants are fully integrated and as part of the operational integration plan, we conducted preplan maintenance activity that required to shut down the power plant. The plant maintenance activity were longer than expected and impacted the Electricity segment profitability in the second quarter. We are continuing to optimize our operation at U.S. Geothermal and expect to have a positive contribution to electricity segment performances in the second half of 2018. The growth we delivered in the past 12 months from organic growth and from acquisitions mitigated the impact of the shut down in Puna and enabled us to increase the Electricity segment revenue and maintain a constant level of total revenues quarter-over-quarter, by compensating for the expected reduction in the product segment. As it relates to the product statement, during the second quarter, we signed new contracts which contributed to our backlog and enabled us to increase product signal revenue guidance for 2018. This quarter, we recorded a net loss as a result of an expected tax expense related to U.S. tax reform which we expect it to continue to be volatile between the periods in line of the evolving regulation tax code in the U.S. I'd like to emphasize that U.S. tax provision in our P&L has no cash impact on our operational results. Excluding this tax expense, we had adjusted net income attributable to the company's stockholders of $16.6 million. I believe the results and our guidance clearly demonstrate the resiliency of our business model and speak to our geographic and business diversification. I will turn the call over to Doron for a review of the financial results before I provide an update on our operations. Doron please.

Thank you, Isaac. Good morning everyone. Starting with the revenues on slide seven. For the second quarter of 2018, total revenues were $178.3 million, a slight decrease of 0.6% for $179.4 million for the second quarter last year. The decrease was attributable to a 18.7% year-over-year decrease in product segment revenue, which was partially offset by 10.2% increase in revenue from our Electricity segment and a 36.8% increase in other segments. Moving to slide eight. Electricity segment revenues increased 10.2% to $122.2 million for the second quarter of 2018, up from $110.9 million in the second quarter of 2017. The increase was due to the commencement of Platanares power plant in September of 2017, the commencement of Tungsten Mountain power plant in December of 2017, the consolidation of U.S. Geothermal, which is an acquisition closed on April 24th, 2018, and higher energy rates under the new Ormesa 1 PPA, which commenced in December of 2017. These increases were partially offset by decrease in revenue at our Puna plant following the Kilauea volcanic eruption on May 3rd, 2018. Since then, the power plant was shut down. Additionally, the increase was offset by a decrease in generation in some of our power plants that was taken offline to address maintenance issues and enhancement. Turning to slide nine. Product segment revenues were $54.9 million for the second quarter of 2018 compared to $67.6 million for the second quarter last year. In slide 10, you can see that the new segment we added last quarter contributed $1.2 million of revenue from our storage and demand response activities conducted by Viridity compared to $0.9 million in the second quarter of 2017. Moving to slide 11 for look at our total gross profit and margin. Gross margin was 32.2% of total revenues for the second quarter of 2018 compared to 39.3% in the second quarter of 2017. The decrease was mainly attributable to a decrease in electricity segment gross margin. Moving to slide 12 for Electricity segment gross margin. Electricity segment gross margin was 33.5% compared to 43.0%. This decrease was primarily due to the gross loss from Puna where we recorded cost revenues with no associated revenue. Additionally, this decrease was due to a gross loss from U.S. Geothermal due to the planned maintenance outages that were longer than expect. Electricity segment gross margin for the second quarter of 2018 excluding the impact from the outages from Puna and the plant maintenance in U.S. Geothermal was 40.7% compared to 43% last year. If we look at the first half of 2018, excluding Puna and USG, the gross margin was approximately 43%, a similar level to last year. Moving to slide 13. In our product segment, gross margin was 31.6% compared to 35.7% in the second quarter of 2017 reflecting the decrease in segment's revenues and slightly higher cost of revenue primarily attributable to the different scope of work and different margin in the various sales quarter. As we previously guided, the gross margin for the entire year is expected to be between 27% and 30%. Our other segments reported a negative gross margin. Turning to slide 14. General and administrative expenses for the second quarter of 2018 were $15.9 million compared to $12.2 million for the second quarter last year. The increase was primarily attributable to $2 million in G&A expenses coming from the first time inclusion of U.S. Geothermal and higher cost with our identification of the material weakness related to the taxes in the fourth quarter of 2017 and diversified the statement of our second, third, and full year 2017 financial statement. Operating income for the second quarter of 2018 was $36.6 million compared to $53.2 million for the second quarter last year, a decrease of 31.1% year-over-year. The decrease in operating income was mainly due to the decrease in both our Electricity and product segments gross margin and the increase in G&A expenses. Turning to slide 15. Operating income attributable to our electricity segment for the second quarter of 2018 was $27.5 million compared to $38 million for the second quarter last year. Operating income attributable to our product segment was $10.8 million for the second quarter of 2018 compared to $17 million for the second quarter last year. Operating loss attributable to our other segments for the second quarter of 2018 was $1.6 million compared to operating loss of $1.9 million for the second quarter last year. Turning to slide 16. Net interest expense for the second quarter of 2018 was $15.8 million compared to $14.5 million last year, up 9%. This increase was primarily attributable to the $100 million of proceed from a senior unsecured loan received on March 22nd, 2018. Additionally, the increase was due to net proceeds of $107.1 million from revolving credit lines with commercial banks. The increase was also due to the interest expense associated with the loans of U.S. Geothermal. The increase was offset by lower interest expense as a result of principal payment of long-term debt. We received issuance and investment related to the rig that was consumed by the lava in Hawaii. The $7 million of investment is reflected in the other non-operating income of our P&L and was excluded from our adjusted EBITDA for the second quarter. Turning to slide 17. The income tax provision for the second quarter of 2018 was $29.1 million compared to income tax provision of $32.8 million for the second quarter of 2017. Our effective tax rate is primarily based upon the composition of our income in different countries and changes related to valuation allowance for certain countries. Excluding the release of the valuation allowance, our effective tax rate for the second quarter of 2018 was approximately 38.5%. If you have to estimate the effective tax rate going forward, due to the continued update from the IRS on the U.S. tax reform. I would like to remind you that in light of our net operating losses and production tax credit in the U.S., we don't expect to pay cash tax in the U.S. in the coming years. Turning to slide 18. Net loss attributable to the company shareholder was $0.3 million or $0.01 per diluted share compared to a net income attributable to the company's shareholder of $8.6 million or $0.17 per diluted share in the second quarter of 2017. In the second quarter of 2018, we recorded a non-cash tax expense of $16.9 million. This expense represent a cost in reverse as expected with a tax benefit of $44.4 million that was recorded in the first quarter of 2018 for the reduction of the valuation allowance related to flowing tax credit and production tax. Adjusted net income attributable to the company's shareholders is $16.6 million or $0.32 per diluted share compared to $29.5 million or $0.58 per diluted share in the second quarter of 2017. Adjusted net income attributable to the company's stockholders and diluted EPS for the second quarter of 2018 excludes the increase in valuation allowance, which is volatile between the periods in light of the evolving regulation in tax code in the U.S. Following the new tax act, the result is indicative to our long-term operations and goal. Turning to slide 19. Adjusted EBITDA for the second quarter of 2018 was $80.8 million compared to $88.1 million in the same period last year. The reduction was due to an expected reduction in revenues and profitability of the product segment, gross loss in Puna plant and U.S. Geothermal. The decrease was partially offset by increase in revenue from the Electricity segment and by an increase in Ormesa's proportionate share in EBITDA of solar and geothermal power plants. The shutdown in Puna resulted in approximately $7 million loss in adjusted EBITDA compared to the same period last year. We expect that part of this loss may be covered in the insurance claim for the loss of profit. The Electricity segment portion of our total adjusted EBITDA in the second quarter was 86.4% compared to 76.3% in the second quarter of 2017. Reconciliation of EBITDA and adjusted EBITDA are provided in the appendix slide. Turning to slide 20. Cash and cash equivalents and restricted cash as of June 30, 2018, increased to $142.7 million, up from $96.6 million as of December 31st, 2017. The accompanying slide breaks down the use of cash for the quarter. Our long-term debt as of June 30, 2018 was $1.2 billion net of deferred financing cost, and it's payment schedule is presented on slide 21. Total debt was increased by $122 million due to the U.S. Geothermal loans and due to the increase in short-term revolving credit lines with banks. The average cost of debt for the company is 4.9%. Our net debt as of June 30, 2018 was $1 billion. Please turn to slide 22. During the second quarter, we entered into a tax equity partnership agreement with a private investor, to efficiently monetize the production tax credit available for the Tungsten Mountain geothermal power plant. Under the transaction documents, the private investor acquired membership interest in the Tungsten Mountain geothermal power plant for an initial purchase price of approximately $33.4 million. Additionally, the private investor will pay additional installment that is expected to amount to approximately $13 million. We will continue to operate and maintain the power plant and will receive substantially all the distributive end cash flow generated by the power plant. And finally, on August 7, 2018, Ormat's Board of Directors approved payment of a quarterly dividend of $0.10 per share for the second quarter of 2018. The dividend will be paid on August 29, 2018 to shareholders of record as of close of business on August 21, 2018. In addition, we expect to pay a dividend of $0.10 per share in the next quarter. That concludes my financial overview. I would now like to turn the floor to Isaac for an operational and business update. Isaac?

Thank you very much, Doron. Starting with slide 24 for an update on operations. I'd like to start and provide an update on Puna plant in Hawaii. As we updated on our previous communications, as you can see in the summary on the slides, when the nearby Kilauea volcano erupted on May 3rd, 2018, we moved quickly to respond to the natural disaster and took the steps to protect the pipeline and mitigate damage to the nearby community, our staff in Puna facility. As part of these steps, we kept -- evacuated the building from the site, we clenched all the production well, and donated $150,000 to support the local community. In addition, we made a commitment to maintain all Puna employees for a duration of at least a year. As you can see on slide 25, the event is still ongoing and may be sometime before the power plant will be up and running, again, as the level continues to flow. Puna is one of the two plants that we operate there adjacent an active volcano, and as such, we carry business interruption and property insurance covering those two plants in our portfolio. With respect to Puna, as Doron mentioned in his remarks, we have already received insurance settlements for the damage to rig. We are currently discussing with our insurers to a reimbursement for a loss of profits and for damage to the property. It's important to note that as part of the insurance policy, we need to take on ourselves the loss of revenues in the first 30 days that the plant was shut down. This revenue loss amounts to approximately $3 million and is included in the Q2 results. Turning to slide 26. Power generation increased in the second quarter by 7.7%, primarily due to commencement of our Platanares and Tungsten Mountain power plant. Additionally, the consolidation of geothermal power plants, U.S. Geothermal power plants, contributed to increase in generation. The increase was partially offset by a decrease in the generation at our power -- Puna plant and by a decrease at some of our power plants, mainly due to scheduled maintenance outages. Despite the outage in Puna and the planned maintenance activity in the U.S. Geothermal power plants, and assuming we will receive the insurance reimbursement by the end of the year, we expected profitability in the Electricity segment in the full year to be in line to last year profitability. Again, this sustains to the strength of our Electricity segment. Turning to slide 27. As of August 1st, 2018, our product segment backlog was approximately $229 million. We are working to secure near contracts to support revenue for 2019 and beyond and are encouraged by the opportunities in the pipeline for the product segment. Turning to slide 28. During the second quarter, we announced that the 11-megawatt expansion project in Olkaria III complex in Kenya successfully commenced commercial operation. The expansion demonstrates, once again, the creativity of our engineering group to analyze the Olkaria complex operation, equipment in PPA, and come up with a plan that enabled us to increase the Olkaria III complex capacity to 150 megawatts in a short timeframe and at the cost effective manner. Turning to slide 29. We are continuing with our growth plans and pleased with the growth we achieved from the beginning of the year, bringing our total portfolio to 862 megawatts. We are on track with our near-term growth target and plan toward between 115 megawatts and 125 megawatts by the end of 2020. As you can see in the table, we removed Puna enhancement from our plans as the project is currently on hold and we added an enhancement project for Steamboat Hills power plant where we expect to add additional 16 megawatts to the existing power plant before the end of 2020. Steamboat Hills and its additional capacity will sell its power under the SCPPA portfolio PPA. Turning to slide 30. We also continue to make progress in energy storage activity. During the second quarter, we broke ground on the two 20 megawatt hour utility scale in front of the meter energy storage systems in New Jersey. We expect this project to will be operational in the fourth quarter of 2018. These systems will be utilized to provide ancillary services to assist PJM, a regional transmission organization in balancing electric grid and will also be able as capacity asset. Turning to slide 31. Our estimated capital needs for the remainder of 2018 include approximately $33 million for construction of new projects and enhancement of our existing power plants. In addition, we estimate approximately $65 million for maintenance Capex for investments in exploration, development, storage activity, and for investment in our production facility. In the aggregate, we estimate total capital expenditures of approximately $98 million for the remainder of 2018. We expect $32 million for long-term debt repayment and $72 million for revolving bank credits repayments. Please turn to slide 33 for a discussion of our 2018 guidance. In light of the continued lave flow into the Puna power plant and the relevant accounting treatment that does not allow to record insurance payouts in revenues, we are adjusting our full year 2018 guidance for the Electricity segment revenues to be between $500 million and $510 million to reflect the Puna plant shut down. We increased our guidance for the product segment revenues to be between $190 million and $200 million. There is no change to revenues from energy storage and demand response activities, which are expected to be between $8 million and $12 million. As such, guidance for the total revenues is between $698 million and $722 million. We increased our 2018 adjusted EBITDA to be between $370 million and $380 million for the full year, assuming successful resolution by the end of 2018 of our insurance claim for the loss of profit at Puna power plant. In the event, we want to resolve our insurance claim by the end of 2018; the 2018 adjusted EBITDA will be negatively impacted by approximately $20 million. We expect annually adjusted EBITDA attributable to the minority interest to be approximately $30 million. The minority interest includes our partner shares in the insurance claim for the Puna plant. In summary, this was a challenging and a busy quarter. I am very proud of how our teams responded to a natural disaster, moving professionally and quickly to mitigate damages and protect our neighbors. There is no doubt that the impact was significant and I believe, we have done all we can do to manage through these challenges. We are moving quickly to integrate the U.S. Geothermal power plant and are on track with our near and long-term growth plan. This concludes our prepared remarks. Now, I'd like to open the call for questions. Operator?

We will now begin the question-and-answer session. [Operator Instructions] The first question comes from Noah Kaye of Oppenheimer. Please go ahead.

Yes, hi. Good morning. Thank you for taking our questions. This is Kristen on for Noah. Just wanted to ask, first of all, if we can isolate the USG integration in terms of gross margin and even a headwind, if we strip out sort of the maintenance shutdown that you called out or the planned maintenance shutdowns, what was that headwind from USG alone? And then, how should we see that trend in the coming quarters?

Doron, would you like to take that?

Yes. So, we have excluded U.S. Geothermal and Puna from Q2 numbers and from the first half year. So, in the Q2 numbers, the Electricity segment gross margin was 40.7%, and in this past year, it was 42.9%. Overall, in U.S. Geothermal power plants in 2019, once we do implement some of our enhancement come through our regular margins. In Puna, based on the accounting, we cannot recognize the revenue and we have cost, so once we finalize the insurance -- the discussion with insurance, Puna will not impact the margin going forward.

Maybe I would like to add here. It will be the last time that we will be mentioning USG. At the end of today, we have three new power plants, which we are consolidating and I believe that starting next quarter and going forward, slowly but surely, with the help of the excellent employees that we have there, those power plants will be performing as any other regular power plant that we have in our fleet.

Thank you. I do want to talk a little bit about the Puna plant. The damage to the road in terms of transmission infrastructure does appear to be pretty significant, but on the other hand, this is obviously a major supplier power to the island, and clearly, there's a need being unmet today. Hypothetically, if there were no more meaningful damage incurred after today, what do you see as a realistic timeframe for bringing that plant back online?

As you mentioned, Kristen, there is significant damage to the roads, but less significant damage to the transmission, which I was -- we visited -- we meaning myself and part of management, visited Puna few weeks ago, met with Telco CEO, local -- the Governor of Hawaii and local leaders in Hawaii. At the day of the incident, we were providing almost 30% of the power at the island -- in the island, which means that it is a very, very significant part of the electricity. And everybody is keying that this power plant to go online as soon as this thing is over. Unfortunately, as we all know, it's very, very difficult to estimate how long the Puna flow will continue, even though there is decrease, I don't know if it's on the -- the decrease will continue. So, in the future, but there is a decrease in the flow as of two days ago. In any case, if the flow will be -- will stop completely or even it could be very slow, we will be able to look into bringing the power plant back. It will take us at least 18 months to do so.

Okay. That's helpful color. And last one for us. Can you give us any additional information on the pipeline for adding the backlog and products? Just some color on the bidding activity or regional mix, where you think you might end up for the year in terms of backlog?

As I explained in our last conference call, the majority of our sales in 2018 are to Turkey, and we have a significant backlog in Turkey. But looking forward, the geographies are changing and we are looking into new wins, which are already in the backlog and which we have in our pipeline, which are not included in the backlog yet, are coming from other geographies in Far East and in the states, which somehow are mitigating -- maybe the word mitigating is not the right word. It may be changing the percentage of our Turkish numbers. Overall, looking at the fact that we also increased the numbers for the product segment 2018, the outlook for 2019 and forward for the product segment is more positive than I expected few quarters ago.

Great. Thank you so much. We'll turn it over.

Thank you very much Kristen.

[Operator Instructions] The next question comes from Sophie Karp of Guggenheim. Please go ahead.

Hi, good morning guys. Thank you for taking my question. I wanted to ask you about Viridity, and you put a slide in the deck about one of the projects that you're working on there. But can you give us more color about the order of the backlog or leads in the business look like? How much business you expect to get there in the next few years, maybe? Can you give us some color on that?

Okay. As I already said before, we have to get rid of Viridity or to storage operation of the company as a startup, which we are in the investment stage as of now. We already have running facility, which is of one megawatt, which is showing us that the system and the concept is working. We have two more facilities that are going to be online within the next two quarters, which will bring us something like $8 million of revenues constantly. We have another one, which is being signed as we speak, and that will add more. So, at the end of the day, it is a small operation for us as of now, but our expectation that the growth will be exponentially within the next few years of this thing. I cannot really say today when this thing will reach $100 million. It could take a few years, but we might surprise ourselves with the growth in this. As you know, the market is growing exponentially also specifically in 2018 and looking forward.

All right. Thank you.

Thanks Sophie.

[Operator Instructions] The next question comes from Jeff Osborne of Cowen and Company. please go ahead.

Hey good morning guys. Quick question on the U.S. Geothermal. Can you just elaborate on the nature of the delays of doing the upgrades and retrofits that you were doing? Was there any weather impacts or lack of familiarity with the equipment? Any detail you provide would be helpful.

Thanks, Jeff. It was a different nature in each one of the three power plants, but it was mainly drilling and well related, the major delays. And as you know, on drilling activities, you know when you start it's very difficult to anticipate. It's going to take another week or two weeks, and most of the delays were exploration and drilling related. What we're doing is we're trying to prepare all these power plants to be par or in line with our operation. Elsewhere, we expect that after this shutdown during Q2, the behavior of these power plants will be much better than before and obviously, we will continue to invest in those power plants until, as we said before, that their profitability will be much higher than they were before -- before they were consolidated into our operation.

I think -- if my memory is right, one of the other items that you were doing to improve profitability in the plants was also to port the monitoring to remote monitoring. Is that something you've already done? Or is that something -- an additional step in the future?

No. We already incorporated within -- if I recall right, two out of the three, the monitoring systems and -- but as I said before, the major thing was not necessarily in the monitoring or any other or relating to drilling.

Got it. Makes sense.

Jeff, if I can add if we have U.S. Geothermal are only two months in our numbers and in the specific two months, you have a planned maintenance and outages, the impact on this specific two months is much bigger. And if we look on our forecast, though, we see that the second half is definitely profitable and is starting to generate much more revenues and profit. So, it's a combination of the fact that the planned maintenance were longer than expected, but also, when you have a maintenance or a specific power plant in a specific quarter, then that quarter is not representing of the power plant.

Got it. Just two other qualifications. Can you talk about the process for recouping the insurance funds? Is this a matter of paperwork or investigation? Or is it still a question of if you'll get it? Or is it more of a when question? Anything along those lines. And then another clarification is just on the other revenue segment with storage and demand response. Was there any percent completion revenue accounting for the storage products in New Jersey this quarter? Or is it a safer assumption to say that the revenue you posted this quarter is more the quarterly run rate at the demand response from the legacy Viridity business?

Doron, you take the insurance. I'll take the second one.

Yes. So, on the insurance, as you can expect, this potentially has very high amount of -- it's very high insurance claim. And obviously, there's some discussions with insurance on the timing. The lava hasn't stopped yet flowing. Obviously, the event is still continuing. So, we are discussing with them the timing and the magnitude of the reimbursement. And since it is a high volume, we do expect the insurance company might attempt to negotiate with us this issue. Our analysis is that this should be [Indiscernible].

Got it. And then on the demand response question?

Yes. Jeff, you have to look at those two businesses as two separate businesses. Basically, what you have as of today is, as you rightly mention, is the demand response revenues. Even though it's a solid market, it's at a much slower growing market than the storage market. And we expect in the future, our demand response serving will grow, but in a less faster manner than the storage. The storage revenues are not yet in our numbers. There will be -- we will be consolidating storage numbers only in Q4 2018. On the other hand, the storage market growth we expect to be much higher than to the demand response. What are we also looking at is that the demand response in the future combined with storage, which those customers that would be more sophisticated than the -- today if they are customers that relate also storage element into the DR. And in one hand, it will make their DR much more effective and they will be able to also to provide ancillary services to the grid while these storage assets are not using them in the DR process.

Makes sense. I appreciate the detailed response. Thank you.

Thank you.

This concludes our question-and-answer session. I would now like to turn the conference back over to management for closing remarks.

As I said before, and this was a challenging quarter for us, almost everywhere, mainly in Puna, which we mitigated through accelerating our growth in the Electricity segment. And it was challenging in our tax calculations. We expect to be -- the company and all our employees are working very hard to mitigate all these issues and as we are reflecting in our future guidance, we are optimistic in the outcome of 2018 and also looking forward. Thank you very much and thanks for your support.

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