Start Time: 08:07
End Time: 09:05
Macquarie Infrastructure Company LLC (NYSE:MIC)
Q2 2014 Earnings Conference Call
July 31, 2014 08:00 AM ET
James Hooke - CEO
Jay Davis - Managing Director, IR
Ian Zaffino - Oppenheimer & Co.
Sameer Rathod - Macquarie Capital
Young Ku - Wells Fargo Securities
Good day and welcome to the Macquarie Infrastructure Company Second Quarter 2014 Earnings Conference Call. Today’s call is being recorded. At this time, I’d like to turn the conference over to Mr. Jay Davis, Managing Director, Investor Relations. Please go ahead, sir.
Thank you, Candice. Thank you and welcome once again to Macquarie Infrastructure Company’s earning conference call, this one covering the second quarter of 2014. Our call today is being Webcast and is open to the media. In addition to discussing our quarterly financial performance on this call, we published press release summarizing the results and filed the financial report on Form 10-Q with the Securities and Exchange Commission. These materials were released last evening and may be downloaded from our Web site at www.macquarie.com/mic.
Before turning the proceedings over to Macquarie Infrastructure Company’s Chief Executive Officer, James Hooke, let me remind you that this presentation is proprietary and all rights are reserved. Any recording, rebroadcast or other use of this presentation in whole or in part without the prior written consent of Macquarie Infrastructure Company is prohibited.
This presentation is based on information generally available to the public and does not contain any material non-public information. The presentation has been prepared solely for information purposes and is not a solicitation of an offer to buy or sell any security or instrument. This presentation contains forward-looking statements. We may in some cases use words that convey uncertainty of future events or outcomes to identify these forward-looking statements. Forward-looking statements in this presentation are subject to a number of risks and uncertainties.
A description of known risks that could cause our actual results to differ appears under the caption “Risk Factors” in our Form 10-K. Our actual results, performance, prospects or opportunities could differ materially from those expressed in or implied by the forward-looking statements. Additional risks of which we are not currently aware could also cause our actual results to differ. The forward-looking events in this presentation may not occur. These forward-looking statements are made as of the date of this presentation. We undertake no obligation to publicly update or revise any forward-looking statements after the completion of this presentation whether as a result of new information, future events or otherwise except as required by law.
With that, it is my pleasure to introduce Macquarie Infrastructure Company’s Chief Executive Officer, James Hooke.
Thank you, Jay, and thanks to those of you participating in our earnings conference call today. And a special thanks to those of you who maybe joining us for the first time as a result of having participated in our following offering earlier this month. We appreciate all of you joining us for this update on MIC.
MIC’s headline growth in free cash flow per share was good, up 8.7% to $1 per share. However, when you consider the impact of the delay in closing the Galaxy acquisitions and various transaction related costs of approximately $2 million, underlying growth in free cash flow per share was up nearly 16% to $1.07.
In the second quarter, our three largest businesses each generated an all-time high in EBITDA over the trailing 12 months. I think it’s fair to say that fundamentally our businesses are in good shape and continue to deliver the level of growth in free cash flow that we expect. Consistent with that our distribution has been increased for the third time in as many quarters and is now at $0.95 per share per quarter, or $3.80 on an annualized basis.
MIC and its businesses continue to perform well in the second quarter of 2014. Our results were inline with and possibly a bit ahead of our expectations for the full-year. Despite the noise in the second quarter related to 700,000 barrels of tankage being offline for scheduled cleaning and inspection, IMTT delivered the modest performance improvement we expected.
Atlantic Aviation continue to grow faster than industry activity and further benefited from two months of ownership of the six newly acquired Galaxy locations. As predicted, Hawaii Gas rebounded quickly from the supply disruptions it faced in the first quarter of the year.
Contracted Power and Energy generated more cash as a larger number of facilities were online in 2014. And on the back of this good performance, our Board authorized an increase in our quarterly cash dividend to $0.95 per share or $3.80 on an annualized basis.
We generated $2.15 in free cash flow per share in the first half of 2014, even with a 14.4% year-over-year increase in the number of shares outstanding. And we’ve provided guidance that we expect to win at least $4.55 per share in underlying free cash flow for 2014, including the impact of our recent acquisitions.
So at the middle of the year, we’re right where we expected to be and we’ve a little more upside in the second half than we had originally envisaged, such as the nature of the predictable cash flows that our businesses generated.
Through the end of the second quarter, our businesses generated proportionally combined EBITDA of $189.4 million. This is up 11.3% on the first half of 2014. Given that we will benefit from a full six months of contributions from the Galaxy transactions and the related hangar at Palm Beach in the second half of the year, as well as the growth in the CP&E segment, we feel that we’re on target relative to our product guidance of $385 million for 2014 if anything were slightly ahead of that figure.
We come to the same conclusion looking at free cash flow. Annualizing our $2.15 per share in proportionally combined free cash flow through six months, and we’re just below our February guidance of $4.35 to $4.50 for the full-year.
Again, including expected second half contributions from the Galaxy transactions and CP&E, we’re on target or slightly ahead of target. In aggregate, the portfolio is doing everything we expected it would when we began the year.
As we discussed when we provided you our guidance, we thought there was upside in our free cash flow for the year if we were able to avoid paying increased federal income taxes at IMTT for the year.
Recall we said that if we were able to offset the roughly $13 million federal liability that IMTT incurred in 2013 we’d be at the high-end of the range of our free cash flow guidance. Beyond that we said that there was upside in being able to offset the incremental $30 million in federal taxes expected to be incurred in 2014. But due to the IMTT transaction this month, we can no longer do that.
By acquiring the other half of IMTT we crystallize the current portion of the federal taxes due for the year-to-date period as of the date of closing the transaction. That means including the 15 days in July during which IMTT was jointly owned, our cash tax liability relating to IMTT will be about $17 million and there is nothing we can do about that.
The good news is that we expect that any federal income tax liability generated by IMTT over the remainder of this year and the next will be offset by the application of MIC net operating loss carryforwards. As a result of having been looking for opportunities to deploy tax equity at IMTT, we have a good pipeline of opportunities to pursue, as the sponsor equity, the way we have with our CP&E deals to date or as the tax equity if we think we can use the tax benefits or both.
The remaining upside in our story is of course the additional contribution from IMTT that will be included in our results for the last 5.5 months of the year. The increased contribution from IMTT will be partially offset by firstly the dilution associated with the issuing the new shares and secondly the increase in interest expense associated with the issuance of the convertible debt.
These factors combined with the assumed continued stable performance of our business, all contribute to an upward revision in our free cash flow guidance for the full-year to $4.55 per share. We estimate the weighted number -- the weighted average number of shares outstanding at the end of the year to be right around 63 million shares.
I’ll share some additional thoughts on our third quarter and the full-year in a few minutes. Right now I’ll turn to an overview of the performance and prospects for each of our businesses starting with IMTT.
IMTT and as you know we acquired the 50% of IMTT we did not own in a transaction that closed on July 16th. The final transaction came together quickly in June and early July. We immediately went to the market to raise the funds necessary to conclude the transaction following the announcement of the deal itself. I’d like once again to thank all of you who participated in our offerings for your support. We feel this is an important acquisition for MIC.
The short version of the story is, we paid $1.025 billion for the second half of IMTT at 10.7 times multiple of trailing EBITDA for the 12 months ended March 31, 2014. We funded the transaction with $115 million in MIC stock issued to the seller and $910 million in cash that was raised by public offerings of shares and convertible debt.
Specifically, MIC issued 11.5 million new shares at a public offering price of $66.50, and issued $350 million in convertible debt. Both of these figures include the full exercise of the over allotment option that had been extended to the underwriters.
The remaining proceeds over and above the amount needed for the transaction is now available to fund growth capital projects and acquisitions by our existing businesses. Looking at the quarter just ended, terminal revenue at IMTT was up, but only by 1.2% versus the prior comparable period. More than 100% of that increase was driven by increases in firm commitments. The contracted portion of terminal revenue that today comprises just over 84% of total revenue.
For the six months, total terminal revenue increased by 5.7% compared with the first half of 2013. While the quarter has the appearance of being a bit soft, it was as we expected. The biggest contributor to the relatively slower growth in terminal revenue in the quarter was the large number of tanks that were off to scheduled cleaning and inspection as we had previously foreshadowed.
You will have seen that utilization was down to 91.6% in the quarter, considerably below the historical norm of 94% to 95% range. As a result of having more than 700,000 barrels of capacity out for scheduled cleaning and inspection during the quarter. Clearly, once the work on these tanks has been completed and they’re returned to service, we will see an uptick in both utilization and terminal revenue.
Three other items to note are, firstly, the heating throughput and ancillary revenues were down in the second quarter. While they’ve been up nicely in the first quarter, they’re a bit softer in the second. Secondly, no growth CapEx projects came online in the June quarter. And thirdly, there were only a very small number of contracts that actually came up for renewal in Q2.
As we’ve said, storage contracts are generally spread ratably out over more than four-year cycle, meaning that in any one-year about one quarter of the contracts will come up for renewal. However, within anyone quarter, the number can be lumpy and the second quarter was one in which few contracts renewed.
It’s important to note that storage pricing is inline with our forecast. In fact the pricing environment in IMTT has been largely unchanged for the past four quarters. There were two anecdotal positives I can give. Firstly, [ph] [six] oil storage demand from utilities has been stronger in 2014 following the severe winter and lumpy gas prices during that time. And secondly, we did see a gasoline storage contract in Bayonne renewed early and at a step up in rate at the end of the second quarter.
Total revenue increased 13.3% and 12.9% over the quarter and year-to-date periods in part as a result of contribution from OMI Environmental Services. Remember, OMI Environmental Services used to be called Oil Mop.
As I mentioned in our last call, OMI was working on a spill along the Gulf Coast and that the contribution from that part of the business would overlap the first and second quarters. While the OMI contribution looks impressive at the gross profit line, remember that unlike the terminal business a large portion of OMI’s incremental costs are in the SG&A line.
OMI has a much lower EBITDA margin on incremental revenue than the terminalling business. So the contribution from OMI to IMTT EBITDA, while welcome and pleasing, was nowhere near as large as OMI’s gross profit growth suggests.
As it’s been the case over the past couple of years, cost control remained an issue in the second quarter. Reported terminal operating costs were up 10.9% compared with the second quarter of 2013. To be fair, terminal operating costs in the second quarter of 2013 included an offset associated with insurance recoveries related to hurricane Sandy.
As disclosed at the time, these totaled about $2.5 million. Adjusting for the recoveries in the prior period, terminal operating costs rose by a bit over 5%. That's about twice the rate of inflation and an area that needs attention. As the 100% owner of the business going forward, terminal operating costs will be a focus for us.
As a result of these factors IMTT’s reported EBITDA for the quarter rose 2.2%. However, normalizing the reported results for the tanks out of service for cleaning and inspection special and last year’s insurance recoveries, EBITDA would have been up by approximately 10% consistent with both past performance and our expectations.
The flow-through to our reported 32.7% increase in free cash flow reflects an unusual year-on-year change as well. In particular, maintenance capital expenditures in 2013 were sharply higher than normal, partially as a result of work being done at the Bayonne terminal in the aftermath of Hurricane Sandy. While vastly improved, maintenance capital expenditures are still not where we’d like them to be.
In fact a $26 million for the six months through June, expenditures are running ahead of our guidance. Maintenance capital expenditures for the full-year are expected now to be $50 million to $55 million. To be clear, we’ve included that $50 million to $55 million number in our revised guidance for free cash flow of $4.55 per share in 2014.
To summarize IMTT’s results for the second quarter -- to summarize, sorry, IMTT’s results for the second quarter included a lot of noise, noise that obscures an otherwise normal quarter for the business. We’re getting through the cleaning and inspection of tanks as quickly and prudently as we can and the pricing environment remains unchanged. There remain expense and growth issues to be dealt with, but the difference this time is its now our problem and the question is what are we going to do about it.
So let me shift from a historical to the prospective for a moment and discuss some of the initiatives we have underway and those we expect to commence over the near-term. First, we’re taking a very careful look at operating expenses. There are what the pundits would call the low hanging fruit opportunity such as, first, the savings associated with salaries for employees of IMTT who have retired or left and will not be replaced.
Second, the implementation of our insurance purchasing capabilities and, third, other process improvements. For example, cost approval, delegated authority process, procurements and competitive tendering processes that will result in cost savings. But we’re also being decisive with matters that will see other benefits materialize.
Let me give you two examples from the last week. One related to costs and one related to revenue. First, the costs. This week, following a recommendation from the management on site at St. Rose, we agreed to wind up the operations of a nursery business at the St. Rose facility. I’m talking about plants here, not small children.
I doubt whether too many of you ever knew that there was a small nursery business at St. Rose. The facility had until recently been a supplier of cut flowers to a large retail chain. Most years, it struggled to wash its face from an earnings point of view on a marginal cost basis, but it never contributed materially to IMTT’s overall result.
On a fully loaded basis, it has being loosing money from some time. After failing to renew the cut flower contract however, the nursery became a money loosing proposition even on a marginal cost basis. IMTT management had been wrestling with the issue of how and when to wind up the business for several years.
While we don’t take the closing of the business lightly, especially given the impact it will have on those employees and their families, it’s unfair and wrong to burden the rest of the operations with a non-performing -- underperforming loss making asset. So we made the immediate decision to close the business with the support of management. The land currently occupied by the nursery will be cleared and made available for additional storage and storage related activities.
In relation to revenue, there was a small initiative, but we approved an investment in an enhanced IT capability for IMTT to promote -- for OMI, sorry, to promote direct sales. The system had been under review for some time, but will immediately generate a small amount of revenue. So we pulled the trigger on it immediately. We are trying to ensure IMTT makes quicker decisions. These are very small examples, but I wanted to give you an idea of how we spend our first two weeks of ownership.
Maintenance capital expenditures are another area of opportunity in our view. We believe that the run rate $50 million to $55 million per year in maintenance can safely be reduced meaningfully with the implementation of better policies and processes. By that I mean putting in place scheduled maintenance cycles, putting maintenance work out to competitive tender, and making cost of capital and input into the evaluation process of scope and timing of work. That means by the way that we also have to put in place the kind of incentives that will encourage project management along these dimensions.
The other area of opportunity is, of course, driving growth at IMTT over and above the organic growth rate inherent in the business. Those of you who participated in our last couple of results calls or in the conversations that we had during the capital raising activities, will recall that in addition to talking about operating expenses and maintenance capital expenses, we were discussing growth projects as well. Specifically, we were talking about what we felt were a lack of projects being contracted, notwithstanding the large pipeline of opportunities and demand that we believe should be arising out of the investment in the petchem sector that’s taking place in the U.S.
As I’ve been saying for sometime, the effective deployment of growth capital at IMTT is a high priority course. In fact, we anticipate adding additional resources to IMTT’s project development team to capitalize on the opportunities that exist in IMTT’s key markets.
And finally, following our own advice, and moving quickly, we have kicked off projects looking at financing options for IMTT’s debt and projects looking at tax structuring options, including MLP opportunities. I'd note that as a term at the sale and purchase agreement, nothing can be done on the MLP front for at least a year. And even then, it's not clear to us today what opportunity exists and whether they would create shareholder value, but we’ve commenced the work on both fronts.
Turning now to Atlantic Aviation. Atlantic’s results for the second quarter reflect continued increases in the number of general aviation flight movements in the U.S, together with effective on the ground management of controllable variables such as pricing and costs. A portion of the improved operating performance in both the quarter and six-month periods was offset by the increase in interest expense associated with last year's successful refinancing of the business as well as transaction costs associated with the Galaxy acquisitions. The quarter-over-quarter comparisons will be clear of the interest expense issue going forward, given the refinancing was concluded in May of 2013.
Overall, Atlantic Aviation continues to move in a very positive direction. Flight activity, as reported by the FAA, increased on average by 3.9% for the quarter. Same-store gross profit at Atlantic Aviation rose by 5.1%. So, Atlantic Aviation was able to grow its same-store gross profit 34% faster than industry activity grew.
Including the impact of acquisitions going back to Hangar 10 last December and Galaxy in April, total gross profit was up more than 11%. The results for the second quarter reflect both the cyclical recovery in this business that has been underway since early 2009 and the structural shift taking place in the industry. With flight movements up 3.9% and gross profit up 5.1%, it's clear that a large successful network like Atlantic Aviation is benefiting not only from activity trends, but is gaining market share as well.
Offsetting the improvement in the top line were, of course, the costs associated with the Hangar 10 and Galaxy transactions, as well as the related general and administrative expense resulted from adding about 10% of the size of Atlantic’s portfolio.
SG&A was up 9.7%. But assuming no transaction costs in the future, the percentage change should decline in subsequent quarters. Once we’ve completed the integration of Galaxy, we will provide commentary on the new Atlantic cost base.
The improved performance translated into growth and EBITDA of over 13% and growth in free cash flow of 15.7%. These figures include not-insubstantial transaction costs that could not be capitalized. Once again, we see the considerable operational leverage that exists in this business, driving increases in distributable cash.
We are very pleased with the performance of Atlantic Aviation and believe that the continued improvement in the U.S economy, together with effective management of the business, will drive growth in cash generation over the medium term.
I’d note that the performance of the business in the summer of 2013 was particularly strong. Where characteristically Atlantic Aviation and the GA industry experiences a slowdown in activity in late summer, that wasn't the case last year. And therefore Atlantic has a more difficult comp in the third quarter this year. That said, the performance of the business through July has been good and up on last year.
The performance of the Galaxy FBOs has been consistent with our expectations. Not surprisingly, there is considerable seasonality in the Galaxy business. Florida is a lovely place to fly to in January and a great place to fly from or to avoid completely when it gets hot and humid.
As planned, we’ve implemented some of the strategies we highlighted when we announced the acquisition, notably, our fuel and insurance purchasing programs. And we continue to exploit opportunities to reduce costs and drive revenue growth. We are pleased that the new Hangar at Palm Beach is fully operational. Clearly, it would have been better to have it contributing to the Atlantic result from the time that the acquisition closed, but not everything with the new construction goes exactly as envisaged. In this case, the Hangar floors were not finished to spec and had to be resurfaced.
The biggest issue we have with the Galaxy acquisition is simply the fact that we didn’t close it when we thought they would. As a result, we’re sitting on the equity -- we were sitting on the equity to fund the transactions for 4.5 months without any of the contribution from the acquisitions to offset the carrying costs. But if that’s the biggest issue we have at Atlantic Aviation, then clearly we don't have too many things to be concerned about.
Going forward, we will continue to look for opportunities to deploy growth capital within the business. For example, in acquiring fuel farms on the airports at which we operate, or in the acquisition of additional probably individual FBOs where there is a good strategic value and we can make the acquisition at a reasonable price.
Hawaii Gas. At Hawaii Gas, the aggregate volume of gas sold increased for the quarter and six-month periods. Along with the volume growth, Hawaii Gas benefited from price increases implemented on the non-utility side of the business in February. In addition, local supplies of propane stabilized to a large extent. Together these factors resulted in a nice recovery at Hawaii Gas in the second quarter compared with the first.
You remember that in the first quarter of 2014, Hawaii Gas EBITDA declined by 4.6% versus Q1 2013. We attributed that decline to supply chain disruptions and historically anomalous commodity fluctuations, and said that we were confident the business would rebound.
Some of you rightly asked whether Hawaii Gas had lost its mojo. Happily, the business did rebound, and Hawaii Gas EBITDA was up 31.3% in the second quarter versus the first quarter -- versus the second quarter of last year. Year-to-date Hawaii Gas EBITDA is up 10.5% versus the first half of 2013 and the business clearly has its mojo back. Jay has asked me to remind you that mojo is a non-GAAP term.
The headline 5.6% increase in both the volume of gas sold in the non-utility portion of the business reflects both the outright increase in volume and the change in customer tank inventory levels. Excluding the change in customer tank inventory levels, the volume increase was 3.1%.
Said another way, the volume of gas sold in the quarter includes that which was consumed in the current and prior quarters in which the tanks were not filled as much. This is a normal consequence of the volatility of supply. If local supplies are not particularly stable, then tank left fill levels will be allowed to drop lower in order to accommodate the influx of large shipments from off-island sources.
As a result of the improved stability in local supplies of propane, Hawaii Gas sourced a considerably smaller portion of its total propane sold in the second quarter from off-island sources as compared with the second quarter in 2013, and indeed as compared with the first quarter of this year.
The risk of future supply interruptions in local supplies remains however. In an effort to mitigate this risk, Hawaii Gas will continue to develop additional storage capacity that will provide it with large reserve and the ability to accept larger off-island shipments. In addition to improving the businesses ability to meet local demand, the increased capacity makes it possible for Hawaii Gas to lower its unit cost of purchasing propane from off-island sources.
With our first quarter results, we were able to report that Hawaii Gas had begun moving shipments of LNG from the U.S. mainland to Hawaii. The LNG is being used as a backup supplement to the locally sourced synthetic natural gas. Hawaii Gas distributes via the regulated side of the business. We characterize that as Phase I in our LNG strategy.
We continue to work with Hawaii Gas and local stakeholders in the second quarter to progress Phase II and Phase III of our LNG strategy; increased use of containerized LNG in Phase II, and bulk storage of LNG in Phase III. We’re making solid progress on Phase II. On Phase III, the bulk LNG program I would characterize our efforts as ongoing predevelopment work. We’re working closely with the state, the Hawaiian regulators and like mind in stakeholders to speed the process up and eliminate roadblocks.
Deployment of capital at Hawaii Gas and development of our LNG strategy has the potential to generate a step function increase in the cash generating capacity of this business. As I’ve said before, the Phase III effort would add 50% or more to the earnings of the business or while lowering energy costs for customers and improving the environment.
While we continue to advance our LNG strategy, we wouldn’t ignore all more conventions means of driving value at Hawaii Gas. At this point we envisage pursuing the right case on behalf of the regulated portion of the business in 2015 with an expectation that new rates would be effective sometime in 2016.
Our last rate case filing was in 2008 with an effective date in 2009. We have maintained that rate structure for perhaps longer than we should have and the business is now under-earning relative to its allowable rate of return. However it’s been important to demonstrate our commitment to the fair and equitable treatment of the right payers in Hawaii.
Last quarter we characterized the performance of Hawaii Gas as a temporary step backward. It’s clear through the middle of the year that the business is back on track with respect to existing operations, and we’re pressing forward with our primary growth initiative large scale bulk LNG storage.
Contracted Power and Energy, our existing portfolio of contracted generating facilities performed as we expected they would. We are starting to see some preliminary scale benefits from our portfolio having recently aggregated the insurance procurement across the portfolio, and it has resulted in cost savings versus purchasing a similar level of coverage on a side-by-side basis.
This is just the first step in securing economic advantage from the platform we are creating. We have successfully deployed additional capital in the growth of Contracted Power and Energy segment. We concluded an acquisition of a controlling interest in a wind farm in New Mexico on July 3, deploying $10.6 million including capitalized transaction costs in a facility that generates just under 20 megawatts of power.
The CP&E segment now controls a total of approximately 77 megawatts of power generating capacity and we continue to evaluate what we believe to be attractive opportunities in this space. To this point, we have invested a sponsor equity, a small portion of the overall capital stack in these operations, and we have been the consolidating entity. In the future however, we maybe able to value tax shields associated with an investment as tax equity.
Solar Projects generate both accelerated depreciation of the plant and equipment and in investment tax credit equal to a substantial portion of the tax equity investment in year one. Wind Projects on the other hand generate accelerated depreciation and a production tax credit that has given equal to a substantial portion of tax equity investment for over several years not all in one year.
Speaking of tax benefits, among the benefits resulting from the acquisition of the reminder of IMTT is the ability to consolidate the business for tax purposes as well as financial and reporting purposes. That means we can shield the income generated by IMTT with federal tax at our MIC of our -- from federal tax with our MIC level net operating loss carry forwards. It also means the tax benefits associated with the development of capital in any of our businesses are available for the benefit of all. For example, building new gas storage capacity in Hawaii has the potential to offset a portion of the tax liability generated by IMTT.
Many of you undoubtedly saw our commentary on this segment in our press release. But just as a reminder, assuming the sale of the District Energy businesses that completed in the third quarter, we expect the entire segment to generate about $10 million in free cash flow for the year. We’re providing you with this update simply because the varied interest we have in the business that form the segment make it exceedingly difficult for someone outside of the company to model the results. I realize it doesn’t move the needle a whole lot, but it probably does reduce some frustration.
Looking ahead, before I ask our operator to open the phone lines up to your questions, I’d like to take just a couple of minutes to look ahead to our third quarter reporting and mention a couple of things that you can expect at that point.
We expect the second half of the year to be even stronger than the first half of the year. Firstly, we will own 100% of IMTT from July 15, 2014 onwards. Secondly, IMTT taxes through the closing date of the transaction were crystallized at $0.24 per share and we expect the federal tax liability generated by IMTT in the second half of the year to be offset by the application of MIC NOLs. Thirdly, the Galaxy transaction closed at the end of April, so the first half results included two months of Galaxy cash flows while the second half will have six and thirdly we expect positive earnings momentum at both Hawaii Gas and the CP&E segments to continue.
We expect that there will be noise in our third quarter results surrounding the transaction cost and pension contribution at IMTT that flow from our recent acquisition as well as costs related to our wind investment and the divestment of District Energy. However these costs should be plainly identified so that the result’s excluding this noise is clear for all to see. We have estimated that these items to be approximately $30 million.
Our third quarter results will also include the impact of the remainder of the taxes due at IMTT in the form of amounts over and above estimated payments have already been made, and any liability for the stub period from July 1 through July 15. Total interest expense will be higher as a result of the issuance of $350 million of convertible debt and the ticking fees related to the availability of drawings on our new $250 million holding company level revolver.
There will be a substantial long cash gain running through our P&L in the third quarter as a result of moving from equity accounting for IMTT to consolidating the business. This has to do with fair valuing the 50% of the business we acquired as of the purchase date. And finally much to Jay’s relief, we’ll be reporting our interest in IMTT on a consolidated basis not a proportionally combined basis. IMTT will be combined for two and half months from July 16, not the full three months of the quarter, but consolidated just the same.
In the third quarter and beyond our commentary is likely to be much more focused on our consolidated results rather than on the minutiae of how full a propane tank is in Hawaii for example. I think this will have added benefit of making it quicker and easier for all of you to stay abreast of what's happening at MIC. With the acquisition of the remaining 50% of IMTT, MIC’s consolidated results will now mean something, substantially simplifying the MIC story.
One of the areas we intent to improve is our commentary on growth capital deployment opportunities and these are likely to be the primary source of inorganic growth over the medium term. We’re still working out the details, but in addition to commentary on contracted growth opportunities we’d like to be able to provide you with clearer view into our growth pipeline. One of the options we’re considering is publishing a probability weighted indicator of the types of opportunities being evaluated.
We have substantial liquidity to fund the growth over the next few years, in excess of $1 billion of cash and un-drawn revolver capacity. However as I’ve said before a man with money in his pocket is an easy target. So we’ll remain disciplined in our capital allocation. As 2014 shows where an asset like District Energy is worth more to someone else than it is to us, we will sell it. When its worth more to us and we can acquire it at a prudent price like IMTT at 10.7 times trailing EBITDA, we will look at buying it. We will push our management teams to deploy capital prudently not just to deploy capital. And I trust that you, they and we will be smart enough and disciplined enough to spot the difference.
To sum up, I would characterize MIC’s performance in the second quarter of 2014 as good and consistent with our expectations. There was as ever some noise in the result particularly at IMTT, but nothing we haven’t discussed previously and therefore not really any sort of surprise.
Our primary focus continues to be on finding and executing on good growth opportunities principally at IMTT, but also in the Contracted Power and Energy segment and at each of our other operating entities. Considering all that has gone on of late, we’re pleased to be able to provide you with revised guidance for the full year 2014 with which we expect to grow free cash flow by better than a 11% to $4.55 per share.
With that, I thank you once again for your participation in our call and ask that our operator to open the phone lines for your questions.
Thank you. (Operator Instructions) And our first question comes from the line of Ian Zaffino of Oppenheimer. Your line is now open.
Ian Zaffino - Oppenheimer & Co.
Hi. Great. Thank you very much. On the IMTT side, the barrels that you took offline, back online and then, do you anticipate any additional barrels coming offline to be cleaned and then also then brought back online?
Yes. So a large portion of the barrels that were offline are back online, and there are some new tanks that are now offline. So, I think you’ll see probably a sequential uptick in utilization in the third quarter, but we still got more cleaning to do. And I’d say it all will probably have a number of months to run before we’re back up to the historical norm utilization levels.
Ian Zaffino - Oppenheimer & Co.
Okay. So, if we look at sort of a fourth quarter number, we should expect historic level capacity levels or?
There’s still another 500,000 barrel tank at St. Rose that’s got to be taken out. We haven’t decided yet when we’ll take that our over the next 18 months. So, its hard for me to give guidance partly we’re being sort of tactical in terms of when customers come up for renewal and where we see a sort of window as to whether to do it. So, some of that is going to be operationally tactical.
Ian Zaffino - Oppenheimer & Co.
Okay. And then if we look into next year, are we looking at normal levels again?
You should be seeing improved levels. Again it depends on when we take that 500,000 -- if we take that 500,000 barrel tank out next year rather than this year it will move around depending on exactly when we decide to do that.
Ian Zaffino - Oppenheimer & Co.
Okay. And then, as far as the contract renewals in IMTT, what do they look like next year? If you could give us an idea of the potential of potentially raising prices again, how many contracts are rolling off? How many are, let’s just say below market? And what's sort of the pricing opportunity I should look into, maybe fourth quarter and even into next year?
So if you look at next year, next year has roughly the same number of contracts rolling off as any given year. So roughly 25% of the contracts roll off, maybe a little less than 25%. And in terms of the pricing environment, its part of -- the supply demand equation is still positive in our favor as to what product categories we have more pricing -- we’ve got more pricing power in some categories than others. But what I would expect is to see that what we’ve seen over the last four quarter is that the year-on-year growth in pricing has been a sort of constant rate of growth and I would -- that’s the best visibility I’ve got into that. I think some folks have said, with the changes in management that were -- or the change in ownership and management focus at IMTT, will we be focused on pushing pricing harder. I think the answer to that is we’re much more focused on cost control, maintenance CapEx control and driving growth CapEx. I think pricing -- I’d say IMTT management has done a good job of optimizing pricing in terms of getting the most it can from the opportunities that it faces. So, I don’t think there’s any plan we have at this point in time to change IMTT’s pricing strategy from what's it’s been during our period of ownership.
Ian Zaffino - Oppenheimer & Co.
Okay, great. Thank you very much.
Thank you. And our next question comes from the line of Sameer Rathod of Macquarie. Your line is now open.
Sameer Rathod - Macquarie Capital
Hi, good morning. A few questions here. First, I was wondering if you can comment on what percent of your IMTT storage capacity goes to financial institutions and trading houses. And if you’re seeing any type of fall-off there given that, it seems like a lot of banks and what have you are getting out of commodities?
Yes. So, we don’t break down the nature of the counterparties of the business. It’s a somewhat semantic distinction anyway. And the example, -- and I’ll tell you why, the example I’ll give is for instance in Hawaii where there’s one the refineries in operation, one of the large banks sort of manages the commodity trading position for that refinery. So some of the proprietary trading for one of the better terms the financial service institutions do, they’re doing on behalf of underlying customers. In the case though of people like J.P. Morgan exiting the business they sold their business to, I think it was Macquarie. So when most of these people are exiting the business the physical human beings doing the trading are just changing the font on their business card from a bold bracket firm logo and font to a new trading company firm. So I wouldn’t see to date we have seen any change in demand associated with what you’re talking about as people getting out of those -- the banks getting out of trading businesses. We have seen a change in the name of the counterparty, but often that’s the change in the name of the entity who’s the counterparty, the individual trader who we’re dealing with remains the same person. But I would tell you -- so that would be the sort of macro overview I’d give. The other I would say is, without breaking down the list of clients, the biggest customers of ours are all the big oil companies and the large non-financial service trading companies, the names like Glencore, Trafigura, people like that. So, we do have an exposure to the financial services guys, but they don’t make up. They’re not the biggest customers we have.
Sameer Rathod - Macquarie Capital
Right, right. I guess, my next question on IMTT is, if I think about the lower Mississippi and the growth that’s going on there. It’s clear in New York Harbor that you have a strategic advantage. Are there various entry in the lower Mississippi for storage capacity? It seems like in my visits there, people can add capacity. Are you worried that there might be over capitalization of that industry in this petchem boom?
I’m not really worried about lower Mississippi. I think there are some people with land like ourselves at St. Rose can add capacity. Some of the, you’ve seen in the crude space which is not one we play in and you’ve seen New Star and Plains add extra capacity. The thing I would say, there are barriers to entry in the lower Mississippi which is if you want to get a dock on the Mississippi there are enormous regulatory hurdles to jump through to be able to build a dock. Some waterfront land, a large amount of waterfront land is not suitable for docks because of the flow in the river or the bend in the river or water speeds or water depths or where silt builds up at certain points. So, not all land on the lower Mississippi was created equal. In relation to overbuild, I do think we’ve seen an enormous amount of capacity added in Houston. I don’t think we’ve seen anywhere near as much as added in the lower Mississippi. Having said that, with a lot of the Houston capacity that’s been added the crude processing that’s going on as part of all the liquids being found with the shale gas plays is seeing just a massive increase in product flow through all of those Gulf Coast locations to the Gulf Coast refineries. So I mean, I think high level answer, there are barriers to entry and barriers to construction on the lower Mississippi. I am not that worried about overbuild or excess build there. The area where you’ve seen a lot of capacity added is Houston. Having said that, you’ve obviously seen a lot of incremental product going into Houston as well. So, because we’re not in Houston I am less able to say whether it’s been overbuild there, but there has been a lot of capacity added.
Sameer Rathod - Macquarie Capital
Right. And I guess my last question on IMTT and I’ll turn it over is, I think historically you’ve reported rental rate increases. Can you at least give us directionally what that was? I think based on your comments I kind of found stable or is that a fair characterization?
No, I guess what we said is the rental rate increases have been -- we have been seeing the same level of rental rate increase for the last four quarters, so it’s what we’ve been steering to. I think what we said to people though is, because of the change in contracting type to firm commitments rather than just storage contracts there are some people who are renting just dock access or renting infrastructure and rail availability payments on top of storage commitments. We sort of came to the conclusion in the third quarter of last year that just breaking out storage price in and off itself wasn’t as meaningful as breaking out firm commitments.
Sameer Rathod - Macquarie Capital
Okay. Thanks a lot.
Thank you. And our next question comes from the line of Young Ku with Wells Fargo. Your line is now open.
Young Ku - Wells Fargo Securities
Thank you. I just want to go back to IMTT for a little bit. Just a question on your cost cutting initiative’s there. What kind of a longer term cuts in terminal operating cost and maintenance CapEx do you expect, and how much of that can we expect to be done in 2015?
So what we’ve said in relation to that is, we think that we can reduce costs at IMTT by $10 million, and that, that will be the first target to take $10 million out of the cost base. And as I discussed in my prepared remarks, we’ve already taken a number of the steps to bring about those cost reductions. In relation to maintenance CapEx, we said out that our goals are first to get the maintenance CapEx to $50 million, then to $45 million. And once we’ve got it to $45 million per year, we’ll see if it’s prudent to take it to $40 million per year, but we’ll deliver those in a staged way. Whether we get to the $45 million in 2015 or 2016 is still an open item. And the reason I say that is, there maybe some incremental maintenance CapEx that we do in 2015 as part of a preventative maintenance CapEx schedule to get us to where we want to be. So that will either be a ’15 or a ’16 that we hit that target and then we’ll move to get it to $40 million. In terms of the benchmarks as to why we’re confident with getting that, 2013 IMTT spent even excluding the sandy expenses spent 27% of its EBITDA on maintenance CapEx. Weighted average for the mid-stream terminalling sector is around 7% of the EBITDA. We think we can get IMTT’s maintenance CapEx well down. But even if its double industry average that would be sort of 15% which would be well down on the 27% we spent. That’s why we’re confident we can do it safely and prudently. Obviously we wanted to do it if we think it will compromise our safety or our operations. But I think there are ways to do it including the ways that I outlined in my prepared remarks around more planned and preventative maintenance CapEx rather than reactive maintenance CapEx, a three year planning cycle on maintenance CapEx for each location, competitive tendering of a lot more of the work that we do on a maintenance CapEx basis than has been done to date. So a number of those initiatives, but I think the targets we’ve said $10 million in cost reduction and getting maintenance CapEx to $45 million and then with a review to $40 million. Having said that, I don’t think -- if the answer is that there’s considerably more cost than $10 million, we’ll obviously pursue that and people can look at the example of the cost reduction we’ve done at Atlantic Aviation in the past to see that. The reason we’re not going to promise more than $10 million is that, there’s some areas where we may actually want to invest a little more in costs, for instance in adding to the growth development team. So, what we’re saying is that, we’ll get a net $10 initially, and then we may revisit and see if there’s more to be done than just the net $10 million.
Young Ku - Wells Fargo Securities
Great, that’s helpful. Thank you. You just mentioned kind of potentially adding to the growth team. What kind of the normalized growth CapEx levels that we expect at IMTT?
So, over the last 8 years IMTT has averaged a $100 million a year with a high level of standard deviation around that $100 million. At the moment for the last three or so years, that average has dropped down to about $50 million. The first step for us is to get that average back up to a $100 million. And so we’d like to see IMTT at $100 million and then $125 million a year of normalized growth CapEx.
Young Ku - Wells Fargo Securities
Got it. That’s helpful. And one last question, just going back to IMTT utilization a little bit, it’s little over 91% now. You said normalized that it gets to 94% and 95%. How long do you think it could potentially take to get to that level?
Look, I think it will be bumpy for the next months and by bumpy the big lump that we’ve got to still digest is the remaining 500,000 barrel tank. So whether you see it jump back up in the fourth quarter of this year for a few quarters and then drop down in the back end of ’15 and then rise back up again in ’16 or whether we push that out a little further is still a sort of a tactical question that we’re working through. But I think our view is that those historical normalized rates at some point in the next 18 months will be reviewed and that 500,000 barrel tank when it comes offline will be offline anyway from 6 to 12 months while be in cleaning and inspection goes on. So if you sort of model in 9 months that’s the midpoint of that range. And the reason I say, until you actually get into the tank, workout how long its going to take you to clean out the floor and then workout what repairs you’ve got to make, its not clear exactly how long it takes which is why the wide range from 6 to 12 months.
Young Ku - Wells Fargo Securities
Okay, great. Thank you very much.
Thank you. And I’m showing no further questions at this time. I would now like to turn the call back over to Mr. Hooke for any further remarks.
Thanks very much. It feels like we’re being sprinting non-stop for the past 6 or 8 weeks. I’d certainly be remiss if I didn’t thank my team for an incredible effort in getting the IMTT deal over the line and then turning around and getting the quarter pulled together as well. Our lenders, advisers, accountants, and lawyers all did a great job and we appreciate their efforts even if we don’t appreciate the amount they charge for those efforts. I’d like to thank James May for his efforts during this period as the Asset Director of IMTT, and to congratulate him on his new role as Chief Financial Officer at IMTT. We look forward to providing you with an update of our results for the third quarter in late October or prior to that as events warrant. As always, feel free to contact us with any questions you may have along the way. Thank you.
Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program and you may all disconnect. Have a great day everyone.
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