Northland Power's (NPIFF) CEO John Brace on Q2 2014 Results - Earnings Call Transcript

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 |  About: Northland Power, Inc. (NPIFF)
by: SA Transcripts

Northland Power, Inc. (OTCPK:NPIFF) Q2 2014 Earnings Conference Call August 6, 2014 10:00 AM ET

Executives

John Brace – CEO

Paul Bradley – CFO

Sean Durfy – President and Chief Development Officer

Analysts

Nelson Ng – RBC Capital Markets

Paul Lechem – CIBC

Mathew Akman – Scotia Capital

Steven Paget – FirstEnergy Capital

Sean Steuart – TD Securities

Mac Whale – Cormark Securities

Ben Pham – BMO Capital Markets

Operator

Good morning and welcome to this Northland Power Conference Call to discuss the 2014 Second Quarter Results. Thank you for joining us. At this time all participants are in a listen-only mode.

Conducting this call for Northland Power are John Brace, CEO of Northland Power; Paul Bradley, Northland’s Chief Financial Officer; Adam Beaumont, Northland’s Director of Finance and Sean Durfy, President and Chief Development Officer. A question-and-answer session will follow the summary of results. [Operator Instructions], For the record this conference call is being recorded on Wednesday August 6th at 10am Eastern Daylight Time.

Northland Power Management has asked me to caution you that their summary of results and responses to your questions may contain forward-looking statements that include assumptions and are subject to various risks. Actual results may differ materially from management’s expected or forecasted results. Please read the forward-looking statements section in the yesterday’s news release announcing Northland Power’s results and be guided by its content in making investment decisions or recommendations. The release is available at www.northlandpower.ca.

I will now turn the call over to John Brace, Chief Executive Officer of Northland Power.

John Brace

Thank you operator, and thank you to all of you for joining us this morning. The second quarter was very productive for Northland. And I’m pleased to share the results with you today. Over the past three months the company completed a number of initiatives and made excellent progress on others.

In addition, our financial results were strong, reflecting the continued growth of Northland’s operating portfolio, which is made up of 20 long-term contracted clean and green energy producing facilities. Due to our strong performance so far in 2014, we have increased our adjusted EBITDA, annual forecast and favorably adjusted our payout ratio guidance for 2014. Paul will provide additional details on our financial results later on the call.

We had a number of highlights this quarter, including reaching financial close on Gemini, our 600 megawatt offshore wind farm to be located 85 kilometers off the coast of the Netherlands in the North Sea. If you are familiar with the details of the transaction, which represented the largest ever project financing for renewable energy project, I will review the key – as follows.

Prior to financial close Northland [indiscernible] end the project. The purchase price and subsequent equity investment [indiscernible] funded through a combination of Northland’s 250 million term facility, cash on hand and funds raised March 5th 2014 public offering, common shares, convertible unsecured subordinated debentures

Quick to the acquisition project Gemini reached financial [indiscernible] having placed all of the 2.8 billion euros of equity and debt – project more than 22 parties. Northland and the other project sponsors, which consist of Siemens, the turbine supplier – and along with Van Oord contractor and HVC, a Dutch utility at 10% each, combined equity of 441.5 billion Euros.

In addition Northland provided an 80 million Euro subordinated loan to Gemini alongside an identical 120 million Euro subordinated loan by a group of Danish pension funds. The project has already begun construction of the onshore sub-station and fabrication of the wind turbine monopile foundations and other key hardware such as transition pieces and export cables are well underway.

In addition to achieving this critical milestone for Gemini, we also made significant progress on our construction projects located here in Ontario.

On May 1st 2014, Northland 60 megawatt McLean’s wind project located on Manitoulin Island the third commercial operation. Project which is a 50-50 partnership with the new existing power, a group of First Nation, was completed on time and on budget and has a 20 year power purchase agreement under the Ontario power authorities renewable energy feed-in-tariff program.

Fortunately, shortly thereafter, we took a 21 day outage to repair a failure of the power export cable caused by inappropriate installation of the project contractor.

Other areas during the quarter, our 100 megawatt Grand Bend wind project received its renewable energy approval. However, the renewable energy approval has been appealed by one party on issues related to general health associated with the implementation of wind turbines. These types of appeals have not been successful in the past in Ontario.

Looking at the other side of our unfavorable renewable portfolio, on April 24th Northland completed financing for five solar projects totaling 50 megawatts which comprised the fourth and last phase of our 130 megawatt ground-mounted the program.

The financing facility consists of a 240 million construction credit facility with an 18 year term loan. The final five projects in the program are all in construction and are anticipated to begin commercial operation in 2014 and –

Looking to the United States, during the quarter JP Morgan, the majority equity owner of the 230 megawatt Panda-Brandywine natural gas facility located outside Washington DC exercised its existing rate to terminate the facilities PPA. Northland held a 19% equity interest in this project.

As part of the PPA termination the generating assets of Panda-Brandywine facility were transferred to JP Morgan and Northland will have no further involvement in this project. As a result Northland received a dividend payment of $3.3 million in 08, 2014 and we expect the remaining dividend payments to be approximately $500,000 as the final settlements are determined.

As well on April 23rd, Northland sold its wood shipping facility in British Columbia. Northland’s operating assets now total approximately 1335 megawatts in terms of our net economic interest in them. From an operational standpoint, all of Northland’s facilities met or exceeded management’s expectations for the quarter, except for Northland’s wind projects as we will describe further momentarily.

All of these activities contributed to strong financial results this year, including a 63% increase in quarterly adjusted EBITDA from 2013 and a 43% increase in quarterly free cash flow from 2013. The company continues to demonstrate dependable financial results supported by continued growth and consistent execution on our commitments.

We act under the guidance of our Board of Directors which recently welcomed two new members Barry Gilmore, Russell Goodman. Both of our new directors are seasoned business professionals and we look forward to capitalizing on their experience and knowledge as we continue to operate and grow our portfolio of long-term sustainable energy assets. But the track record that demonstrates strong results and a development pipeline that displays great promise, I believe the company has positioned itself for continued success and achievement over the long-term.

I’ll now turn it over to Paul who will provide additional detail on our financial results.

Paul Bradley

Thank you John and to everyone for joining us this morning. John mentioned we’ve had another very busy and very successful quarter. First I’d like to address a few housekeeping items. John previously described, and is highlighted in the quarterly report release last night. Northland acquired a 60% controlling interest at project Gemini in May and brought it to a successful financial closing.

As a result of our controlling interest, Northland is required to consolidate the financial results of project Gemini and its related entities. Currently while the project is in construction, majority of the impact will be observed through amounts on the balance sheet.

The only impact on the income statement will be the fair value accounting entries on the interest rate swaps associated with the project senior debt. It’s worth noting for this quarter a significant portion, approximately 110 million of the second quarter net loss, represents the non-cash mark-to-market on a Gemini interest rate hedges.

Northland’s business practice is to hedge interest rate and foreign exchange exposures were material. However, for accounting the changes in market rates give rise to non-cash mark-to-market adjustments each quarter flow through the net income line. As per past practice Northland has elected to forgo the application of hedge accounting as it adds various complexities to the other aspects for accounting program.

These fair value adjustments are non-cash items that will reverse over time, have no impact on the cash obligation at Northland or its projects. For our transparency and greater clarity, Gemini will be reported as its own segment in the financial statement notes and in the MD&A.

We recognize that this will add some complexity to our financial statements; however we will make every effort to ensure we provide the disclosures required for our financial statement readers to understand the changes that will result from consolidating project Gemini.

From an operating standpoint, for reference plant operations generally exceeded our expectations for the quarter. First – introduced $81 million of adjusted EBITDA, increase of 63% for 2013.

Northland generated free cash flow of 31 million, again, an increase of 43% from 22 million in 2013. The key factors resulting in the increased adjusted EBITDA for the quarter include one, additional contributions from the full quarter inclusion of North Battleford and the operational ground-mounted solar phase I and phase II projects.

Two, an increase in adjusted EBITDA from Northland’s other facilities bring higher dividends from Panda-Brandywine, interest on the Gemini subordinated debt, which we also refer to as a subordinated loan.

This net increase in EBITDA was partially offset by a decrease from Northland’s existing thermal and wind facilities. These decreases were largely due to planned maintenance outages at Kingston and Iroquois Falls and McLean’s outage resulting from a cable failure as John described earlier. In addition as part of Northland’s growth, we incurred increased corporate management and administration costs.

For reference free cash flow for the quarter increased by 9 million over the same quarter in 2013, for the same reasons as the increase in adjusted EBITDA as offset primarily by the increase in interest expense and scheduled debt repayments due to the addition of a full quarter results for North Battleford in ground-mounted solar phase I, which are introduced to our operating fleet last year during this quarter.

Our dividend payout ratio for the quarter was 126% versus 144% in 2013 all on a total dividend basis, including the affective dividends reinvested through Northland’s DRIP program. The cash dividend payout was 93% compared to a 108% in 2013.

This improving downward trend, the payout ratio reflects Northland’s favorable execution and its development and construction program and is in line with the guidance we have been giving over the last several years about the payout ratio reducing to below 100% as the projects reach completion.

The net loss of 92 million exceeded the prior year, primarily as a result of the fair value accounting loss on interest rate swaps at the Gemini facility, which are now being consolidated. Again this represents the accounting policy as opposed to the economic reality for the project.

Reference financing activities this quarter continued the pace set in the first quarter. In April Northland completed – project financing with a syndicate of finance institutions for the remaining five ground-mounted solar projects under the Ontario feed-in-tariff program.

In May, Northland used 250 million of its term loan capacity on the main corporate credit facility to a fund a portion of its investment in Gemini as we have previously disclosed.

Northland also entered into foreign exchange contracts to effectively fix the foreign exchange conversion rate on substantially all projected Euro denominated cash inflows from project Gemini for approximately 15 years following the completion of construction.

I will now comment on our financial outlook for 2014. Due to the strong performance in our operations over the first half of 2014 Northland has increased our adjusted EBITDA annual forecast upward by 5 million to 350 million to 360 million for 2014.

Commensurate with adjusted EBITDA for 2014, we have also favorably adjusted our forecasted payout ratio for the year to be in the range of 100% to 110% of free cash flow on a total dividend basis improved from 105% to 115% as previously guided.

Due to the amount of corporate capital required for Gemini, Northland’s payout ratio may exceed 100% until Gemini’s completed in 2017, excluding the benefits from this –.

We are not at all concerned about our ability to bridge the payout of free cash flow and excess dividend during this period.

Looking forward, the payout ratio in excess of 100% during Gemini’s construction is expected to be significantly lower and shorter in duration in previous major growth cycles from 2009 to the end of 2013, reflecting our bigger base of operations from the successful deployment of capital.

Going into the third quarter of 2014, we’re continuing to grow our portfolio of projects and believe our financial liquidity continues to remain very healthy.

And with that I will turn the call back to John for concluding remarks before taking your questions.

John Brace

Thank you Paul. I’m pleased to once again deliver results to match the promises we’ve made to our investors. Meeting our commitment to create healthy stable returns is top of mind each and every day for all of us at Northland. We have and will continue to deliver by doing what we do best, finding, developing and building sustainable power projects located in jurisdictions with stable markets and attractive returns, which we then operate throughout their lifetimes.

With proven results across Canada, we have already begun deploying our development strategy to other jurisdictions in Latin America and Europe that match our scrupulous investment criteria. However, our focus remains unchanged, building a diverse portfolio of reliable, sustainable energy assets with investors and stakeholders can count on over the long-term.

That concludes our formal remarks. We will be pleased to take your questions at this time, but beforehand I’d like to apologize for the sound quality. We hear a considerable amount of static at our end of the line, we’re out of the office and although we tested the system beforehand, the hotels equipment seems to be somewhat substandard, so I sincerely apologize for that. Operator, would you please conduct the question-and-answer period please.

Question-and-Answer-Session

Operator

Yes thank you. [Operator Instructions]. Our first question comes from the line of Nelson Ng with RBC Capital Markets, please proceed.

Nelson Ng – RBC Capital Markets

Great, thanks. Good morning everyone. Just a quick question on Gemini, now that financing is out of the way, like from your perspective, what are the key milestones this year and the next year?

John Brace

This year 2014 is going to be relatively quiet in terms of actual physical activities on site. The summer of next year things will ramp up in a big way as monopiles start to be installed, so I’d look for around about mid next year monopiles and big construction activity starting to happen in the project. Most of the time between now and then is manufacturing those things and getting ready for the construction season next year.

Paul Bradley

Right, and add to that the manufacturing process for a number of the key lead-time items is well underway on ahead of schedule. And also, just interestingly, the project gets built from the onshore outward. And we’ve already driven most of the piles for the onshore sub-station, and most of that equipment’s getting ready to be delivered. So there will be a number of things happening, not so dramatic in the background, as John mentioned, until next summer.

Nelson Ng – RBC Capital Markets

Okay thanks. And then, I guess the next question is, it sounds like you guys are actively looking at opportunities outside of Canada, like you’ve mentioned in Latin America and Europe. Can you comment on roughly how many people you have outside of Canada who are focused on seeking development opportunities and what’s the approach to – in terms of seeking these developments?

Sean Durfy

Sure, Sean Durfy here. Yeah, we have the ability to re-deploy some of our folks in the development group to go into places like Mexico and into Chile and also into different parts of Europe, to capture some of the North Sea opportunities. So if you look at Chile, we have representation over there, by two folks were based in Toronto and who work over there. We have different types of arrangements with organizations and people in Mexico, Chile and then in Europe, we have dedicated resources over there as well. So what we do is we re-deploy into the areas of opportunity.

Nelson Ng – RBC Capital Markets

Okay that makes sense. And then just quickly on the opportunities in Ontario, I don’t think there’s been much mention of the CHP opportunities at Queen’s Quay and also at the GM offshore sight. Are those projects on the back burner?

Sean Durfy

They’re in – development is an interesting phenomena right, there’s different phases of development. Some of these developments are longer term and some are shorter term. They are where they’re supposed to be, I guess, within the development cycle within Ontario. As you know on Ontario, the renewables and the renewable sector is sort of in its maturity stage, we still see lots of opportunity, but within Canada it’s much more mature than other parts of Canada. So they’re in a certain phase, other opportunities throughout different parts of the world are coming along quicker than those, but they are still in the development phase.

John Brace

Maybe just add to that, as far as we are doing our best to make sure that the decision makers and the government and other places are aware of the wisdom and benefit of the projects we’re working on, but it takes two to tango as John says.

Nelson Ng – RBC Capital Markets

Got it, thanks. And then just one little last question, in terms of the two gas developments in Illinois, has there been any progress in terms of getting a contract. Like has there been a process set up for those facilities to – or in those regions to a word contracts or are you still working on the I guess background stuff to get it ready for a future RFP?

Sean Durfy

Yeah, so we’ve got two projects, one is – they call it the Illinois peaker so it’s an peaking plant that we’re looking at development in that area. And also, we have an Oakwood Hills plant that we’re looking at to base little plants also. What happens with those two, again, during the green – what I would call the Greenfield development, it’s at very early stages still and we’re still looking at taking the product, specifically the Illinois peaker product out to credit counter parties and looking at PPAs.

We had the community consultation process with the Oakwood Hills plants. And there was a lot of interest, maybe not positive interest, but a lot of interest that came out of that discussion. And we’re assessing what we want to do with that opportunity. So we’re still, again, it’s in the development phase; we’re in the marketing phase of trying to secure PPA’s with credit worthy comp price.

Nelson Ng – RBC Capital Markets

Okay, thanks John.

Operator

Thank you, our next question comes from the line of Paul Lechem with CIBC.

Paul Lechem – CIBC

Well thank you, good morning. Just going back to Gemini for a second, I was wondering, can you discuss the actual project Gemini theme or the operations that have been set up over in Europe. Is that fully staffed up now, can you describe what’s going on there and then how much continual oversight and work that’s being delivered by Northland itself at this point in time?

John Brace

Sure, Gemini the project itself, basically think of it as a stand-alone company that has or will have all of the resources necessary to successfully execute the project. That team is largely in place, the CEO of Gemini has been with the project since part way through last year. And he has been staffing up the rest of the team, a large number of those have come from people who had been working on the project during the development phase and there’s been hiring elsewhere. So that’s largely intact, there’s a few holes to go and a few things that one would not staff fully at this point in time, given the stage of the project. So consider that sort of the frontline execution of the project, on top of that there’s a board of directors.

We sit on that board, Paul and I are Northland’s representatives, and that’s really the oversight for the project. And through that form, we exercise our rights and decision making privileges in the project, I happen to be the chair of that board. In addition to that, there are people from Northland, including myself, who spend fair bit of time on a day-to-day basis understanding what’s going on with the project, monitoring what progress going well and what progress may need some attention. And so we’re intimately involved in that in terms of execution of the project.

Paul Bradley

And I’ll add to that that we also have the CFO on board, who’s a very seasoned Dutch professional. Our board seats that John and I carry, carry 60% of the votes, however during construction to the extent there is any issue with the turbine supply or the balance of plant, those board members are excused, that involves their firm. So effectively, on a normal course John and I would carry 60% of the votes, but in reality for big construction issues or turbine suppliers.

We’re going to carry substantially more votes on that. I’d also add that there were service level agreements between [inaudible] where we have people inserted into the project at various different levels, but in order to comply with the governance, we have it done under a service level agreement. So net-net as we have quite a number of eyeballs on the project at current.

Paul Lechem – CIBC

I got you , thanks. In terms of the of the CapEx? [indiscernible]of that 2.8 billion euros, how does spread out through 2017; do you have a rough guideline?

John Brace

We have not published anything at this point. So, we have something that we’ll have to look at providing perhaps in the future. The – what we can say is that it’s a little bit bipolar, in other words we have some very heavy expenditures in the beginning in a sense that we got to order equipment and put deposits down and manufacture a lot of steel components and turbine deposits. And then as you could imagine towards the back end of the project you got a lot of it, literally heavy lifting going on and final progress payments, but we will see if we can develop something that maybe of more use.

Paul Lechem – CIBC

Okay. Thanks. And then just lastly on the business development front, I was wondering given the Gemini spend over next few years, what is the appetite to take on significant more new projects over that timeframe, I understand you are looking around, but what does that mean in reality over the next couple of years in terms of how much you are prepared to actually dive into more projects?

John Brace

Well, I think, if you look at the opportunities that are looking at us on the face in and with regard to offshore wind in the North Sea, given our success on Gemini one of the first IPPs to successfully non-recourse finance a large project, we do have a lot of opportunities that we’re looking at right now, currently. So, I would suggest, if the projects return the type of return that’s commensurate with the risks in taking on these projects, if they are accretive, and if they are within our competency wheelhouse,

I would suggest why wouldn’t we look at them and get involved in more opportunities in the North Sea. So, we like what we see over there and we like the dynamic where, a lot of the utilities were involved in offshore wind are looking for partners help on the project finance side and it fits our expertise very well. So, I would say, yeah, we’re going to continue to look at all opportunities that come our way.

Paul Lechem – CIBC

Okay. Thank you for that.

Operator

Thank you. Our next question comes from the line of Mathew Akman with Scotia Capital. Please proceed.

Mathew Akman – Scotia Capital

Thank you very much. Good morning. Just to the follow-on to the development question, the Latin America reference I guess, was mentioned in the first quarter but was published in the MD&A in this quarter, and I am just wondering if that is significant in terms of getting closer on projects there, and maybe if so, just expand on the attraction of the region?

John Brace

Yeah, I am – I am going to have to apologize to the folks in Latin America and Mexico because I group them together and I probably shouldn’t do that. So, two specific areas we are looking at is Mexico and Chile and surrounding areas around Chile depending on the political and the regulatory environment.

We looked at opportunities in Mexico at the beginning of the year; we saw that one that we really liked but, at the time we were very deep into Gemini, and we decided to concentrate on that. We continue to see opportunities on the wind side in Mexico, same idea in Chile.

What we like about Mexico is, they are going to need 54 Giga watts of power over the next ten years or less to power the manufacturing sectors, specifically in the automotive sector in Mexico. They also are going to, as you probably know, the deregulation of their electricity and energy market in general. So, with that there is a tremendous opportunity, and I have seen that first hand in Alberta market, where I first got my teeth in the energy sector and where you can – where you can really leverage the opportunities.

So, yeah, I like Mexico and Chile is very good location for Canadian investment, and we are talking specifically to some of the mining operations that need that. There is also a constrained system in Chile which allows for, favorable environment for renewables. So, like, I think those two marketplaces over the long term in terms of development are very positive.

Mathew Akman – Scotia Capital

Just as a follow on, I guess, do you see any risks in Mexico that you wouldn’t see in other North American markets or in Europe?

John Brace

Sure, what I mean – listen, a hostile crowd in Illinois is a risk as well. Right so, yes we see risks and I don’t mean to be flipping about it, but we see risks in other jurisdictions, security risks specifically in Mexico, and we’ve actually had analysis done by a third party to look at the risks in Mexico and to look at specific areas where we see substantial projects happening, and the areas that we could tolerate the security risks. So there are several areas that are – what we could call the green light areas, the goal areas, of course but there is also – a phase that we probably we wouldn’t enter into. So there is lots of opportunity but we are accepting those risks.

Paul Bradley

As our job is to find projects, look at projects, understand the risks, control the risks and to bring them into a world that is acceptable to us and our shareholders.

Mathew Akman – Scotia Capital

Yeah, I appreciate that’s a – some other Canadian companies have not done so well in power in Mexico, has that helped you study as an example?

John Brace

Yes we are.

Paul Bradley

Yeah.

Mathew Akman – Scotia Capital

Thanks guys. Those were my questions.

John Brace

Thank you.

Operator

Thank you [Operator Instructions] Our next question comes from the line of Steven Paget with FirstEnergy Cap. Please proceed.

Steven Paget – FirstEnergy Capital

Thank you and good morning. Could you please let us know how long you plan to have a DRIP in place given that some of you have already financed Gemini’s, is the DRIP really providing the equity financing for Grand Bend and Frampton?

Paul Bradley

Steven, the – while the DRIP right now is on, as you can imagine, that it’s one of the tools that we used to give the confidence to investors that we have liquidity to get through the growth period, we do have development spending going on in equity required in Grand Bend and in Frampton, for example, as well as anything else that may come along the pipeline, and certainly on a probability weighted basis – there certainly – we soon expect that to happen.

The DRIP is the most efficient way for us to raise equities instead of dollar cost averaging if you will, as you go to the equity markets. So really unless and until we see a period of time we will never have to go back to market to raise equity; the DRIP is a pretty effective and a efficient way for us to raise a bit of equity capital as we go and do it an orderly fashion. And as there’s really no commissions payable on that but the discount is pretty favorable given there’s no transaction cost really associated with it.

Steven Paget – FirstEnergy Capital

Excellent. Thank you, Paul. And John, may be you could describe where you expect Gemini to be at yearend 2015? How much of the CapEx had been spent and how much of a sub-sea construction will be complete?

John Brace

On the CapEx front, David, I will come back to Paul’s discussion to one of the prior questions about that we haven’t provided any breakdown of the spend curve for the project. So we will look at that and see how we can rise to the needs of you and others for information of that nature. On the physical side of the plant, by the end of 2015, if I recall correctly, we should see basically the monopiles in place for the project. 2016 is basically the campaign for installing the turbines and bringing them into operation which will be completed in 2017.

One thing I would add to the capital expenditure profile over time, of course being a project financed project, all of the equity goes in first to get spent first and the debt follows. And, finally, I just remind you to remember that the offshore high-voltage platform should be put in place in 2015.

Steven Paget – FirstEnergy Capital

Yeah, that’s a credible component. And thank you both. And at McLean’s is the cables fixed and has there been any net charge to Northland?

John Brace

The cable has been fixed, yet in terms of net charge to Northland the real cost to us was a business interruption deductible. Coincidentally, the period of the interruption was basically equal to our deductible period in the business interruption.

Steven Paget – FirstEnergy Capital

Okay. Thank you. And finally, and I am sorry if I missed this, did Gemini return the initial $24 million your, old letter of credit?

Paul Bradley

That has now been returned.

Steven Paget – FirstEnergy Capital

Alright, thank you Paul and those were my questions.

Paul Bradley

Thanks Steven.

Operator

Thank you, our next question comes from the line of Sean Steuart with TD Securities. Please proceed.

Sean Steuart – TD Securities

Thanks. Good morning everyone. Question I guess on your circling back on your willingness to take on more development opportunities while Gemini is being built. And you obviously have a lot of potential, whether it’s on Latin America the States or Europe. Is there any context you can give us or benchmarks around how high you’d be willing to push the payout ratio.

We’re appreciating it won’t be as high it was when you were building North Battleford and the ground-mounted solar, but is there a level we should think about in terms of your comfort level of, your willingness to take on more mid-term growth opportunities while Gemini’s still being built?

Paul Bradley

Yeah Sean, that’s an excellent question, and you could imagine that’s something that we debate everyday in the management team and with our board, which we had one yesterday. And it’s a paradox between development for Northland is always going to cause the payout ratio to be elevated beyond where it would otherwise be because there’s a lag between when equity is raised and when projects deliver its income.

So it’s a question of degree – and some degree, we’re going to have our comfort level and the market will have its comfort level. And as we’ve seen in the past, those don’t always converge. And part of our job is to get everyone comfortable that when we are at a payout ratio above 100% then it’s really a bridge, it isn’t any kind of perpetual condition.

So therefore where does that specifically get to your question, at what level do we get comfortable? That’s something that we sort of look at a guide post of perhaps a 150% of our payout ratio as to where it gets to be a tougher story to explain, depending on how long that bridge is going to be. Right, if we have it at, again go back to where we were back in 2012 at 197% and that’s going to endure for three years. That was a pretty big bridge to go over for a lot of folks, despite the fact that management team knew exactly how that bridge crosses the water.

Now as you know, we’re at a significantly different place than that, notwithstanding that we’ve got the largest project we ever done under construction. So ultimately do we have room for something approaching the size of a Gemini, one project or several projects? And I would say I believe we do. Could we do two or three of them at once? Yeah, that’s probably a bit of a tall order. So it’s, again, going to be more an issue of whether we believe the market gets very uncomfortable more than it is, where we get uncomfortable.

Sean Steuart – TD Securities

Got it. Thanks for the context, Paul. And that’s all I had.

Paul Bradley

Okay Sean, thanks.

Operator

[Operator Instructions] Our next question comes from the line of Mac Whale with Cormark Securities. Please proceed.

Mac Whale – Cormark Securities

Hi Paul could you give a rough split on the Gemini cost related to equipment versus installation, I guess its 50-50 or 80-20?

Paul Bradley

That’s a good question. I would have been able to answer that a few chapter and verse, about three months ago.

Sean Durfy

Mahesh Maybe I could try Mac. Roughly speaking if you look at the 2.8 billion cost, something more than half of that is related to the contract with Van Oord, which is a combination of installation and the equipment that they are supplying and some things, somewhat less than half of that is associated with the contract of Siemens for the supply of the turbine. So it’s not, not a strict equipment installation split, but it’s really the scope in the responsibility split within the project.

Paul Bradley

Yeah and if you think about it, we write three major checks a month. And that’s one to Siemens, one to Van Oord and then we have to pay the interest on construction. Obviously we have things like payroll and office rent and whatever, but those are the three big checks that we write. And what’s underneath Van Oord’s scope as John mentioned. – may launch between equipment and the labor, whereas the turbines are pretty straight forward although some of it does include installation and other services.

Mac Whale – Cormark Securities

Okay so would the profile – payments look the same over the time?

Paul Bradley

No, no they have different dynamics to them, yeah.

Mac Whale – Cormark Securities

Okay moving on just to, I’m just curious about the development process and how its changed internally, – would have been going on the conference call around this certainly in different ways, but I’m just wondering whether if you look at say two years ago versus now. Have you gone to your internal development people and said, “we don’t want to see anything over, under a certain size,” or has it really stayed the same. And I guess this has to do with your return on your investment in those people if you will on them. I’m just trying to understand whether something, whether anything is changed internally about how you manage your development process?

Paul Bradley

It’s a great question and its one that, that we actually had a conversation at the board yesterday about. And I would say yes it has changed. Gemini has fundamentally shifted the way we look at projects. Its fundamentally changed Northland Power for all the right reasons and for good reasons. And it’s elevated our setting to the next level.

So what happens with that is, in order to what I would call move the needle, we’re looking at projects that are somewhat larger in size. There is a screening process that we have to focus the folks in terms of, here’s the technologies we’re looking at, here’s the geographies we’re looking at. Here’s a type of returns we look at and then here’s the size of projects we would look at.

And we estimate that we’ve got to deploy somewhere in the tune of $125 million to a $150 million in equity a year over the next decade. On average and it will be lumpy, because there will be different size projects. If you look at how we would have deployed equity over the last decade in the first half of the last decade we deployed somewhere between 30, 40, 50 million in equity would be substantial projects.

And then in the last half of the last decade it would be 90, 100, 110 million. And so now we’re up to 125 million to 150 million in equity per year. So it’s’ changed, it sure has changed. And again, what I see happening is the amount of time and effort and brain trust that has to go into doing smaller projects and projects with partners.

It’s probably the same or sometimes a little more than the amount of breakups that has to go into doing these larger projects. So yeah, it’s changed and I think for the better. And as you see these projects becoming more complex, we as an organization are putting, I think, a more diligence in place. Gemini for example has a board committee that has governance oversight in terms of the actual Gemini project on a whole. So we actually have a board committee established from the last year. So the proper governance internally is being respected, so yeah things have changed.

Mac Whale – Cormark Securities

Alright. That’s helpful because I think it puts – sets the stage what we should be thinking about your, the yardstick against what we, what we perhaps judge your success against on a development front. I think that’s helpful. And I guess the last thing then related to that is, by shifting that sort of threshold. When you look at your strength, it really is in papering the deals, it’s controlling and managing the risk in going bigger. Is there anything, are there any parts of that process and the risk control that gets problematic.

Like it surely isn’t exactly the same, or is it. I’m just trying to get an idea of whether it was anything in the process and the control of that process that gets difficult to handle over what you’re used to?

Sean Durfy

Mahesh Let me, I’ll start and then I’m sure the guys will chime in, but I think one of the things that’s been evident to me as I’ve transitioned I guess, from a board seat to manage and looking at the smaller deals and then in the last three years looking at Gemini from a board and from a management perspective. One of the things that has been incredibly refreshing is, and comforting, is the knowledge base that we have brought to projects like Gemini in terms of our fundamental understanding of contract management and contract evolution and being able to look at contracts differently than either utilities or other folks who don’t have our competency.

So, when you come to a project like Gemini, the value that we brought was understanding contracts, negotiating contracts, writing contracts and then getting those contracts ready to be project financed, and that’s one of the largest renewable projects ever financed. So I think a lot of our skills are transferable regardless of the size, but I’ll let Paul get into the next.

Paul Bradley

Yeah no, I’d echo that and I’d probably reemphasis the project finance discipline as the cornerstone of how we’ve always done our business and how we’ve always looked at managing risk from the standpoint that, if you have a lender putting in the proponents of the capital on a non-recourse basis. And they need to have that debt service covered by, call it 1.3 times and then get covered with a lot of belts and suspenders; we look at the project pretty much the same way.

And to the extent that you can get to a closing on a project finance, it means by definition you had to plug the majority of the risks along the way. And what, for something like project Gemini, we have a CEO and a CFO on board. The company, the project company whereas on a small project in Northland I might have the equivalent of a fifth and a finance person on that project. So it’s bigger in scale, but in some ways what we lose in the complexity.

We gain in the attention span because that CFO now focuses 110% on that project alone, as opposed to spreading out among a number of them. So there’s some wins and losses from the risk management, but I think from an overall basis, one of the things we stuck to our guns right from the beginning of Gemini with our consortium members and with the banks and with the investor community was, this project’s going to have to fit the same risk management mould that all of our other projects have.

And I think to date we’ve actually delivered on that. So the other component that becomes more challenging, and this had to do more with where Gemini was located than it did the size of Gemini, is that suddenly we have a material exposure to a foreign currency. And we’ve had some more complex borrowing situation and that creates a more complex hedging situations for the debt and some of the equity returns that we have coming back.

But likewise within Northland you’ll see in our discussion in the MD&A, you’ll see some of our corporate administration expenses have gone higher because we’ve been doing things over the last two and a half three years. Such as building a treasury department and building other areas to handle those new risks that we have. So this is really all evolving in a pretty logical unfolding with projects getting bigger.

Sean Durfy

Maybe I’ll just add a few thoughts as well, starting off with, if you really look at the big picture of what’s happening. We all know on this call that the opportunity for growth in Canada or anybody in the power sectors is fairly limited. We have a number of projects that we think highly of, they were continuing to try to pursue but, and all things put together, Canada our home base where we’ve grown up and understood the business very well. If we want to provide additional value to our shareholders, we’ve got to look further afield, which is what we have been doing.

If you look at projects themselves, the construction contracts, the equipment supply contracts etcetera. The disciplines are very transportable from one jurisdiction to another. Once you enter into the equation when you go somewhere else, are all the risks that come with not knowing, at the beginning anyway, details about the energy sector, information about political stability and on and on. And then dealing with the very important project questions like Paul was just talking about, like foreign exchange exposure.

So as we have all entered other jurisdictions we are taking the heart of our expertise from history and adding to it the capabilities to analyze and understand and control the new elements that have been brought into the equation, because when it’s all said and done, where it’s not our intent to increase the risk exposure to our shareholders for Northland power.

Mac Whale – Cormark Securities

Great that was helpful, thanks. That’s all my questions.

Operator

Thank you our next question comes from the line of Ben Pham with BMO Capital Markets. Please proceed.

Ben Pham – BMO Capital Markets

Okay. Just stay on Gemini and this is on page 23 of the package, just the additional risk that you’re disclosing on the project Gemini. And I just wondered if you could provide a reminder of the residual risks if any, that you have. Or that project Gemini has in terms of natural event risk? There’s also commentary about a strict timeline of November 2016 to initiate the first contract on your first turbines? Can you expand a little bit more on that sentence?

Paul Bradley

In terms of your first part of your question. The residual risk, again, I think we have very diligently looked at the project and tried to understand and control and deal with all of the risks. What is new perhaps, that you brought up in a sense, is the offshore, it sounds and feels the same but the offshore element of the project, it is more difficult to build projects in the offshore than it is on the onshore, you’ve got waves, you’ve got ships that are involved with it.

However, as we’ve gone about the project and as we contracted with Van Oord and Siemens. We have, to a very large part, as the risk to them for the marine environment in the construction. And we believe we have more than sufficient contingency in the project and the project budgets to deal with anything that would be beyond what they’re talking about.

Paul Bradley

And perhaps more specifically as we’ve shared, as we’ve talked to investors and I think on some other calls as well, that I mean the two main headline risks that boil out of here are basically weather risk, which is substantially pushed off on to the contractors but not totally. And there are unknown sub-surface condition risks, and the three examples that we used there are for example boulders, there’s unexploded munitions from the various conflicts in the North Sea.

And there’s things like shipwrecks that become archeological dig sites. And those, the mitigations there are we have latitude to put foundations in around those issues if we do hit them, but of course if there are any of those that present themselves and we do end up with a bit of cost.

And in sizing our contingency with the banks, we had to do a pretty detailed assessment of the probability factor of putting in 150 turbines, there’s some probability factor that so many of them are going to hit boulders or UFO’s or some other type of condition where we’ll have to move them or perhaps we’ll have to amputate one of the monopiles and start over. And that’s a known amount and it’s something that’s controllable within our base contingency of the project.

So those are typically the headline risks that we’d say, what’s that, how would that be unusual from something like a McLean’s Mountain or Grand Bend wind farm.

Paul Bradley

Just to, however to say there’s already been a lot of sub-surface investigation for all of those issues conducted already even before financing. With regard to the schedule November 16, 2016 we don’t view that as a material risk for the project and its schedule.

Ben Pham – BMO Capital Markets

So on November 16th I wanted to clarify, so you’re going to reach x critical math on x percent of your turbines and you’re going to initiate on the first contract and then the balance of the turbines you would initiate a second contract?

Paul Bradley

No, it’s just that you have to have the first turbine operating even though its, you don’t have to have the whole wind farm in operation in order to qualify for that. And even beyond that if there the project were late, it would underscore the importance of this project to the Dutch government and exit. Our conclusion is it’s not a material risk.

Ben Pham – BMO Capital Markets

Okay very good. That’s the only question I had. Thanks everybody.

Paul Bradley

Thank you Ben.

Operator

And I have no further questions at this time.

Paul Bradley

Okay thank you everyone.

John Brace

Yes thank you everyone for joining us. We’ll hold our next call following the release of our third quarter results in November. And I would like to once again apologize for whatever difficulties you are having with the sound system as we are having here. Thank you very much.

Operator

Thank you ladies and gentlemen. That does conclude the conference call for today. We thank you for your participation. I ask you to please disconnect your line.

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