InfraREIT, Inc. (NYSE:HIFR)
Q3 2015 Earnings Conference Call
November 06, 2015, 11:00 ET
Brook Wootton - Director, Investor Relations
David Campbell - Chief Executive Officer
Brant Meleski - Chief Financial Officer
Greg Gordon - Evercore ISI
Sophie Karp - Citigroup
Good morning and welcome to the InfraREIT Third Quarter 2015 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Brook Wootton. Please go ahead.
Thanks, Amy. Good morning and welcome to InfraREIT’s third quarter 2015 earnings conference call. Joining me today are David Campbell, Chief Executive Officer and Brant Meleski, our Chief Financial Officer.
Before we begin, I would like to make everyone aware of certain language contained in our Safe Harbor statements. The company cautions that statements made during this call are forward-looking and are subject to various risks and uncertainties. Actual results may differ materially from our projections and expectations. These risks and uncertainties are discussed in our reports filed with the SEC. Our forward-looking statements represent our outlook only as of today. We disclaim any obligation to update these statements except as maybe required by law. In addition, during this conference call we will make reference to certain non-GAAP measures. A reconciliation of these non-GAAP financial measures, are available on the Investor Relations section of our website.
I will now turn the call over to Brant Meleski.
Thank you, Brook and thanks everyone for joining us this morning. We have a positive 2015 third quarter to report for InfraREIT. I will open the call today with a review of our financial performance and then turn it over to David to discuss our updated guidance and development pipeline. I would like to direct your attention to the supplemental slide that we posted on our website this morning.
Slide 3 summarizes our key financial metrics for the third quarter. Lease revenue grew 6% in the third quarter of 2015 relative to the third quarter of last year. Adjusted EBITDA for the third quarter of 2015 grew at a 9% rate compared to the third quarter of 2014 and cash available for distribution increased 19% in the third quarter of 2015 relative to last year.
Slide 4 covers the same metrics for the nine-month period ended September 30, 2015. For that period, lease revenues grew approximately 12% compared to the same nine-month period of 2014. Adjusted EBITDA for the nine months ended September 30, 2015 increased 12% relative to the first nine months of 2014. Finally, cash available for distribution year-to-date 2015 increased 23% compared to the year-to-date 2014.
On Slide 5, you can see that a $2.2 million increase in lease revenue was the primary driver of our adjusted EBITDA growth compared with the third quarter of last year. G&A expense was $5.5 million in the third quarter, a decrease of approximately $600,000 over last year, largely a result of lower professional service fees associated with the reorganization ahead of our IPO and partially offset by higher management fees. In our calculation of adjusted EBITDA, we adjust for percentage rent and straight line rent impacts in our calculations.
As we have discussed in detail on prior calls, it is important to remember the revenue recognition of base and percentage rent payments are different from the cash payments described in our leases. The difference between the cash received in the quarterly lease payment associated with the percentage rent and GAAP revenue is reflected in the row on Slide 5 described as percentage rent adjustment. We began recognizing percentage rent during the third quarter as our tenant exceeded certain annual specified breakpoints under our leases. The third quarter included an adjustment of negative $2.8 million compared to a negative $4.2 million adjustment in the prior year. The difference is primarily driven by the fact that a higher percent of our revenue was received through base rent during the third quarter of 2015 versus the third quarter of 2014. We also adjusted the difference between the base lease payments in the third quarter and the GAAP revenue recognized in the third quarter under straight line rent accounting.
As shown on the row labeled base rent adjustment on Slide 5, this adjustment equaled $300,000 this quarter compared with $900,000 in the third quarter of 2014. During 2014, we incurred reorganization expenses of approximately $800,000 related to restructuring the company to prepare for our IPO in early 2015. The final adjustment backs out non-cash income of approximately $700,000 primarily consisting of AFUDC equity resulting in $33.5 million of adjusted EBITDA in the third quarter of 2015, a 9% increase over last year.
Slide 6 covers the adjusted EBITDA numbers for the year-to-date period ended September 30, 2015 compared to September 30, 2014. We make the same line item changes as the third quarter except of first quarter included $44.9 million non-cash restructuring charge that is reflected in our G&A expense and then backed out to calculate adjusted EBITDA. Through September 30, 2015, our adjusted EBITDA was $101.8 million, an increase of 12% driven primarily by a $10.9 million increase in our lease revenues.
Slide 7 covers the calculation of cash available for distribution or CAD building up from the net income of $19.4 million in the third quarter of this year. The line items on this page generally match the adjusted EBITDA table with a couple of additions. First, we add back the non-cash amortization of deferred financing costs of $612,000. Second, we add back non-cash Director equity compensation of $185,000. Third, we deduct $10.3 million, which is the amount of capital expenditures required to offset depreciation during the quarter and maintain our net assets at a constant level.
Since our contractual lease revenue falls over time to reflect the depreciation of our existing assets, we need ongoing investments to equal depreciation in order to maintain our lease revenues. For this reason, we deduct an amount of capital expenditures equal to depreciation which we refer to as capital expenditures required to maintain net assets before determining our CAD. This is an important element in ensuring that CAD reflects the sustained revenue potential of our business and that’s informed decisions related to dividends.
Slide 7 shows our CAD this quarter was $0.28 per share and Slide 8 reviews the CAD calculation for the year-to-date ended September 30, 2015 of $0.88 per share. Slide 9 highlights that we ended the quarter with approximately $335 million of liquidity and our long-term debt decreased slightly due to the principal repayments in a few outstanding notes. There was an increase in our short-term debt of $20 million during the quarter as we have invested the excess cash form the IPO and we will now begin to utilize our revolving credit facilities to fund our capital expenditures.
Turning to Slide 10, one of our priorities for this year is to refinance our $389 million senior credit facility which we expect to complete before the end of the year. Longer term we target consolidated credit metrics of 60% debt to total capitalization and 12% adjusted FFO to debt. We remain confident we will be able to fund our Footprint project capital expenditures through 2018 without additional equity issuances. To fund ROFO project acquisitions, we anticipate raising equity proceeds that will enable us to maintain our long-term debt to cap and adjusted FFO to debt targets. Assuming the independent directors approved the purchase of the two ROFO projects during 2016 and given their size, we would expect to issue equity to fund a portion of these acquisitions. We are monitoring the equity capital markets and any final determination to issue equity will depend upon market conditions, the ongoing evolution of our business, negotiations with the sellers as well as input from our independent directors. In summary, financial results were as expected in the third quarter of 2015 reflecting the fundamentals that drive the growth in our business.
I will now turn the call over to David.
Thanks, Brant and thank you to everyone on the call for your interest in InfraREIT. Turning to Slide 11, as Brant described, our third quarter performance continues to highlight the strengths of the fundamentals of our business. For the full year, we are increasing our CAD per share guidance outlook from a range of $1.07 to $1.12 per share to our new guidance range of $1.10 to $1.15 per share. The increase primarily reflects the impact of lower than expected interest expense due to refinancing the senior credit facility later in the year than previously expected.
The full year CAD projection also incorporates the expected impacts of incremental G&A cost associated with increased evaluation of the ROFO projects and other strategic opportunities. We expect our fourth quarter 2015 dividend to remain at $0.225 per share since the interest expense savings are one-time in nature. We are reaffirming our guidance for the three-year annual growth in distributions per share of 10% to 15% to the end of 2018. We expect organic growth in our base business driven by capital expenditures associated with footprint projects will enable achieving the lower half of the company’s target of 10% to 15% annual growth in distributions per share. Additional footprint project capital expenditures and potential acquisitions, including the acquisition of the Cross Valley transition line and the Golden Spread interconnection project, negotiations for which are imminent would enable the company to achieve the top half of the 10% to 15%.
Investment in our existing service territory through what we call footprint projects is described on Slides 12 and 13. Our CapEx for the first nine months of 2015 equaled $159 million. Of this total, approximately 60% of CapEx funded transmission investments, while the balance went towards distribution investments. For the full year, we are updating our CapEx forecast for 2015 from a range of $240 million to $250 million to a range of $210 million to $220 million. This decrease was driven primarily by two factors. First, revised plan for the sequencing of the construction of transmission projects in order to ensure safety and reliability while these projects are underway, and second, unexpected land acquisition issues has delayed the deployment of projects and related follow-on work.
The change in 2015 CapEx is timing related rather than the reflection of cancelled projects. On a related front, the update to our three-year capital expenditure plan highlighted other phasing changes, our current estimate of total 2015 to 2017 footprint projects, capital expenditures of $720 million to $775 million. The high end of this range is in line with our prior guidance, while the low end of the range has decreased from $745 million to $720 million. This shift reflects the widening of the range for each individual year largely to embed more swing for potential timing changes. The yearly estimates are shown in detail on Slide 13.
Relative to our prior estimates, the data on Slide 13 reflects the shift in CapEx for footprint projects from 2016 into 2017 driven primarily by the revised phasing estimates for the addition of the second circuit to our CREZ lines in the Panhandle. With respect to the latter project, a positive milestone was achieved at the September 24 Texas Public Utility Commission meeting, during which the commissioners voted to recommend the completion of the CREZ second circuit. This project will require CCN approval, the application for which Sharyland intends to file on early 2016.
Additionally, based on the number of wind generation interconnects in the Texas Panhandle at the Regional Planning Group Meeting in October, ERCOT staff recommended the installation of synchronous condensers on our Panhandle assets. The Board of Directors of ERCOT is expected to review this recommendation at a December meeting. Both of these projects were included in InfraREIT’s prior 2015 to 2017 footprint project forecast and they remain in our long range plan.
Slide 13 also breaks down our forward CapEx estimates between distribution and transmission projects. The slide flips out the expected timing and amount of CapEx for both the second circuit and the synchronous condensers. The timing and dollar amounts of these large projects may vary as they move to the regulatory and construction planning process.
To provide a broader picture, Slide 14 shows the Hunt development team’s geographic areas of focus. For those of you who are new to the InfraREIT story, the projects in light blue and dark blue indicates the specific lines and defined categories with respect to which InfraREIT has a right of first offer or ROFO project. The two projects highlighted in black represent examples of additional opportunities that Hunt is pursuing. While these and similar new development efforts pursued by Hunt’s dedicated development team do not fall under ROFO category. Hunt has previously stated its intend for InfraREIT to be the primary owner of these future T&D development projects.
The ROFO projects are making significant progress. Slide 15 summarizes important recent developments. Construction on the Golden Spread electric cooperative generation interconnection also known as GSEC continues to progress as planned in structural installation and wire stringing is in process. The current estimated cost is in the range of $80 million to $100 million including financing costs consistent to the prior guidance. The development team expects the GSEC line to come online late in the first quarter or early in the second quarter of 2016. During this timeline negotiations between Hunt and the InfraREIT complex committee will begin before year end. Dependent upon approval of InfraREIT’s complex committee, the acquisition and lease terms should be finalized before the line is energized in early 2016.
The Cross Valley transmission line in South Texas is also moving forward as expected. This line involves more complicated line routing and terrain in the GSEC Interconnection. The Hunt development team has confirmed that the cost estimate for the Cross Valley line is unchanged with the range of $160 million to $185 million including financing costs. Based on current estimates this line is expected to come online in late second quarter or early third quarter of next year. We will provide further updates on costs and project schedule in our upcoming calls and through periodic monthly updates posted to our website.
Slide 15 also summarizes the status of the Verde and Southline projects. There are no material updates on Verde. Southline is the proposed high voltage electric transmission line Southern New Mexico and Arizona. This line if approved would allow up to 1,000 megawatts of bidirectional capacity and provides system benefits throughout the Southwest. In early May the Hunt development team submitted to FERC a petition for declaratory order with regards to negotiated rates and a capacity allocation mechanism for Southline. The order was granted by FERC in September. I am also pleased to report that earlier today notice of the final environmental impact statement for Southline appeared in the Federal Register. The development team expects to receive the record of decision before year end. Following the grant of the record decision, Southline intends to launch the open foot [ph] station in early 2016. The project’s total cost is estimated to be $700 million to $800 million before financing. And given the size and location of the project we expect that the Hunt developer may partner with third parties in the line.
I will conclude my remarks with some comments on the EFH bankruptcy process. As discussed on last quarter’s call on June 7 of this year, Hunt filed an amendment to Hunt’s Schedule 13D relating to it’s ownership in InfraREIT. This filing disclosed that Hunt was in discussions with EFH regarding possible transactions that would involve the direct or indirect acquisition of all or substantially all the equity interest in Oncor of one or more entities that may be owned by Hunt or other potential investors. The filing also disclosed that Hunt had determined based on recent discussions with potential investors that it was appropriate to commence discussions with an independent committee of directors of InfraREIT regarding a possible business combination involving Oncor and InfraREIT if the pursuit of the Oncor acquisition is successful.
Also on June 7, InfraREIT issued a press release noting that as of the June 7 filing, we had not received a proposal regarding any potential business combination that the complex committee of our Board of Directors and informed the company that it intends to carefully consider any potential transactions involving Oncor and the company if and when any proposal is made to the complex committee. Hunt has not filed an updated Form 13D, so its June 7 filing continues to reflect its intent. On August 9 the purchase agreement and plan of merger were filed with the U.S. Bankruptcy Court for the District of Delaware. That proposed transaction in which Hunt consolidated is involved is now making its way through multiple approval processes. InfraREIT is not a part of the proposed transaction nor its related approval process. How the EFH restructuring process plays out and what implications the potential transaction involving Hunt, consolidated might or might not have from InfraREIT are matters of speculation at this point. Accordingly, we will not have additional comments about the EFH bankruptcy or Oncor on today’s call.
In conclusion, we had another positive quarter with solid execution enabling us to raise our guidance for 2015. We continue to be very confident in the fundamentals and the growth prospects of our business. Thank you again for your interest in InfraREIT. And at this point in the call, we would welcome your questions.
[Operator Instructions] And our first question is from Greg Gordon at Evercore ISI.
Thanks. Good morning.
Good morning, Greg.
Hi. Sorry, I was double booked on the other conference call, so I missed some of your prepared remarks, but as I was looking at the change in the CapEx on the footprint projects, it looks to me like it’s simply a deferral of the overall capital plan and no material reduction in the assumed underlying total amount of capital deployed for rate-based growth. Is that correct?
That’s correct, Greg. You got it exactly right.
Okay, great. And then on the New Mexico project, can you explain again how because that’s I think you explained to me before maybe it was offline not in a public Q&A that even though that’s a FERC regulated project, it’s – actually, it’s a commercial line and not a FERC tariff regulated line. So, the potential to get a lessor/lessee structure there and be able to contribute that to InfraREIT is a little bit easier, because you don’t have to worry about getting approval of a FERC regulated tariff, is that right?
Greg, it is right that, that is a line that will have negotiated rates. And the development team at Hunt submitted a petition for declaratory order to FERC in May. That was granted in September authorizing moving forward with negotiated rates. And as part of that filing petition for declaratory order, it involved a lessor/lessee structure. So, it’s given that the final EIS was just granted, notice of that was actually posted earlier today. We anticipate that the development team for Hunt will launch itself in solicitation early next year, but you have the mechanics of it right. It’s not a tariff. This will be negotiated rates in this line.
Right. So, is it functionally then already now approved, so if you are able to fully subscribe the line and construct it, you don’t need any further regulatory approvals or is there another gating regulatory approval you need to get it to the finish line?
I think we have the main ones. The final EIS has to be moralized in a record of decision which the team expects by year end knows. So, the main environmental approvals have been achieved. It’s gone through the process in WEC and received an approved rating in the Phase 3 status. And maybe some state approvals in individual rights of way, but the overall line has been approved. So, the main hurdles have been crossed. So, now the main next step is around the commercial negotiation.
Okay. Thanks, guys. Take care.
[Operator Instructions] Our next question is from Sophie Karp at Citigroup.
Hello. Can you hear me?
Yes, we can.
Hi. Congrats on the great quarter guys. Thank you for taking my question. I am curious can you give us a little more color on what you are seeing in the debt markets today and you mentioned it you need to refinance your part of your debt by the end of the year sort of what kind of cost of capital you are looking at here and just generally what is the state of the market for you?
Sure. Hi, Sophie, it’s Brant Meleski. I will take that one. So, we make a couple of comments there. One, we are monitoring the debt capital markets. Treasuries are obviously up-to-date. But as we think about movements in interest rates, they impact the business a couple of different ways. They impact our long-term debt rates that when we raise capital, but over a period of time those will be recovered through rates during the rate-making process. Changes in interest rates can impact our business through any short-term debt that we have. Right now, I think what I mentioned in my prepared remarks at the end of the quarter it was only $20 million in our revolver and then the balance in the Sharyland projects that that will be refinanced. So from an overall access to the debt capital markets and the ability to raise debt in conversations that we have had with a variety of banks, debt capital markets for utility businesses continue to open and availability of capital is – we believe is there for us to complete this financing before the end of the year.
Okay. And is it still your sort of underlying assumption that you will receive a lower recovery for debt course in the next rate case, if I recall it was supposed to be lower than what you have right now, right?
In our existing or in that – in the last rate case the allowed cost of debt was just over 6.7% which was the embedded cost of debt for the utility at that time. We do expect that to be lower in the next rate case that we will file middle of next year.
[Operator Instructions] I see no further questions. I would like to turn the conference back over to David Campbell for closing remarks.
Well, I might set a record. Thanks to everyone for attending and for your interest in InfraREIT. We look forward to seeing many of you at EI next week, we will be there. And if you have follow-up questions, please contact Brook Wootton. Thanks again.
This conference is now concluded. Thank you for attending today’s presentation. You may now disconnect.
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