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Edited Transcript of PEGI earnings conference call or presentation 10-May-19 2:30pm GMT

Q1 2019 Pattern Energy Group Inc Earnings Call

San Francisco May 17, 2019 (Thomson StreetEvents) -- Edited Transcript of Pattern Energy Group Inc earnings conference call or presentation Friday, May 10, 2019 at 2:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Esben W. Pedersen

Pattern Energy Group Inc. - CFO

* Michael M. Garland

Pattern Energy Group Inc. - CEO & Director

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Conference Call Participants

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* Adnan Waheed

National Bank Financial, Inc., Research Division - Associate

* Antoine Pierre Jean Aurimond

BofA Merrill Lynch, Research Division - Associate

* Benjamin Pham

BMO Capital Markets Equity Research - Analyst

* Brian K. Lee

Goldman Sachs Group Inc., Research Division - VP & Senior Clean Energy Analyst

* Colin William Rusch

Oppenheimer & Co. Inc., Research Division - MD and Senior Analyst

* Julien Patrick Dumoulin-Smith

BofA Merrill Lynch, Research Division - Director and Head of the US Power, Utilities & Alternative Energy Equity Research

* Nelson Ng

RBC Capital Markets, LLC, Research Division - Analyst

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Presentation

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Operator [1]

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Good morning, ladies and gentlemen. Welcome to Pattern Energy Group's 2019 First Quarter Results Conference Call. (Operator Instructions)

I would like to remind everyone that today's discussions may contain forward-looking statements that reflect current views with respect to future events. Any such statements are subject to risks and uncertainties that could cause actual results to differ materially from those projected in the forward-looking statements. For more information on Pattern's risks and uncertainties related to these forward-looking statements, please refer to the company's 10-K, which will be filed later today and available on EDGAR or SEDAR.

Now I'd like to turn the call over to Mike Garland, Chief Executive Officer of Pattern Energy Group Inc.

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Michael M. Garland, Pattern Energy Group Inc. - CEO & Director [2]

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Thank you, operator. Good morning, and thank you for joining us today. Earlier this morning, we released our 2019 first quarter results, which you can find on our website at patternenergy.com. You can also download a copy of the presentation that accompanies today's call from our website by selecting Invest, then Events on our web page.

Turning to Slide 3 of the presentation. But before I start the presentation, let me just make a personal note. I have been fighting off a cold, so if you hear a little less energy in my voice today, it's not because of our business, we're still very excited and positive about the quarter and our outlook, but I have a little less personal energy this morning.

The first quarter was good from a financial and operational perspective. We reported $53 million in CAFD, cash available for distribution, up 23% from the prior year period and in line with our expectations. As a result, we are reconfirming our 2019 CAFD guidance in the range of $160 million to $190 million this morning.

We are now providing segmented accounting, as Esben will discuss in a moment. Our adjusted EBITDA included $113 million from operations and a loss of $12 million from our investment in Pattern Development, and after other adjustments, totaled $98 million.

Revenue was $135 million, up 21%. Production was 92% of long-term average, LTA, in the quarter, included compensated curtailment, primarily as a result of lower wind in the Eastern U.S. Our production shortfall was fully mitigated at the CAFD level by a combination of higher average power prices, other revenues and improved debt service costs.

Today we announced our second quarter dividend of $0.422 per share, unchanged from the prior period. We are committed to maintaining our dividend and have a clear path that will be laid out -- that we laid out on our last call to drive down our payout ratio through growth without requiring the use of new common equity.

This morning, we will highlight the continued growth opportunities we have in front of us, specifically: one, distribution outlooks -- the distribution outlook from our investment in Pattern Development; two, opportunities for continued optimization of our assets like the repowering of Gulf Wind; and three, visibility into our drop-down acquisitions.

Moving on to Slide 4. We view our investment in Pattern Development as a clear differentiator for our business compared to our peers. We continue to believe that well done development offers the best risk/reward profile in the renewables value chain, and one of the few ways to get more attractive returns than simply acquiring assets from third parties.

Our total investment in Pattern Development now stands at $190 million, with an additional $7 million invested in Q1. We target investment returns at Pattern Development of 15% or more on an IRR basis and 2x on a MOIC basis. As we outlined on our year-end call in March, we anticipate reporting gains on sale of assets in 2019 and receiving initial distributions from Pattern Development in fiscal 2020.

We are confident and on track to achieve these objectives. As a reminder, Pattern Development already booked its first project gain on sale of the Stillwater project in 2018. The Grady project represents the second in a series of opportunities to realize a gain on sale in New Mexico. Grady is nearing the end of construction and is scheduled to commence commercial operations in the third quarter.

Similar to our existing Broadview project, Grady will sell electricity to the California market. Pattern Development is also constructing 3 projects in Mexico, which we are expected to commence -- which are expected to commence commercial operations in the fourth quarter. Pattern Development will sell these projects to a third party, as I've described in earlier calls. This is another benefit of investing in the development business as it provides an upside to us even in the cases where we believe select assets are not a good fit for our portfolio.

Pattern Development also has more than 300 megawatts of 100% PTC-eligible projects which are scheduled for construction in 2019 and 2020. These projects include the ones where we expect to utilize 100% PTC-qualifying turbines, in addition to other development projects in the U.S., including solar.

In April, Pattern Development agreed to sell -- to the sale of the Western Spirit transmission project it's developing in New Mexico to PNM upon the project's completion next year. This 145-mile transmission project is designed to enable 800 megawatts of renewable capacity developed by Pattern or possibly other developers.

In Japan, the development business continues to be very exciting. We have 200-plus megawatts in Japan on our iROFO list today, consisting of Sumita and Ishikari. These 2 projects are being prepared for financing which we expect to close in early 2020.

In addition to our growth prospects at development, we also continue to pursue opportunities to optimize and improve our existing assets.

Moving on to Slide 5. Gulf is a great example. As you are aware, Gulf Wind was coming off an attractively priced hedge agreement in April of this year, and with that the expectation that we would be selling power into the spot market for the balance of the year. This morning, we announced that we have executed a short-term hedge agreement for Gulf Wind that takes advantage of the strong forward price curves we're seeing for the summer months. The hedge runs from April to August and includes a very good price, close to the hedge price that terminated in April, which represents a very positive improvement of our expected revenues from the Gulf Wind project.

And the hedge provides greater certainty on the cash flows from the project in advance of repowering. As to repowering, we expect to finalize the development of financing in 2019, with construction commencing in Q1 2020 and completion scheduled for Q2 2020.

We have invested approximately $19 million to date, and expect to commit a total of $50 million in permanent equity in the completion of the project. We expect to receive development-like returns from the investments, or 6x to 8x CAFD multiple versus the 10x multiple at which we typically drop an operating asset.

We have a couple of opportunities to construct -- to contract for the power from the repowered Gulf Wind project that we are currently evaluating. And we will decide soon how we will proceed. Our existing assets in Japan are performing well as we build a portfolio of scale in that market.

Our Tsugaru project is on budget and schedule -- and scheduled to commence commercial operations in the second quarter of 2020. All civil and electrical work has resumed from the winter, with foundation scheduled to be completed in the next couple months and the electrical complete in fall. We have just started turbine erection and we have our first turbine in the air.

As we've mentioned in the past, a 100-megawatt project in Japan is comparable to a 200, 300-megawatt or larger U.S. project based on the cost to construct. And the power prices, which are many times higher than the U.S. prices, resulting in very attractive returns.

As a result, we believe that once Tsugaru reaches COD, we will have an operating portfolio of scale in Japan. Additionally, the opportunity exists to monetize a significant portion of our Japanese portfolio with low-cost domestic capital in Japan. [Assessing] permanent capital at a more attractive cost in Japan will provide us with flexibility to fund new growth either in Japan, based on our robust opportunity set, or even in North America.

On Slide 6, we outline our iROFO list as it stands today. We have a series of opportunities in 2019 and '20, including Belle River, North Kent, Henvey and Grady. We did remove one project from the iROFO list, the Crazy Mountain -- 80 megawatts Crazy Mountain project. The project was subject to a court challenge and we decided to put the project on hold. While disappointing, it is only one project from a portfolio of candidates on the iROFO list.

Without Crazy, our iROFO list currently stands at over 1.3 gigawatts, and we expect it to continue to grow with additions this year which will significantly increase our opportunities.

This list provides visibility into our potential drop-downs and the growth available to us. Prior to turning it over to Esben to discuss our financial results, I'd like to review our production for the quarter. Production was 1,116 (sic) [2,116] gigawatts hours, which was -- we reported on a proportional basis. The production result was primarily driven by good performance in most markets except in the Eastern U.S., where we saw lower-than-expected wind.

In Q1 2019, it was a developing Central Pacific based El Niño that was declared officially by NOAA in February 2019. What is interesting is the impact this event had in different regions of North America. With this type of El Niño, there is a southern jet stream that tends to reduce the strength of the storms that typically are brought down by the polar jetstream during the winter months. The Eastern region depends largely on the polar jetstream in the winter for its resource. As a result of these interactions, the West wasn't impacted as much as our Eastern fleet, which is dominated by our Texas projects, but also includes Kansas, Indiana and Missouri.

And that bore out into our portfolio, as you can see on Slide 7. The impact was greatest in the Eastern U.S. region. Wind resource in Western U.S., Canada and Japan was essentially at our long-term average, LTA. We are in the business of managing for wind variability, and we anticipated a lower-than-normal Q1 for wind. And we have demonstrated that consistent track record of being able to manage these situations.

At this point, I'd like to turn it over to Esben to review the financials in more detail.

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Esben W. Pedersen, Pattern Energy Group Inc. - CFO [3]

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Thank you, Mike. Let's start with a review of how we did in the first quarter relative to what we had expected when we outlined our 2019 guidance. As Mike mentioned, we remain on track for our CAFD guidance. Our CAFD for Q1 2019 was $53 million and the guidance range for the year remains $160 million to $190 million with a midpoint of $175 million. Our 2020 guidance is $185 million to $225 million with a midpoint of $205 million, which represents a CAGR of approximately 10% on a CAFD per share basis over our 2018 results. We believe we can achieve these growth targets without issuing new common equity.

To provide some background on our overall results. Revenues of $135 million were lower than expected due to lower LTA, but was partially offset by higher average prices and contingencies included in our original forecast. In particular, our new assets, namely Japan and MSM, outperformed expectations. Our revenues also included compensation for lost production in one project of approximately $2.7 million, which will be paid to our tax equity partner in a later period. Our project and corporate costs were largely unchanged relative to our expectations, but we realized better-than-expected debt service cost.

I want to highlight a change we made in our prior filings. In our 10-K, we began segment reporting in 2 primary segments, the operating segment and the development segment. We view these 2 areas of our business as distinct, and our primary performance measure in evaluating each segment is adjusted EBITDA in addition to CAFD for our overall business.

Starting with our operating segments. We recorded $113 million in adjusted EBITDA, which is modestly lower than expectations and largely reflective of the operational performance I have just described.

In our Pattern Development segment, our adjusted EBITDA included a $12 million loss, primarily due to increased development costs, G&A and write-downs. We had no sales of development assets in Q2 to offset these expenses, which is consistent with our plan.

In addition to the operating segment and the development segment, we have corporate and other activities, which resulted in a total adjusted EBITDA of $98 million. It is important to note here that the development business is a separate investment from our normal operating business, and it has already been funded through capital costs. The reported losses are ordinary course business for development as Pattern Development continues to invest in opportunities, which will be offset over time as the portfolio matures and assets are monetized.

Our confidence in the development business is based on our medium and long-term view of what development can deliver through growth and CAFD starting in 2020.

As Mike mentioned this morning, we declared our second quarter dividend of $0.422, and it's unchanged from the previous period. Without any additional dividend increases for the year, at the midpoint of our guidance, we would end the year with a 95% payout ratio.

Moving to Slide 10. We review the year here -- year-over-year changes to our results. First, revenues were up 21% compared to the same period in 2018. The primary drivers were increased revenues from our existing portfolio that improved $14 million compared to Q1 2018, mainly due to lower congestion and curtailment in ERCOT higher average prices and better performance in our U.S. Western region. As part of this increase, approximately $6 million is due to lower unrealized losses at Gulf Wind as the hedge terminates.

In addition, revenues from new projects were $18 million higher than Q1 from our acquisitions of the Japan portfolio, MSM and Stillwater. These improvements were partially offset by the sale of El Arráyan which accounted for $8 million.

Adjusted EBITDA was $98 million, reflecting income from our operating segment and losses of Pattern Development, which is overall down 6% compared to the same period last year.

First, our performance from existing operations was up slightly at $2 million compared to Q1 '18, and our project -- our new projects contributed $16 million to our performance. These improvements were offset primarily due to higher equity earnings losses of $10 million in Pattern Development as well as the sale of K2 and El Arráyan which accounted for $13 million.

CAFD was of $53 million, up 23% compared to the same period in 2018. The improvements in CAFD is due to the items I mentioned earlier. I want to mention that the pickup between adjusted EBITDA and CAFD is primarily due to project-level debt service being lower year-over-year and better performance out of our JVs in terms of distributions received compared to the net income recorded, which impacts our adjusted EBITDA.

In addition, Pattern Development impacted adjusted EBITDA, but not CAFD.

Moving to Slide 11. As of March 31, 2019, our available liquidity was $677 million, which consisted of $93 million of unrestricted cash on hand; $15 million of restricted cash; $170 million available under our revolving credit agreement; and $223 million available undrawn capacity on the certain project debt facilities and $176 million of post-construction project facilities.

Our corporate rating outlooks remained unchanged at BB-/Ba3 and we ended the quarter with corporate debt to corporate EBITDA in the mid-3s, which is consistent with our financial policy.

We believe we have flexibility to access cost-effective capital to fund growth without requiring us to issue new common equity. The new capital could take a variety of forms, including monetization of the portion of portfolio of Japan as Mike discussed, recycling additional assets giving the success we achieved in sale of K2 and El Arrayán, a consideration of hybrid equity options making use of available capacity at the project level to add or consolidate debt at certain projects, including refinancing of our Canadian portfolio. And making use of the available capacity at the corporate level either by expanding our convertible debt, issuing additional unsecured notes or separately expanding our revolver facility. We remain -- we maintain a conservative capital structure which provides us an opportunity to access additional capital while maintaining our stated financial policy.

In short, we believe there are multiple options available to us that demonstrate the flexibility of our balance sheet prior to returning to the capital markets.

We have effectively positioned the company to maintain our commitment to the current dividend level and to fund growth opportunities we have in the near term. Thank you. And I will now turn it back over to Mike Garland.

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Michael M. Garland, Pattern Energy Group Inc. - CEO & Director [4]

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Thanks, Esben. We have a clear path to execute on our continued growth opportunities through our investment in Pattern Development, the management of our existing operations to optimize assets and/or capture wind resources, and our robust opportunity set on the iROFO list, which consists of near-term opportunities in 2019 as well as projects we can transact on through to '21 and '22. We delivered strong CAFD in Q1. With this result, we remain on track to meet our 2019 guidance, which we reaffirm this morning.

We are still on a growth -- path to growth, grow our CAFD per share approximately 10% on a CAGR basis through 2020 without the requirement of new common equity, and driving down our payout ratio. We believe our opportunities in New Mexico and Japan together with our investment in Pattern Development will continue material growth in the business in 2020 and beyond. And our material ownership interest in Pattern -- the development business is a clear differentiator to other players in the market.

I'd like to thank our shareholders. We have a plan for creating long-term value for investors, changing the way electricity is made and transferred in the developed countries, while respecting the communities and the environment where our projects are located.

Now we'd like to turn it over to your questions. Operator?

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Questions and Answers

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Operator [1]

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(Operator Instructions) And your first question comes from the line of Nelson Ng of RBC Capital Markets.

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Nelson Ng, RBC Capital Markets, LLC, Research Division - Analyst [2]

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In terms of Pattern Development's, can I just confirm that adjusted EBITDA included a negative $14 million contribution from Pattern Development?

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Esben W. Pedersen, Pattern Energy Group Inc. - CFO [3]

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That's correct, Nelson.

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Nelson Ng, RBC Capital Markets, LLC, Research Division - Analyst [4]

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Okay. And I think $4 million of that relates to writing down the Crazy Mountain project. So would $10 million be like a normal rate per quarter if Pattern Development doesn't sell any assets?

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Esben W. Pedersen, Pattern Energy Group Inc. - CFO [5]

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It's lumpy. It will be different every quarter. Last year, I can point you to -- it was approximately $40 million for the year. So that would average out at $10 million a quarter, but I just expect it to be variable quarter-over-quarter.

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Nelson Ng, RBC Capital Markets, LLC, Research Division - Analyst [6]

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Okay. Got it. And then you talked about the revenue -- the year-over-year revenue increase. I think one of the drivers was receiving some reimbursement for lost PTCs at Broadview due to an outage. Do you remember roughly what that amount was? Like -- whether that was a large amount or not?

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Esben W. Pedersen, Pattern Energy Group Inc. - CFO [7]

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It was $2.7 million.

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Nelson Ng, RBC Capital Markets, LLC, Research Division - Analyst [8]

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Okay. That's not that material. And then more on Pattern Development. I think Mike mentioned that there is 3 projects in Mexico that Pattern Development would be divesting. Roughly what's the total size of those projects in terms of megawatts?

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Michael M. Garland, Pattern Energy Group Inc. - CEO & Director [9]

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Two of them are solar projects for a total of 300 megawatts. And then, I think, it is a 23-megawatt wind project, [San Mathias].

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Nelson Ng, RBC Capital Markets, LLC, Research Division - Analyst [10]

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Okay. Got it. And then just one last question on financing. I know that last year you guys fully repaid the Spring Valley debt. So can you just give a bit more color as to why it was fully repaid? And whether you're looking to raise new debt at that project?

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Esben W. Pedersen, Pattern Energy Group Inc. - CFO [11]

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Yes. I mean -- first of all, part of what we continue to do is look at where can we balance the overall mix of debt between corporate and project debt, as we were trying to consolidate into more simple capital structures and not have debt spread over multiple places. As we had cash from proceeds of K2, it was a logical thing to pay the Spring Valley debt down. We have mentioned before we have other refinancing -- project refinancing opportunities in the works and that could result in a dividend recap getting us basically back to potentially the same levels of total indebtedness. But we just continue to look at how to mix the overall capital structure.

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Operator [12]

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Your next question comes from the line of Brian Lee of Goldman Sachs.

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Brian K. Lee, Goldman Sachs Group Inc., Research Division - VP & Senior Clean Energy Analyst [13]

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I guess first off, on the Eastern U.S. fleet here where you saw the production weakness, was that weak throughout the quarter? Or was it concentrated in part of the quarter? And has that seen any change in the early part of 2Q?

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Michael M. Garland, Pattern Energy Group Inc. - CEO & Director [14]

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Yes. I don't know how -- depends on your sensitivity. I'd say generally it was across the quarter. It's close enough. It was -- depending both in the East and the West. For example, on the Western area we saw February was very strong out West. So it did have variations. I don't think it's that critical to distinguish them. For example, Spring Valley was like 200% LTA for the quarter -- or for the month in February. But -- and so if you look out east, I think you -- really it's the Central U.S., it was pretty much over the quarter. There were a few good weeks and a few bad weeks around those. We don't really talk about current arrangements or situations for the coming quarter or the current quarter because we haven't announced anything on it. So I'd rather not speak to what's happened this last month.

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Brian K. Lee, Goldman Sachs Group Inc., Research Division - VP & Senior Clean Energy Analyst [15]

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Okay. Fair enough. And then just a second question for me and I'll pass it on. The better CAFD performance year-on-year, it seem like a part of that was the smaller drag from unconsolidated investment earnings, if I'm reading the financials correctly. I know this is lumpy and it can move around from quarter-to-quarter, but can you speak to that a little bit more in detail? What drove the year-on-year change? And is that kind of the sustainable trend level for that line item going forward in terms of the CAFD calculations for this year?

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Esben W. Pedersen, Pattern Energy Group Inc. - CFO [16]

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Yes. Brian, it was -- part of it was just the difference between how it gets picked up in adjusted EBITDA versus CAFD. And at the CAFD level, it wasn't materially different than what the expectations were but -- and it does move around. And as you know, it comes in as cash comes in, so it tends to be a little more lumpy. So I think that there wasn't anything extraordinary in those results.

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Operator [17]

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Your next question comes from the line of Colin Rusch of Oppenheimer.

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Colin William Rusch, Oppenheimer & Co. Inc., Research Division - MD and Senior Analyst [18]

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Can you talk a little bit about your propensity for taking in outside capital should the terms be attractive? Certainly there has been a lot of money looking at different opportunities in this space and some recent deals. I'd love to take your temperature on that.

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Esben W. Pedersen, Pattern Energy Group Inc. - CFO [19]

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Yes. I think generally there is very healthy appetite for really capital coming into the renewable space. And that really exists at all levels. So at the project level, we find there is a lot of appetite and portfolios or at the corporate level, there is just a lot of people trying to deploy capital. So we have seen over the last year, a lot of inbound increase to find ways to invest with people like ourselves. And some of the deals that have occurred in the market that you may have seen is very indicative of that. So that is certainly the case. I think the project debt in tax equity markets remain very robust and healthy, and we have really no issue continuing to find ways to optimize cost to capital along all of those lines.

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Colin William Rusch, Oppenheimer & Co. Inc., Research Division - MD and Senior Analyst [20]

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And then obviously you guys have been amongst the best in the business in terms of being able to predict production on these facilities. Are there areas where you're seeing opportunities for investment to improve those capabilities? And how should we think about refinement of projections on an ongoing basis?

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Michael M. Garland, Pattern Energy Group Inc. - CEO & Director [21]

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You should hear our discussions internally, Colin. They're quite robust around that. We do use, particularly these days, we'll use 4, 5 different modeling techniques to search for variations, and primarily anomalies in the modeling techniques. We also use outside advisers that are kind of cutting edge PhD think tank types that are constantly looking, and in particular trying to look ahead, pretty good a few weeks, especially a few days for our short-term trading activities. And as you mentioned that we've been trying to get better at looking ahead in the coming years. Like for example, we did anticipate the first quarter being a bit weak. And that helps us manage the business a bit. And really it's just an ongoing exercise. It's kind of the science of climate is very complicated, as you know. And there are a lot of people working on it now because of climate change modeling and other things. New techniques coming online, but we haven't seen any radical change. But again, the most radical change that we've seen in the last 5 years has come around modeling wake effects and how do you manage wake effects. And then on the weather side, it's just refining as we go based on real-time data that is the most recent data, not relying on historicals from 2, 3 years ago. So I can't give you a whole lot more specifics today of what we do. Because we -- it's, in some ways, a proprietary exercise. But I can tell you that we are constantly looking and using outsides advisers to keep us on top of the industry.

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Operator [22]

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(Operator Instructions) Your next question comes from the line of Ben Pham of BMO.

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Benjamin Pham, BMO Capital Markets Equity Research - Analyst [23]

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Just on your -- you provide update on your liquidity, capital structure. Can you remind us your overall financing needs through 2020 in terms of debt and equity that Tsugaru, Gulf Wind do the workout to try get a sense of how much potential like asset monetization that may be in that bucket?

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Esben W. Pedersen, Pattern Energy Group Inc. - CFO [24]

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Yes. So we have the Tsugaru construction ongoing, and it has been fully financed through COD. At COD, there are 2 payments due. There is approximately $100 million payment due to Pattern Development. And then there is a loan that is not the project loan, but is effectively a secondary loan or mezz loan that sits behind the project loan. That totals a little under $100 million. So that's about $200 million. The loan does not come due. It has a maturity date well beyond the COD date. So we have well past 2020 to get that financed, but we will have to finance that out and would expect to do that. And then we have the Gulf Wind project, which as we've indicated we have invested about $20 million. We don't expect it through the construction period. We would need a lot of additional capital, but on the term-out when tax equity comes in, we would need to end up at about $50 million total investment. Those are the primary investments outside of expansionary growth and buying new assets. We also have refinancings of the convert that we have to tend to. So we are evaluating that, but that's obviously a separate product that at a minimum could just be a rollover.

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Benjamin Pham, BMO Capital Markets Equity Research - Analyst [25]

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Okay. So it looks like the secured projects, there's one that $150 million of equity where you could just -- simply just put on your credit facility and then you go to look at terminating that credit facility or paying it down. And then the convert then -- when you have to kind of attack that, and I know it is in 2020. But how do you think about that? And is there any sort of indication of what's the best capital that could refinance that at this moment?

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Esben W. Pedersen, Pattern Energy Group Inc. - CFO [26]

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In terms of the exact product that we will use is something that we're still evaluating. Rolling the convert is -- entering into a new convert is one option. Using unsecured notes at the corporate level is another option. So I think we have the option of balancing it out with the project debt as well. So I think we'll look at total consolidated leverage and corporate leverage when we make that decision. It is largely dependent on capital market strength and evaluating obviously the option value of -- that's embedded in the convert relative to the unsecured debt.

So that is an ongoing evaluation of those products. And we have until mid-2020 to deal with it. But we think that it's something that we don't want to deal it at the very end obviously. So we want plenty of runway before we -- in order to get that result.

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Benjamin Pham, BMO Capital Markets Equity Research - Analyst [27]

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Okay. The only last thing I wanted to check, you talked a little bit about the development EBITDA drag during the quarter. I just trying to follow the -- how that flows into CAFD? Is it -- your CAFD -- your development expense, it doesn't -- sorry, development EBITDA doesn't flow into CAFD? That's what I heard you said.

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Esben W. Pedersen, Pattern Energy Group Inc. - CFO [28]

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So we pick up the equity and earnings in the EBITDA. And then for CAFD, it would be the cash received from the investment just like the other EMIs.

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Benjamin Pham, BMO Capital Markets Equity Research - Analyst [29]

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Okay. So you're stripping out the equity loss, but there is no distribution, so it's not in there?

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Esben W. Pedersen, Pattern Energy Group Inc. - CFO [30]

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Correct.

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Operator [31]

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Your next question comes from the line of Julien Dumoulin-Smith of Bank of America Merrill Lynch.

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Julien Patrick Dumoulin-Smith, BofA Merrill Lynch, Research Division - Director and Head of the US Power, Utilities & Alternative Energy Equity Research [32]

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Excellent. All righty. So I wanted to follow up a little bit on financing options here. How do you think more conceptually about balancing debt versus equity? When I say debt, obviously there is a spectrum here of equity-like options, like you just talked about with respect to converts. How do you think about rating agency treatment of various tools here and how do you think about the right balance over time? You've obviously articulated the sort of aggregated growth leverage metrics. When do you get to that next point? And how do you think about deferring those options right now because it seems obviously like you've got a litany of tools before you. If you can spell out sort of in aggregate what those tools are, that would be helpful, if you don't mind.

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Esben W. Pedersen, Pattern Energy Group Inc. - CFO [33]

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Okay. And maybe I'll start with the first one. I think a key feature of how we construct all this is looking at what our financial policy is. And I think just to restate it, we generally ensure that our project capital, and that's project debt and tax equity, is fully amortized and paid down over the life of the PPA or contract that we have at the project level. So we really don't have amortization of third-party capital beyond the contract. And we're really just dealing with the residual, and Gulf is an example of that. It's an unleveraged project today. And that we finance things at the project level really to an investment-grade quality, and generally at standards that are better than what -- or more conservative than what you see in the market. So that means the capital that comes up at the corporate level is really investment-grade quality cash flows. And our policy at the corporate level is to target 3 to 4x leverage at the corporate level. So those constraints remain the same. Part of what we have today is an investment in Pattern Development which you can almost think of that's having been funded out of corporate capital. And so we know we have flexibility around our financial policy to go over our leverage targets, at least in the short term, because we know we have a way to deleverage it through proceeds coming out of Pattern Development. Notwithstanding that, our policy is really 3 to 4x. I just want to point out that we have flexibility. What we look at is, now what is the right capital source and where do we optimize the cost. And project debt remains somewhat the cheapest source of capital. So we continue to make sure that we put capital to use there or raise capital there. And so that's a good option. So we have opportunities in projects that are unleveraged, and also projects that we can upsize the leverage in the projects. Then at the corporate level, we have unsecured notes, converts, preferred equity, the former -- the 2 former ones are obviously going to get 100% debt treatment, whereas the hybrids can get anywhere from 100% equity treatment to 50% equity treatment depending on the structure of the hybrid. And then behind that is obviously equity.

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Julien Patrick Dumoulin-Smith, BofA Merrill Lynch, Research Division - Director and Head of the US Power, Utilities & Alternative Energy Equity Research [34]

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Excellent. And then if you don't mind, can we turn to the DevCo side of the business. Obviously, you're going to be pivoting on that from '19 into '20. How should we be thinking about the evolution to the course of this year of your development company, EBITDA or financial metrics to make sure that you're on track to be able to take distributions, right? So for instance, at present I see a small negative number in the DevCo EBITDA. Where should I be pointing to as we think about being able to take distributions out of that company next year? And whatever other metrics you would be thinking about, right, just conceptually into '20?

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Michael M. Garland, Pattern Energy Group Inc. - CEO & Director [35]

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I would just lead with what we've said, which is we will through 2019 report that we've monetized some assets and have created gains on sale, as the first indicator that we're on track to recycling capital and not to where we will be able to make distributions. And the second element, I guess, it's just looking at our pipeline as to what looks like it could be available for monetization in 2020 and 2021. And then the only thing that I'd say is that's not going to be apparent is what's the demand. If the demand is lumpy as we've talked about in the past, in terms of need for capital for new projects, the good news is if we need more capital, it's probably because we got a lot more opportunity. If it stays within the current schedule, we probably don't need much funding. And if it slows down, we need even less. And so we will try to give some indication of whether we are on track or not as we go forward into the end of 2019 and early 2020, but it is a private business. We have the ability to manage it a bit in terms of when we use capital and when we distribute capital. But I think you'll get some indications from us as we go through 2019 and 2020.

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Esben W. Pedersen, Pattern Energy Group Inc. - CFO [36]

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And Julian, can I just maybe add. What we did lay out is a couple of projects that are in construction at Grady, some of the stuff in Mexico. As we go through the year, those projects may be monetized. And so that's one thing to start looking at, when they get monetized. That's not to say that just because they get COD that they will be monetized. But that is the logical place to start thinking about monetization for those projects, and that should show up in financial performance of [P2]. The other thing I will say is, you should expect to continue to see expenses incurred on a consistent basis out of the development business as it happened last year, and that will continue to happen through this year. And the realization -- the moments for realization are going to be lumpy as we've been saying. So you can look at the projects that we're sort of telling you that are already in the construction and obviously will look to monetize those.

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Julien Patrick Dumoulin-Smith, BofA Merrill Lynch, Research Division - Director and Head of the US Power, Utilities & Alternative Energy Equity Research [37]

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Just to clarify, EBITDA on a cumulative annual basis including -- inclusive of gains should be positive in '19 and '20? Or should flip positive?

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Esben W. Pedersen, Pattern Energy Group Inc. - CFO [38]

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We haven't made that -- we've not said that it would be one way or the other. I think it is a very complex set of mechanics that would tell you whether that will be the case. So I don't think I would go that far.

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Operator [39]

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Your next question comes from the line of Adnan Waheed of National Bank Financial.

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Adnan Waheed, National Bank Financial, Inc., Research Division - Associate [40]

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I'll be speaking on behalf of Rupert. To start off, can you give us some update on the regulatory developments in the Japanese offshore wind market. And there have been some partnership announcements recently between various parties of development in Japan. And I was wondering if PEGI is also planning to partner in this market. Could you just give us your thoughts overall with respect to your entering Japan?

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Michael M. Garland, Pattern Energy Group Inc. - CEO & Director [41]

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Sure. On the regulatory side, we haven't seen too much change on the offshore side of things or even on the onshore in the last 6 months. Probably the most active thing that's going on is the Tohoku auction and the results of that, I think, they've announced publicly that they have given a short window for people to withdraw their bids if they want to. And that they have seen one project drop out separate from the open window, which we love. Because we have the opportunity to potentially to see some real step-up in our award in that area, in the Tohoku auction area because we were right on the cusp of a number of projects being eligible previously. So we're hoping in the coming months we'll be able to tell you some good news around Tohoku auction. There have been a number of announced joint ventures, and it's not clear to us yet what they include. Some of them sound like they're very narrow and limited. And others sound like they are more broad-based and with people that we think are modest players or have modest opportunities in their area of -- in one case, an electric utility that joined up with a European that doesn't have a lot of opportunity for offshore in their province. And we are looking at opportunities to team up. We're not committed to it yet, but we are in discussions with a whole number of folks who have a strong interest in our portfolio. We are really only looking at this point at partners that can provide additional, if you will, strategic value to our business. We have one of the strongest pipelines in Japan. I think we are now, if we're not the largest, the second largest developer. We have probably the largest number of FiT contract qualified projects in Japan. And so we're getting a lot of inquiries. We are mostly interested in what partners make sense for the Japanese market. And maybe teaming up with a few folks that have the expertise in the offshore. If you remember, our first offshore project, Ishikari, is a shallow shore, if you will; it's like 20 or 30 meters. So it's not like building a project in the North Sea. It's a fairly much more manageable type of transaction for our first project, which is terrific. But we will find partners who have a lot of experience in building offshore, have the talents to help us build that project. We're not looking at self-building or anything like that. So I can't give you any specifics because we haven't executed on any relationships, but we are in constant discussions. We are not feeling we have to execute on really anything currently, but we think it will add strategically to our opportunities there if we do in certain areas team up with some important strategic Japanese partners.

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Adnan Waheed, National Bank Financial, Inc., Research Division - Associate [42]

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Okay. That's great. I appreciate the color. And then my second question is on the New Mexico transmission line. The Western Spirit project that has been sold for Pattern Development, can you give us some more color on the transaction? Are you expecting any gains at PEGI through your ownership in PD 2.0?

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Michael M. Garland, Pattern Energy Group Inc. - CEO & Director [43]

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Well, all it is, is a sale to PNM. If you're talking about the Western Spirit line, -- sorry about on my voice, I mentioned earlier that I'm fighting off a cold and starting -- hope it doesn't sound too bad. That transaction, we hope, will have some profit in it. It is -- we have to construct it for PNM, but our main driver for those transactions are the wind projects that connect to it. And so while we'll see some -- we hope to see some realizations on the transmission line, we really are looking forward to the opportunity to building out a significant number of megawatts. As I mentioned, I think it's upwards of 800, 850 megawatt capacity line. And we're taking the majority of that for a wind development that we're going to be doing at Pattern Development. So I hope that responds to your question.

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Adnan Waheed, National Bank Financial, Inc., Research Division - Associate [44]

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Yes. That's helpful.

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Operator [45]

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And our next question comes from the line of Antoine Aurimond of Bank of America.

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Antoine Pierre Jean Aurimond, BofA Merrill Lynch, Research Division - Associate [46]

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Just a very quick question, maybe more for Pattern Development. But Talen was talking about developing -- jointly developing a solar project on this side of one of its coal plant, Montour. Just curious if you can discuss that a little bit more? And if there are also opportunities for further projects like that?

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Michael M. Garland, Pattern Energy Group Inc. - CEO & Director [47]

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I guess what we can say is we are doing a joint development with them. I can't say too much more about the project. We think it's a really great opportunity, as you know. A big coal plant has strong interconnection rights and it's a good transition away from coal. And we think it's a starting point of demonstrating to the coal industry that we can come in and help them make the transition from coal to renewables. And we're looking to potentially partner with other coal-owned project owners that could do something similar to Talen.

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Antoine Pierre Jean Aurimond, BofA Merrill Lynch, Research Division - Associate [48]

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Got it. And you expect that to remain at Development or would you potentially drop that down at the yieldco?

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Michael M. Garland, Pattern Energy Group Inc. - CEO & Director [49]

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Yes. Depending on the economics and the benefits, we could drop it down to the yieldco -- to PEGI. But as you know, we don't make a decision about that until the time that Pattern Development determines that it is going to be selling the asset. And at that point, we'll look at PEGI's situation for with capital, what are the returns, what are the risks associated with the project to make a determination if PEGI wants to make an offer that could be attractive to Pattern Development. We'll go through the same normal process that we have for conflicts and so on with the independent members of our Board, reviewing and analyzing the decision on what we should propose.

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Esben W. Pedersen, Pattern Energy Group Inc. - CFO [50]

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Yes, given the structure there, I think it's unlikely that that'll be an opportunity for us. I think it's unlikely there'll be an opportunity.

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Antoine Pierre Jean Aurimond, BofA Merrill Lynch, Research Division - Associate [51]

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And just quickly, in terms of timing, what should we expect for that 100-megawatt project?

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Esben W. Pedersen, Pattern Energy Group Inc. - CFO [52]

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For the Talen portfolio?

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Antoine Pierre Jean Aurimond, BofA Merrill Lynch, Research Division - Associate [53]

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Yes. For the -- yes.

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Esben W. Pedersen, Pattern Energy Group Inc. - CFO [54]

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It's still in, I would say, in early-stage developments. We haven't really indicated the date for MTP at this point.

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Operator [55]

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There are no further questions in the queue. I turn the call back over to the presenters for final remarks.

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Michael M. Garland, Pattern Energy Group Inc. - CEO & Director [56]

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Thank you, everyone. I appreciate your time and questions and interest in the company. Looking forward to the rest of the year. Have a good day.

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Operator [57]

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This concludes today's conference call. You may now disconnect.