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‘Winter Is Coming’ (To Winterfell, Certainly, To The Market, More And More Likely.)

I predict that Game of Thrones, adapted from the books in the series A Song of Ice and Fire by George R.R. Martin, will most certainly outlive the current bull. Having been told repeatedly by scores of analysts that “winter is coming” to this particular market and that the White Walkers will surely destroy the market, we can be forgiven if we have tired of their bearish chatter. So like most residents of the lands south of The Wall, many investors have decided White Walkers (and bear markets) are only myth and we should go on about our business of seeking wealth and the power wealth brings. (Game of Thrones haters, you may read on; I promise to stop making references to the TV serialization or the books…) The point is that bear markets may still occur in our lifetime. At some point it behooves us to perhaps take some profits off the table, accepting the “possibility” that as much money might be made, going forward, in solid income-producing securities, as might be gained by buying index funds and such. Indeed, if the bear is more than a correction and truly awakens from hibernation, such an approach might not only provide reasonable returns in times of turmoil but may actually protect capital so as to provide truly exceptional entry prices at some point a bit down the road. I place myself squarely in this camp. Regular readers have seen a trend since we began to see our trailing stops execute at an accelerating rate in January and February. It seems ever clearer to me that mid-2016 is not likely to be a good time for “risk-on” investing. Why not? There are many reasons, but for this issue let me elaborate on two I have not discussed in as much depth in my previous articles on this subject. Both are strategic issues that must be addressed if the markets are to be trusted and the economy is ever to get out of the current government-induced doldrums. I’ll then provide some ideas for how to protect your capital in this environment. Reason #1: Companies have for years been able to use pro forma rather than GAAP accounting, merrily buying their own shares back to goose the earnings “per share” figure and therefore give their managers massive bonuses. Some analysts think this is a good idea – after all, it’s only stock, not dollars, and the number of shares is diluted over so many shareholders that the dilution isn’t as evident. But just as water flowing over a rock will not visibly alter it, over many years that rock will become “river rock,” not only rounded but smaller. It is the same with individual shareholders’ holdings. Drip by drip, hired administrators and their favored cronies are making as much or more than those few with real talent. The dizzying escalation in executive pay, and worse, stock options, has made a mockery of corporate “governance,” with a few at the top of public companies making hundreds or thousands of times as much as the workers in those companies. This practice is beginning to catch up to these firms as their boards of directors begin to realize their erstwhile golden boys, now retired with a similar-colored parachute, have left the companies far behind in research and development and far behind in capital expenditures. They have paid massive capital-draining salaries and bonuses and are now left behind the curve. Now the current crop of administrators must now make hard decisions. Having paid up to and including top dollar for shares selling at new highs, they need to conserve funds for R&D and CapEx or they will lose market share to those who spent their money more wisely. As this quarter’s results so painfully show, for many large and once-successful companies, their top-line revenues are down, their earnings are down and, for those realizing they can’t keep playing funny-money games, even their earnings per share are down. This leaves just one final illusion to perform. As quarter end approaches, they flurry to the Wall Street analysts who tout their shares and suggest the analysts (who want to look good to get their own bonuses) lower their quarterly earnings “estimates.” This incestuous relationship ensures that the analyst looks good and both Wall Street and the reporting company can trumpet that while revenues may have been down they once again beat the earnings estimates . You ask, they can’t really believe we’re so stupid we don’t notice the sleight-of-hand, can they? I respond: I assume your question is rhetorical. Not only do they believe it, but enough market players (I can’t bring myself to call them “investors”) swallow it hook, line, and sinker, that the game can go on. But by now, it is going on with decreasing volume. As more catch on, I fear for the aging bull. Reason #2: Regulations and red tape are strangling American entrepreneurs. Are we becoming just another tired and bloated European-style social welfare republic? The facts would support this argument. The American Dream of prior years is further and further out of reach of the average American. Red tape is now strangling the entire nation. Do you wonder why the elites in the boardrooms and corporate corner offices, the White House, Congress, the Fed, the SES’s (“Senior Executive Service”) administrators, etc. all tout how wonderfully the economy is doing while any cross-country road or rail trip will show just how poorly “the rest of us” beyond the Beltway are doing? It’s because “their” economy is doing fine. With what they make and who they associate with all doing exceedingly well, they just don’t understand why the rest of the nation doesn’t get it. We do. They don’t. They aren’t trying to start or run private or growing businesses, or earn an honest day’s wage for an honest day’s work at such a company. In many cases, they aren’t even subject to the onerous regulations they have imposed! They have their own “special” plans for special people. I am indebted to a new study by the Mercatus Center at George Mason University, whose authors (Patrick McLaughlin, Bentley Coffey, and Pietro Peretto) have put in dollar terms what those of us running a business or working for a living know: even Nazi Germany or Communist Russia never had this many regulations to run afoul of and, consequently, keep voracious government gorging itself on new fees, fines, licenses, lawsuits and taxes. The Mercatus Center paper looked at regulations imposed since 1977 on 22 different industries, those industries’ real growth rate, and what might have happened if all those regulations had not been imposed. Of course there have been benefits to some of these regulations, fines, fees, and so on. We have cleaner air, safer workplaces, more (though perhaps increasingly difficult to obtain) health care, etc. And I’m sure we’d all be happy to pay an extra, oh, call it a trillion dollars, for those benefits. But $4 trillion, including only federal regulations, not even counting the additional burdens imposed by states, counties, and cities? 4 trillion dollars. That’s how much we taxpayers have given up since 1977 to support the imperious and bloated federal bureaucracy. Click to enlarge The chart above shows that, if the economic growth lost to regulation in the U.S. were its own economy, it would be the fourth largest in the world! That’s not our GDP, it’s not our debt, it’s just our regulatory burden . Are we descending to the third-world model of central planning and economic misery? If ever there was a self-inflicted wound, this is it! Our Code of Federal Regulations is now more than 81,000 pages long! It wasn’t always this way. To cite just one example, in 1939, even after 6 years of the New Deal, our tax code consumed just 504 pages. Today that has mushroomed to 74,608 pages! Who can understand all of this? No one. Who gets to interpret little bits and pieces of it? Clerks within the bureaucracy and lawyers within and outside. The problem has hugely accelerated since 2008. The George Mason study notes that President Obama has imposed 85 more “economically significant” regulations than did President Clinton and 100 more than President Bush. (A total of 372 new pieces of suffocating red tape, 172 during his first term and now, with the finish line of his vision in sight and an acquiescent Congress, 200 more since then.) The cumulative effect of all these diktats are appalling. Not only have they hemmed in our freedom to move, to act, and to live, they have cost each of us financially. The Center’s findings include that if the regulatory regime in place in 1980 was still in evidence today, the US economy in study year 2012 would have been $4 trillion bigger. That would be equal to almost $13,000 per person in that one year alone. Lop off a trillion for the truly worthwhile regulations and it still comes to nearly $10,000 per person. Could you have used an extra $10,000 a year for the past 4 years? Would the country be growing jobs and wages better with an extra $3 trillion in the real world of workers, innovators and businesses than in salaries for lawyers and administrators in federal agencies where more regulations mean more power and money for them? The Tax Code alone directs pork subsidies to allow the already-rich to buy Tesla “Electric Vehicles” (which, by the way, run on electricity produced by — coal, gas, oil etc.) and to buy insurance from a select list, to turn good food corn into more expensive gasoline, to replace our windows, adopt kids, pay for daycare, go to college…and the beat goes on. The latest stifling new batch of regulations include picking favorites from the health care industry, ensuring the survival of the banking and financial services industry, and making sure utilities (read: consumers) pay through the nose for natural gas if they don’t immediately switch to far less efficient wind or solar. We need a complete zero-based review of the cost and benefit of these mandates and dictates. It could happen with the sweep of a new broom in November. Until there is greater clarity there, however, I’ll take the “risk-off” approach that allows our clients to sleep well with fine income holdings. Here are a couple we are currently buying. A Fine Income Holding Starwood Property Trust (NYSE: STWD ) is a commercial real estate lending, servicing and investing company. It is the largest commercial mortgage REIT in the U.S. and one of the biggest and most successful in the world, yet its price has been under pressure lately. This may be because most people don’t believe rates will rise again (ever?). For whatever reason, I believe the current price of STWD offers us a unique opportunity to own a great company at a great price. Formed as the 2007-09 recession ended, and taking full advantage of the decimated commercial lending landscape, the company has yet to lose a dollar, yen or pound in commercial lending, which comprises 61.3% of its total assets. Being formed when it was, the assumption must always be that rates will (someday) rise. That’s why 82% of their loans are indexed to LIBOR; the interest charged will rise as LIBOR rises. Because of its current low valuation (the share price has fluctuated between about 16 1/2 and 24 1/2 the past 52 weeks,) STWD currently yields an excellent 9.9% yield. That’s not unusual for mortgage REITs but it is unusual for one of this heritage and quality. Despite the rebound as a result of somewhat improved investor sentiment toward high-yield stocks, Starwood Property is still down so far this year. It sells for just above 10x earnings, a hair above book value, enjoyed a return on equity (ROE) of just under 13% in the last reported quarter, and sells at a stellar 7.4x operating cash flow. I need to remind readers that what you are buying with a mortgage REIT is cash flow. Unlike equity REITs, 100% mortgage REITs have no opportunity for capital appreciation. Their stock may appreciate based on under-valuation, increased cash flow, or a favorable change in investor sentiment, but the company basically makes lending decisions and collects payments on the money they have lent out. Of course, how smart a company is in assessing and assigning risk is key. In Starwood’s case, their “loan to value” hovers right around 63% and consists primarily of first mortgages. In other words, if they believe a purchase, renovation, or other activity will create an asset value of a billion dollars, they might loan $630 million. Here is one example of the kind of upscale property they have financed: I think Starwood may benefit from all 3 possibilities I cite above for their stock to appreciate. Now the kicker: while STWD has 61% of its assets in commercial mortgage lending, the other 39% is in small equity positions and servicing fees for other lenders. They have the scale to service loans cheaper than many originators do. All this leads me to believe there is an additional possible wind at Starwood Property’s back and that is a dividend increase. With cash flow numbers like these and the likelihood that, in Europe, rates will not go further negative but begin to come back above zero, I think increased cash flow from all segments will mean an increase in the dividend. The company can afford it now and, as a REIT, it must pay at least 90% of its earnings as dividends. Finally, because of Dodd-Frank induced “risk-retention” rules, which force more firms to keep a portion of whatever they package as mortgage-backed securities, I see the number of competitors falling off over the next year or so. This places Starwood Property Trust in a great position. It has the experience, the head start and the right management team to be able to capitalize on the shrinking number of packaging sponsors. A Fine Income Holding, Part II Preferred shares might well lose value in a protracted bear market. In which case, we would simply add more. As long as they are bought at or below par and they are issued by companies with a future we believe to be secure, we’ll always get that nice, steady return. Bought below par, the return is better, of course. Every now and again the market will seriously over-react, as it did in late 2008 and early 2009, and provide us with a cornucopia of delightful offerings. I purchased one such one-time good deal on March 6, 2009 (by chance, not prescience, the absolute lowest day of the entire decline.) I purchased, to provide some ballast for the Aggressive Portfolio, 500 shares of Silicon Valley Bancshares 7% preferred (SIVBO), $25 par value for $10 a share. At the time, the prevailing panic was that all banks would go belly up. I figured if any survived it would be a bank that catered to the best innovators. It worked out. I list SIVBO’s current yield as 6.9% since it sells for a little above par now. But on a “yield-to-cost” basis, we are getting 20% a year in interest on this preferred. If it never moves a penny in capital appreciation, and there is little reason it should, over the past 7 years we have received $4900 in interest on our $5000 investment and now own something worth an additional $12,850. These opportunities don’t come along often but when they do, when the markets look bleak, hearken back to this article and take the plunge. Regrettably, I find no such bargains in preferreds today. It seems everyone has caught on to their benefits. But I have been buying a speculative preferred that is, at least, slightly below par. It is the Qwest Corp (CTY) 6.125% Notes due 2053 a synthetic preferred in that it is really a piece of a bond. It is callable at par (in this case, $25) anytime after June 1, 2018 by the parent company. Because it is part of a bond offering, the income is classified as “interest” and not as a “dividend.” These notes are unsecured and unsubordinated obligations of the company and will rank equally with all existing and future unsecured and unsubordinated indebtedness of the company. Qwest doesn’t exist as an independent company any more. It was purchased 100% by CenturyLink (NYSE: CTL ). The CenturyLink website refers to itself as “a global communications, hosting, cloud and IT services company enabling millions of customers to transform their businesses and their lives through innovative technology solutions. CenturyLink offers network and data systems management, Big Data analytics and IT consulting, and operates more than 55 data centers in North America, Europe and Asia. The company provides broadband, voice, video, data and managed services over a robust 250,000-route-mile U.S. fiber network and a 300,000-route-mile international transport network.” So it isn’t AT&T or Verizon, but neither is it a small fry. It operates in a tough neighborhood but, so far, seems to be holding its own. I think the company is a fair bet to last in its various niches. It has assumed the responsibility to repay the “preferred” shareholders of CTY at maturity. Currently selling for 24.70, we buy when we can. Of course, that goes for all preferreds we favor – below par, we’ll nibble, well below par we’ll back the truck up! Basic, Boring, Dull and Profitable Owning a merger and arbitrage mutual fund or ETF is every bit as exciting as watching paint dry on a too-cool day. But they do reward us with small but steady profits in most market environments. And they tend to be almost completely uncorrelated to what happens in the general markets, while still allowing us to benefit from extraordinary events in the markets. Among the funds I have researched, Vivaldi Merger Arbitrage (MUTF: VARAX ) has been rising to the top. My first caveat is that this is a load fund. It is waived for those broker-dealers and others who have an agreement with Vivaldi to waive the load for (among others?) Registered Investment Advisors, the theory being that we will, for our clients, quickly reach the zero-fee breakpoint anyway. So for our clients, and maybe your advisor, there is no fee. VARAX provides a dose of what we want for the immediate future: low to no correlation with the market and low volatility during what I believe will be volatile times. Merger and arbitrage (M&A) funds don’t buy companies they think “might” be taken over or “hope” will be acquired. Instead, they purchase the stock of a company which has already announced it is being acquired (the “target” company) while at the same time shorting the stock of the company acquiring the target’s stock. The fund profits from the difference in price between the current trading price of the target company following the announcement of the merger (which is usually “close” to the acquisition price), and the acquisition price to be paid for the target company at that future point when the acquisition is consummated. In other words, VARAX is betting that the spread between the price the target jumps to on the news and the price ultimately paid for it justifies their time and attention. Often, of course, even if the deal falls through, there is a contractual fee paid to the target if the acquiring firm is forbidden by the regulators or finds it really wanted a different company or can’t get financing or whatever. In this case, I particularly like the experience level of the principals in knowing “when to hold ’em and when to fold ’em.” And I like what the following two charts so clearly show… It’s always, always about risk and reward. You can’t really compare an M&A fund to the S&P when it comes to performance in a bull market. But performance over time is another matter! As you can see VARAX compares, quite favorably, to both bonds and the S&P. More importantly, given my concerns for the next few months, is where it falls on the risk continuum, which is to say, it barely registers. We are buyers. I also see opportunity for income investors from the exodus of smart money from China and other less-stable, over-regulated regimes in Asia. That will be the subject of my next article… Disclaimer: As a Registered Investment Advisor, I believe it is essential to advise that I do not know your personal financial situation, so the information contained in this communiqué represents the opinions of the staff of Stanford Wealth Management, and should not be construed as “personalized” investment advice. Past performance is no guarantee of future results, rather an obvious statement but clearly too often unheeded judging by the number of investors who buy the current #1 mutual fund one year only to watch it plummet the following year. I encourage you to do your own due diligence on issues I discuss to see if they might be of value in your own investing. I take my responsibility to offer intelligent commentary seriously, but it should not be assumed that investing in any securities my clients or family are investing in will always be profitable. I do our best to get it right, and our firm “eats our own cooking,” but I could be wrong, hence my full disclosure as to whether we or our clients own or are buying the investments we write about. Disclosure: I am/we are long STWD CTY VARAX. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Companhia Paranaense de Energia’s (ELP) CEO Luiz Fernando Leone Vianna on Q1 2016 Results – Earnings Call Transcript

Companhia Paranaense de Energia (NYSE: ELP ) Q1 2016 Earnings Conference Call May 13, 2016 2:30 PM ET Executives Luiz Fernando Leone Vianna – Chief Executive Officer Luiz Eduardo da Veiga Sebastiani – Chief Financial and Investor Relations Officer Adriano Fedalto – Accounting Superintendent Sergio Luiz Lamy – President of Copel GeT Antonio Sergio de Souza Guetter – President of Copel Distribuição Analysts Miguel Rodrigues – Morgan Stanley Operator Good afternoon and thank you for waiting. Welcome to Companhia Paranaense de Energia Copel conference call to discuss the first quarter of 2016 results. We would like to inform you that all participants will be in a listen-only mode during the company’s presentation. Afterwards, we will have a session for questions and answers, when further instructions will be given. [Operator Instructions] Before proceeding, we wish to clarify that forward-looking statements that might be made during the call related to Copel’s business perspectives, operating and financial targets, and projections are beliefs and assumptions of the company’s management as well as information currently available. Forward-looking statements are not guarantees of performance. They involve risks, uncertainties, and assumptions as they refer to future events and therefore will depend on circumstances that may or may not occur. General economic conditions, industry conditions, and other operating factors may affect the future performance of Copel leading to results that differ materially from those expressed in such forward-looking statements. Participating in this call, we have Mr. Luiz Fernando Leone Vianna, CEO of the company; Mr. Luiz Eduardo da Veiga Sebastiani, CFO and Investor Relations Officer; Mr. Gilberto Mendes Fernandes, Business Management Officer; Mr. Jonel Nazareno Iurk, Business Development Officer; Mr. Antonio Sergio de Souza Guetter, President of Copel Distribuição; Mr. Sergio Luiz Lamy, President of Copel GeT; Mr. Ricardo Goldani Dosso, President of Copel Renováveis; Mr. Franklin Kelly Miguel, President of Copel Comercialização; and Mr. Francisco Cesar Farah, CFO of Copel Telecom. The presentation will be made by Copel’s management and it can be followed at the company’s website, www.copel.com/invesor relations. Now, we would like to give the floor to Mr. Luiz Fernando Vianna, CEO of the company. Mr. Vianna, you have the floor. Luiz Fernando Leone Vianna [Interpreted] Good afternoon, everyone. My colleagues in the executive committee, all participants, welcome to our call to talk about the results of the first quarter of 2016. I would like to start by talking about important regulatory issues that bring or could bring relevant impact on Copel. The first point and it couldn’t be different, is the 4th Tariff Revision Cycle of Copel Distribuição. We certainly are a company to develop such as a process. As you have already had access to the documents available at the ANEEL website in the number #20 Public Hearing that shows a net remuneration base of R$4.8 billion with the new cycle. This increase means that our distribution company doubled in size in the last four years. However, it’s important to highlight the investment was not made only with extensions. We also invested quite a lot with the improvement in the quality of service that we deliver. And this led us to be recognized as one of the best distribution companies in the country. Now, with the beginning of the 4th cycle, all these investments will be remunerated. And for this reason, we are certain that we have adopted the adequate strategy for the business. The 4th cycle still brings about other important points such as the remuneration of special obligations and the trajectory of costs that will allow us to have a more adequate coverage for the PMSO expenditures within the cycle that starts in 2016. Nevertheless, the most interesting point is that the practices, [the clever strategy] [ph] by Copel Distribuição should suffer a reduction of approximately 10% with the beginning of the new cycle, which is targeted for consumers, because they will be spending less with energy and for the company as well, because it brings a substantial delinquency reduction and growth in consumption, factors that have been impacting our results in the last few quarters. However, it’s important to stress that the process hasn’t been concluded yet. The hearing is still open until May 19 and after this period the prices would be validated and rectified by the ANEEL administration. And conclusion is estimated for the end of June. According – continuing with the regulatory theme, as Resolution 706, coming from Public Hearing 04, will talk about an important advance into the issue of involuntary over-contracting of business. The new rule allowed us to consider part of the energy that we receive through the quota system as involuntary over-contracting, which was enough to mitigate Copel’s distribution risk [negative as seen] [ph]. In transmission, the Ministry of Mines and Energy got the news about the RBSE implementing, which are the transmission assets already existing in May 2000, by means of ordinance 120 of 2016 and ANEEL established the integration of RBSE to the regulatory asset base, the restatement of the value of the assets since 2012 and payments of indemnity by means of RAP since the tariff process of 2017. This is interesting to say that the cost of own capital to be considered in the restatement of the asset value is 10.4% in near-term, which allows us to have this adequate restatement of the amount to be indemnified. In the case of Copel, this amount has not been ratified by ANEEL yet. And I would like to mention that any effect on our results or conditions to the ratification of the final result of the evaluation report by the regulators, ANEEL. Just to remind you, in March 2015, we submitted to ANEEL the evaluation report to the amount of R$882 million referring to RBSE and the date of it was December 31, 2012. On slide number 4, I would like to highlight that we have important achievements related to the projects that we are building. Starting with Colíder, the Supreme Court of Justice in a decision supported by technical studies canceled the injunction that mandated Copel GeT to suppress 100% of the vegetation of the area to be flooded by the reservoir, and confirmed that the suppression of 70% of the area was environmentally adequate. With that, the work is then concentrated in the construction of the transmission line that will be linking the Colíder plants to the interconnected systems, and the electromechanic assembly of the equipment. Commercial operations should start in the first-half of 2017. We also had an important achievement related to the Baixo Iguaçu project in which we hold a 30% stake and we are building in partnership with Araucária [ph] in a recent decision. And they approved an additional 130 days for waiver of responsibility for the plant and the total number of days now is 756, which means at the beginning of the sale to other utilities was postponed to the end of 2018. And this is enough time for us to build the plant and start commercial operations. In the transmission segment, SPC Matrinchã concluded its construction work and over 1,000 kilometers of lines have already been planted and commissioned successfully. And now, we need a confirmation by the regulators in order to officially start operation of these projects. Besides Matrinchã other transmission projects are about to be concluded and start commercial operation. SPC Guaraciaba should start-up by the end of June, whereas SPC Paranaíba has already concluded construction of 346 kilometers of lines and should come on stream by the end of next month. Jointly, these three projects will bring about to Copel around R$158 million. Lastly, I would like to highlight that we have recently held two auctions for the sale of energy in the free market in which we have sold over 6 million megawatt hours in products, where delivery in two to five years, and starting delivery as of June 1, 2016 then January 1, 2017, and then January 1, 2018. Our strategy is to hold additional auctions in order to reduce the amount of energy, whose contracts have been terminated and allows a better predictability for the generation business. It’s important to highlight that the results already obtained allows us to make or give a significant step in order to reach this objective. Now, I give the floor to my colleague, Sebastiani, our CFO, who will talk in detail about the results for the period. Luiz Eduardo da Veiga Sebastiani [Interpreted] Thank you, Mr. Luiz Leone Vianna, our CEO. As he said, we have a participation of all these executives due to this important moment for the company. And thank you very much for participating in this call. As you will see on Slide #5, some events again impacted our results in the first quarter of 2016. We posted over R$120 million in provisions, of which R$84 million are related to labor litigation and R$32 million to civil loses. We posted R$38 million in allowance for doubtful accounts because of the economic crisis that we are going through in Brazil. And that has a direct impact on Copel Distribuição results. Economic crisis has been impacting energy consumption leading to a drop of 4.3% in the capital market of Copel Distribuição, in line with the drop in consumption that we see in the country. The decrease in Copel’s results is also explained by the lower results of Araucária TPP, which represented only [indiscernible] in the first quarter of 2016, accruing R$14 million loss in the period vis-à-vis earnings of over R$150 million in the first quarter of 2015, besides the drop in results which also impacted by the lower allocation of energy at Copel GeT to the short-term market aligned to the lower value of the spot price in the period. Slide #6 now, details of our operating revenue, with the reduction of 27% in the first quarter of 2016, being close to R$3 billion. The main reason for this decrease is the recognition of the result of sectorial assets and liabilities that was negative by R$527 million in the first quarter of 2016, when there was a positive result of R$561 million in the first quarter of 2015 due to the amortization of R$402 million in the period coming mainly from the recovery via tariff of the deferrals realized in 2013 and 2014, and the negative constitution of R$144 million coming from the reduction in the value of the CDE, the economic development account, and the lower cost with the purchase of energy vis-à-vis the current coverage. Revenue from delivery to end customers grew by 19% due to the adjustments of the tariffs to the Copel Distribuição tariff over last year. Nevertheless, these adjustments were affected negatively by the charges and by the slowdown in the captive markets of Copel Distribuição and the free markets of Copel GeT. Revenue from sales to other utility, that means the many of the sales of Copel GeT and all the sales of Araucária TPP had a 47% reduction in the first quarter of 2016, resulting in the lower dispatch of TPP, the lower volume of energy allocated [indiscernible] by Copel GeT, and lower spot price as we mentioned. Revenue from the use of the power grid grew by 44% due to the tariff adjustment applied by Copel Distribuição in June 2015 and also the increase of revenue of the transmission segment coming from the RAP adjustments and the startup of new Copel assets. Other operating revenues items made up by telco revenue, gas distribution and others grew by 6% and reflect mainly the 31% increase in the telco revenue which comes from the increase in the client base. On the next slide, Slide #7, we show the operating costs and expenses that were below R$2.8 billion in 1Q 2016, 23% less than the one that we had in the same period 2015. This can be attributed mostly to the 33% decrease in the cost with the purchase of energy because of the end of existing energy contracts that were replaced by energy contracts coming from the quota system, much cheaper and the reduction of the Itaipu tariff. Regarding the other costs, it’s important to say, that we had higher expenditures with charges for the use of the grid, due to the dispatch of TPP’s results by the order of merit. Manageable costs went up 12% in the first quarter this year due to higher personnel cost and third-party services due to inflation that reached 10% in the period. The provisions and reserves line, as I said before on Slide 5, represented R$121 million was impacted by labor and doubtful accounts provisions. But when compared to the same period in 2015, we see a 45% decrease in the period. But it’s important to highlight that in the first quarter of 2015 we posted R$73 million in allowance for doubtful accounts related to the difference between the contract of Colíder plants and the spot price, which means a higher amount of provisions at the beginning of last year. On Slide 8, we show the EBITDA that was 37% lower year on year, totally R$528 million in the first quarter this year with 17% margin over the operating revenues. The Copel GeT cash generation accounted for 86% of the consolidated EBITDA and Copel Telecom 5%, the other companies in the group accounted for 9% and the main contribution came from Elejor. Copel Distribuição closed the first quarter of 2016 with a negative EBITDA of R$29 million vis-à-vis a positive result of R$49 million in the beginning of 2015. But we have the effect we consider non-recurring, because of that we show on Slide 9, the comparison between the adjusted EBITDA of Copel Distribuição. As we know, the tariff for Copel Distribuição compensate for coverage for delinquency that for the current tariff cycle is of about R$13 million per quarter. However, the tariff increases and the economic stagnation have been contributing to an increase in the level of delinquency that is higher than the tariff coverage and ended up having a negative impact of R$22 million. The results of the distribution company in this sector decide in a non-recurrent fashion, we posted R$38 million in legal claims, provision for legal claims. And in February, we had some organizational adjustments that caused the transfer of part of our fuel cost from the holding company to subsidiaries with higher impact on Copel Distribuição. Considering these adjustments the adjusted EBITDA of the first quarter of 2016, which has been positive in R$38 million, 58% lower than the adjusted EBITDA of the first quarter of 2015, reflecting very clearly the impact from the market downturn, therefore the economic scenario that we have in the country now. On Slide 10, we show the consolidated net income of Copel, which reached R$136 million in the first quarter of 2016, 71% lower than year-on-year. Analyzing the results of the subsidiaries, you can see that Copel Distribuição posted R$39 million of losses in the first quarter of 2016, vis-à-vis a positive result of R$29 million in the first quarter of 2015. Copel GeT ended the period with R$165 million net income, 60% lower on a year-on-year basis, whereas Copel Telecom reached R$11 million net income, dropping 23% year on year. Specifically about Telecom, it’s important to say that the drop that we saw in the quarterly income is directly related to the increase in the financial expense that came from the increase in the debt that’s necessary to support the subsidiary’s expansion of services. Before opening for questions, I would like to talk about the leverage of the company. As you can see on Slide #11, the indebtedness of Copel measured by the net debt to EBITDA ratio grew in the last few years, then closed March at 3.3 times. It’s important to highlight that this ratio is as planned is below the limit imposed by the covenants that also lower than what we see in similar companies. This increase in the leverage was expected, but it has to do with the significant expansion [indiscernible] the company has been going through and will be reduced with the beginning of the cash flows from the different projects that we are building, many of them starting up in the next few months. So these were now our highlights. We are available to you now to answer any questions that you might have. Question-and-Answer Session Operator Thank you. Now, the floor is open for questions. [Operator Instructions] Mr. [Kaikobet Gonzales] [ph] from Citibank. Unidentified Analyst [Interpreted] Good afternoon, everyone. Thank you for the call. Now, talking about provisions, R$84 million related labor claims, could we go more in-depth, what was exactly that? And do you expect this to continue for the remainder of this year? Thank you. Luiz Fernando Leone Vianna [Interpreted] Thank you. I will give the floor to the accounting person of Copel. Unidentified Company Representative [Interpreted] Good afternoon, Kaikobet. Referring our provisions for contingencies in the first quarter of 2016, in fact we had a very [non-recurring thing] [ph] that was collected to – from the existing labor union, so very prudently we applied a conservative approach and this event represents about R$45 million in our provision. And with here our allowance for doubtful accounts is coming up because of delinquency represented R$30 million of this R$112 million. And the others are the ones that you are familiar with, R$45 million should be non-recurrent for the next few quarters. And we are monitoring very closely the issue of delinquency in order to maintain or to move down as much as we can this amount of provision for that specific end. Thank you. Operator Mr. [Jimmy Saskenia] [ph] from Credit Suisse. Unidentified Analyst [Interpreted] Good afternoon. I have two questions. The first one about provisions, you explained about the provision regarding expenses that there was a big reversal as well. Maybe you could mention what it was all about, could you point any commitment? And the second question has to do with what Sebastiani shared about the covenants. When we look at Slide #11, I understand that there are many projects that will be coming on-stream in the next few quarters. But when we look at the average for the last 12 months, we see deterioration in generation. And the situation has a negative impact may on the third quarter of last year. As we look ahead, okay, you have new projects coming on stream, but as we look at the average of the 12 months, generations and distribution worsened, because of Araucaria maybe. So do you believe there will be any break of covenant? Are you negotiating any of the covenants that you still have? Adriano Fedalto [Interpreted] Good afternoon, one again. This is Adriano from accounting making brief remarks about contingencies. Regarding this reduction, if I understood correctly vis-à-vis last year in 2015 the provision of R$75 million referring to the difference of price for the Colíder plant. And then, we had complied to the contract fully, but there was still a doubt about the price. We only took the full amount and we provisioned the difference of R$75 million prudently. As soon as this is judged, we will be able to reverse this provision in the future quarter as soon as we have a legal decision about that. Unidentified Analyst [Interpreted] Just to clarify, the reversal of R$15 million, you’re saying that we had provision R$75 million for Colíder, and you reverted R$50.8 million of this amount? Adriano Fedalto [Interpreted] No, no. I’m sorry, I’m sorry. There is some misunderstanding. The comparison that I am making is between 2015 to 2016. This is what represents the variation of minus R$47 million in our results. Unidentified Analyst [Interpreted] No. My question was about Slide #5. When you talk about the breakdown of provisions et cetera, there are reversals. On Slide #5, was it something specific that was reverted? Adriano Fedalto [Interpreted] Okay, I understand. So in 2015, we had two events that represent the R$50 million, R$24 million in benefits to employees regarding the Copel Foundation and we were able to revert R$24 million. And another one, which is trivial as well, difference of the context of almost R$28 million, almost R$29 million also is something non-recurring and that was reverted during this period. So if you add up these two events, we have this difference of R$50 million… Unidentified Analyst [Interpreted] Okay, very clear. And the other point is about the covenants. Sergio Luiz Lamy [Interpreted] The President of Copel GeT, good afternoon. Before Mr. Sebastiani make specific remarks about covenants, I would like to make one remark about the result of Copel Generation and Transmission, in the first quarter and the expectation for the second quarter, and of course it is linked to the issue of covenants. As we’ve said before, I would say that three factors came into play that was very relevant in this regard impacting the results of the first quarter. The first one was that last year, we have made an allocation of free energy, which was much stronger in the first quarter, and then this year we made a more linear allocation over the year and this tends to show better results as we evolve over the year. And the second answer was very much impacted also, and this has to do with the spot price with a sensitive recovery and a trend. We believe that the trend would continue to be there for the next few quarters. And we believe there will be more positive impact on our results coming from the increase in the stock price. And then, Araucaria also was a driver as we believe that, at least the second quarter or part of the third quarter. By the end of the second quarter and part of the third quarter, it will come back online due to the Olympics, so we have a positive outlook for better trend. Operator Now, Mr. Sebastiani. Luiz Eduardo da Veiga Sebastiani [Interpreted] One of the most important things that have already been mentioned by Lamy, and the worst moment that we see, which is the beginning of the first quarter and that was already mentioned, because of the economic scenario and the specific reality of this [last year] [ph], and what regards for instance to the non-residential [ph] GDP and the positive outlook that was mentioned by Lamy, so all that leads us to have a positive scenario for the future. The covenants are analyzed on a daily basis, all of the time, we track our covenants, and it was still below the average of the factors, and below the average of the covenants that we see, and that are only posted at the end of the period. So I understand we are concerned which is legitimate, also it is important also to clarify to you and to everybody that we have a permanent monitoring of the covenant, and observing a better scenario from now on for the next few quarters. We’ve driven high degree of comfort with the risk indicator. Unidentified Analyst [Interpreted] So you expect an improvement in the 12-month EBITDA, offsetting the deterioration of distribution and generation compared to last year, so you believe the situation will not worsen? Luiz Eduardo da Veiga Sebastiani [Interpreted] No. Our outlook as far as that is not negative. We have already established our covenants below the limit and below the average of the sector, and because of all the factors that I mentioned, our outlook is positive as we said. Unidentified Analyst [Interpreted] One last question. The issue of exceeding it, is it only for one quarter or two quarters? Did you have any type of debate? Luiz Eduardo da Veiga Sebastiani [Interpreted] It’s at the end of the year – the fiscal year. That will conclude the merger of the covenants with the contracts that we have in place. Unidentified Analyst [Interpreted] Thank you. Operator [Mr. Lacio Lusali] [ph] from UBS. Unidentified Analyst [Interpreted] Regarding to volume of energy that you sold, 300 megawatts sold in each year and the comparison with the price cut. So the price cut over time. It becomes more and more difficult to predict the EBITDA for distribution. What will be the record level of EBITDA? Can you have the visibility? And do you expect an improvement because of the next tariff revision? So how much do you believe the EBITDA will be going up? Unidentified Company Representative [Interpreted] This is [Lamy Matialon] [ph] In relation to the sale to commercialization company in 2016, while the generation company should 2017, 2018, 2019 and 2020. And the amount that we showed, I don’t have the exact figures here with me, but we were rather successful with a sense of selling all the energy that we are making available for this auction. So besides having been able to create all our available energy, we were able to reach average prices that are very satisfactory around R$128 per megawatt hour. I can send you the exact figures for each year later after this conference about the result of the auction, okay. I’ll give them to you later. Unidentified Analyst [Interpreted] Just to the order of magnitude, is there anything – it was reasonably significant, but always within a negotiation strategy? Luiz Fernando Leone Vianna [Interpreted] We’re going to the energy during – over several different auctions during the year. It’s an amount that will exceed the annual value as of 2017 of R$200 million, R$250 million just to give you an order of magnitude, okay. Unidentified Analyst [Interpreted] Okay. Operator [Rodrigo Guchelin from Gusachi] [ph]. Unidentified Analyst [Interpreted] Good afternoon. Thank you for the call. My questions were about the covenants, in your [indiscernible] volume of energy sold. It was not so clear to me, I mean, the volume of energy sold, it seems to me that at the beginning you’re having a more aggressive effort around 125 to 130, they’re also megawatt hour. Am I interpreting correctly, what you said? Luiz Fernando Leone Vianna [Interpreted] What’s your name please? Could you repeat your name? Unidentified Analyst Vudilu [ph]. Luiz Fernando Leone Vianna [Interpreted] Vudilu, good afternoon. The sound is very bad. So I would like to ask you to repeat the question. Unidentified Analyst [Interpreted] I had two questions, one about the covenant that you have already answered. And the other one, I need some more color about the order of magnitude of your energy sales of the Comitaligadura [ph] company. Is it according to the prices that are acceptable between R$130 and R$125 per megawatt hour, could you clarify this, please? Luiz Fernando Leone Vianna [Interpreted] We had a few auctions in place, in which we sold energy from the generation company, in one modality and the Comitaligadura in another modality. So, you are asking about the Comitaligadura company and because of that, I am going to give the floor to the president of this company. Unidentified Company Representative [Interpreted] Good evening. The [indiscernible] it was very concentrated and incentivized and the expectation that we have is attempting around R$165 as of 2017. For 2016, the amount is slightly lower, and with the purchase is more feasible. Within conventional, R$30, R$35 is slightly below this amount. Unidentified Analyst [Interpreted] Thank you. Operator Also Lusali from UBS. Unidentified Analyst [Interpreted] I had a question about distribution and the recurring EBITDA. How much it will increase with the implementation of the tariff revision? And since the move there R$200, R$250 average megawatts that’s already sold by the generation company is very high volume. So, it slightly better than between R$150 and R$200, that’s all I have just checked, okay. Luiz Eduardo da Veiga Sebastiani [Interpreted] Now, I’ll turn it Antonio Guetter, President of Copel Distribuição who will answer your other question. Antonio Sergio de Souza Guetter [Interpreted] Hello, [Murino. No, Marcelli] [ph], sorry, okay, and everybody, about the reduction in our EBITDA as we have said before, it tends mainly from distributions and also by the problems that we have the distribution company regarding the allowance for doubtful account. Because at the moment that the country is dealing with recession and reduction in consumption, and at the same time here in Paraná as another state, we have an increase in cost of energy, and this results a reduction in the size of our market and the increased delinquency. As a consequence, our allowance for doubtful accounts, we have been working very strongly, and our allowance for doubtful account even increasing our cost to – and also work with a client in order to revert this delinquency cost and we believe that this decision with tariff that we have a trend of change in 10% over June, we would be seeing a reversal in this current – of the EBITDA that was negative this quarter. I believe that the market will continue to be weak, and looking at the scenario that we have for this year, we believe we will not even have R$100 million EBITDA do you agree or may be a little bit more than that? [Indiscernible] as our CFO said, we have already reached the worst point of the year, and now we expect EBITDA – we already see that in terms of delinquency because we see already a reversal in our curve, because we put in place many actions in this regard. And we believe that the level that we will have by the end of this year will depend a lot on what a new administration the new government does, but we believe there will be a positive trend in the market reduction in delinquency whether actions regarding allowance for doubtful accounts, we will start to have the effects. Unidentified Analyst [Interpreted] How much of your EBITDA would increase because of the carrying provision, how much should we expect? Luiz Fernando Leone Vianna [Interpreted] I think you are following that, we expect to be doubled our asset. As a consequence, we believe that we will approximately double our EBITDA. Unidentified Analyst [Interpreted] Thank you very much. Thank you for the answer. Operator Miguel Rodrigues from Morgan Stanley. Miguel Rodrigues [Interpreted] Good afternoon. Two things. First, leverage. Net debt to EBITDA that you delivered it is already addressed by the CDE and what is the exact balance today? Going back to the energy portfolio, what about contracts will now come back on, are you going to accelerate expecting prices to pick up or do you tend to have new auctions and what is your intention regarding this? Luiz Fernando Leone Vianna [Interpreted] New covenants, net debt and EBITDA is not part of that calculation, okay. Sergio Luiz Lamy [Interpreted] Good afternoon. This is generation and transmission. Although we have an expectation trend and that’s a trend in the prices of energy from now up until the end of the year. Our strategy, a strategy based on the average price. So we are going to hold many auctions starting next month. So we do have many different auctions during the year not just for us to have an average selling price for the year, okay? Miguel Rodrigues [Interpreted] Let’s say the market conditions worsen, are you expecting R$125 to R$130, and do you expect market price is different from that, are you going to hold back on your auctions? Sergio Luiz Lamy [Interpreted] Our expectation is positive in the phase of having more favorable market prices. Of course, if this does not materialize, then we do have to address the amounts of energy to be sold due to the market prices with the decrease of rate, or increase of rate regarding the market prices and how they develop. Miguel Rodrigues [Interpreted] Thank you. Operator [Operator Instructions] There are no more questions, I would like to give the floor back to the company for the closing remarks. Luiz Fernando Leone Vianna [Interpreted] This is the CEO of Copel speaking. As we have said before, we had not only at Copel, but in the sector as a whole and in the country, we had a very unfavorable first quarter. We understand that the power sector was even better than the average for the country and our outlook, and we are very much convinced when we say we will be back in the second quarter. We will have better results than the first and place our bets on this new moment that the company’s starting to look and expecting a recovery, because of exchange and we are rather hopeful. We believe there would be improvements to the country and we will be able to close 2016 with a much better perspective than we have in the first quarter. Thank you. Operator Copel’s conference call about the results of the first quarter of 2016 is closed. 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American DG’s (ADGE) on Q1 2016 Results – Earnings Call Transcript

American DG Energy Inc. (NYSEMKT: ADGE ) Q1 2016 Results Earnings Conference Call May 13, 2016, 11:00 AM ET Executives Bonnie Brown – Chief Financial Officer John N. Hatsopoulos – Co-Chief Executive Officer Benjamin Locke – Co-Chief Executive Officer Analysts Haydn Cole – Essex Asset Management Tom Retol – Private Investor Andy Rieger – Private Investor Mike Wuzuka – Oppenheimer Walter Schenker – MAZ Partners Operator Good morning and welcome to the American DG Energy First Quarter 2016 Financial Earnings Conference Call. All participants will be in listen-only mode. There will be an opportunity for you to ask questions at the end of today’s presentation. In addition to management Charles Maxwell, American DG Energy’s Chairman and energy industry expert will be available to take your questions during the Q&A session. [Operator Instructions] As a reminder, this conference is being recorded. The recording of this conference call will be available for playback approximately one hour after the end of the call and will remain available until Friday, May 20, 2016. Individuals may access the recording by dialing 877-344-7529 from inside the U.S., 855-669-9658 from Canada or 412-317-0088 from outside the U.S. Enter the replay conference number of 10084854 followed by the pound sign. Now, I would like to introduce Bonnie Brown, American DG Energy’s Chief Financial Officer. Please go ahead. Bonnie Brown Thank you. Good day and thank you all for joining us on our first quarter 2016 earnings call. I’m Bonnie Brown, American DG Energy’s Chief Financial Officer. On the call with me today are John Hatsopoulos and Benjamin Locke, our Co-CEOs, John Estabrook, our VP of Finance and Robert Panora, Director of Operations. Before we begin, I’d like to read our Safe Harbor statement. Various remarks that we may make about the Company’s future expectations, plans and prospects constitute forward-looking statements for purposes of the Safe Harbor provisions under the Private Securities Litigation Reform Act of 1995. We may make forward-looking statements about our future financial performance that involve risks and uncertainties. These risks and uncertainties could cause our results to differ materially from our current expectations. We encourage you to look at the Company’s filings with the SEC to get a more complete picture of our business including the risks and uncertainties just mentioned. Also during this call, we will be referring to certain financial measures not prepared in accordance with Generally Accepted Accounting Principles or GAAP. A reconciliation of the non-GAAP financial measures used on this call to the most directly comparable GAAP measures is available in our press release and in the tables accompanying that release. While we may elect to update forward-looking statements at some point in the future, we specifically disclaim any obligation to do so even if our estimates change, and therefore you should not rely on these forward-looking statements as representing our views as of any date subsequent to today. I now turn it over to John Hatsopoulos for some opening remarks. John N. Hatsopoulos Ladies and gentlemen thank you very much for joining us. This is a period of transition for American DG and with the goal of the returns of our existing facilities rather than continue on growth. We do have a good backlog which Ben Locke my Co-CEO who by the way has done a spectacular job along with Bob Panora in improving the returns of the existing equipment which I believe are about 60 and we are well on our way. I think Ben will tell you where we stand. Our returns are improving; we believe that sometime this year if not whole year will be cash flow positive. Anyway that’s our goal and by the way, it’s not a projection, it’s a goal. With that I’d like to ask Ben to give you an update of where we stand. Benjamin Locke Thank you, John. Before I go on to review of our results, I’d like to provide a quick review of our business for those who might be new to the call. ADGE and EuroSite power are on the business of settling energy into form of electricity, heat and cooling to customers who wish to save money spends on traditional sources of energy. We own the assets that produce the energy onsite and earn revenue as the customers pay ADGE a discounted rate for electricity and heat or cooling. This model called On-Site Utility or OSU is quite common and practical with energy technologies, such as wind, solar and co-generation systems. The OSU model is an essential part of any distributed generation infrastructure, so it’s not every customer at the capital or the financial flexibility to own the asset outright. As I stated in stated in past calls and John has just mentioned, our main focus last year and continuing into this year is to improve the operation of our existing fleet, in order to increase productivity while optimizing our margins and improving our cash flow. Our result of the past quarters and continuing into the first quarter of this year confirmed the success of this effort as we are seeing solid improvements in our margins. I believe demonstrating robust and consistent margins for ADGE is the most important metric to guide our business going forward. We have also undertaken efforts to reduce our operating expenses with good results. With that, I’ll review the financial results for the quarter; followed by an update on operations which Bonnie will provide detail on. Our total revenues for the first quarter were approximately $2.2 million compared to approximately $2.5 million in the first quarter of last year. This reduction in revenue was expected with the reallocation of the underperforming LLC sites in mid-2015. Revenues for the quarter were also adversely affected by other factors such as weather and lower utility rate at some of our sites, which Bonnie will provide more detail on just a few minutes. Our margins excluding depreciation however improved slightly to 32.7%, a 5% increase over the first quarter of 2015. This reaffirms that our efforts to improve performance and reduced costs are affective even with the milder weather and changes in utility rates this quarter. We have achieved on non-GAAP EBITDA cash flow positive quarter with an inflow of approximately $81,000, as opposed to outflows of approximately $430,000 in the comparable prior year period another milestone that supports our efforts over the past year are successful. Other notable accomplishments over the quarter include the reduction in outstanding convertible debt. Last week we eliminated 9.3 million in convertible debentures that was due in May of 2018 in exchange for approximately 14.7 million shares of EuroSite power. With this swap of EuroSite power shares and exchange for partial elimination of the convertible debt American DG Energy reduce the convertible debt outstanding 9.2 million. The company is pursuing a similar debt exchange transaction for the remaining convertible debt outstanding and expect to complete that subsequent transaction in the coming weeks. This transaction substantially improves ADGE’s balance sheet and along with the improvements in margins put ADGE in good position to complete their remaining site improvements and our project backlog. And also eliminates the risk of potential shareholder dilution that may have resulted from a debt to equity conversion. And as I mentioned our efforts to reduce expenses is showing results. Our overall operating expenses have decreased to $1,080,00675, a 21.2% improvement over the first quarter of 2015. Turning to EuroSite. They received almost $370,000 in 2016 from the U.K. government for construction activities in 2015. The enhanced capital allowance program in the U.K. is a cash energy tax incentives for energy saving plant and machinery, which includes CHP system. Also this week EuroSite raised $7.25 million in the private placement. I encourage you to listen to EuroSite’s earning call on Monday for more detail on their progress. With that, I’d like to turn it over to Bonnie for more detail on our operations. Bonnie? Bonnie Brown Thank you, Ben. I’ll be providing an overview of the company’s operations for the first quarter of 2016, more specifically the performance of the systems we are operating here in the United States. Throughout 2015 and 2016, the company has focused on improving domestic fleet operations, which consists of 76 fully owned systems and 16 that have shared ownership with our LLC partner. As we discussed in our last call, we recognized that with efforts these systems could provide significantly better financial returns. In the first quarter of 2016, energy production by CHP system improves for the ADGE fleet by 1% as compared to the same period in 2015. We consider this a positive outcome given the unusually warm winter experienced in the Northeast United States where our fleet is located. With those who lived in this region will not soon forget the winter of 2015 with record cold temperatures in snowfall and as a sharp contrast to one year later. Quantitatively speaking the difference is evident when heating loads are compared, Boston [ph] which is typical with reduction in the 2016 Q1 heating load of 30% in the same period in 2015. While energy production was up by 1% reported revenue declined by 12% due to lower utility rates in the range. However just as utility production cost has dropped due to lower natural gas prices ADD has life like benefit. ADGEs cost to reduced electricity year-over-year have declined more or less in proportion to our revenue. Consequently our gross margin has not suffered by deduction improved by 5%. While electricity prices are down overall, we are encouraged to see electric rates in Massachusetts climbing. We are hopefully this trend will continue and expand into other regions. Our initiatives to improve existing fleet performance has been on two tracks. First has been to selectively complete evaluations and upgrades to those sites that have unrealized potential for revenue and margin. This a very successful strategy, our four clients [ph] sites in New York City area that comprised 37% of our fleet have collectively increased production by 7% in the first quarter of 2016 as compared to the first quarter of 2015. The second track can cause fleet-wide improvements that follow four basic areas; communication, instrumentation, water treatment and demand management. Water treatment has been found to be very effective and inexpensive preventative maintenance measure. In addition, more expensive site instrumentation that’s accessible through the Internet can help us diagnose and correct problems quickly and efficiently. Regarding demand management, we have taken a fleet-wide initiatives to increase our revenue by billing more customers for this additional unbilled financial benefit. Let me explain, commercial towers in the U.S. typically include a significant charge associated with the facilities peak usage. Even if the peak period is only for a few minutes. From an ADF perspective, realizing this benefit requires two elements. First, we must manage the CHP system, such that it is always operational considering key facility usage. Second, we must add additional on-site instrumentation such as the benefit is recorded for accurate invoicing. While this initiative is just under way, we have greatly refined the implementation process and hope to upgrade most of the fleet by year end to include this additional billing and adjust our operating strategy accordingly. We were pleased to have built approximately 50,000 for demand saving in the quarter, a 60% increase from the same period in 2015. We would like to exercise this increased revenue has no associated cost, except for that one-time case instrumentation setup. As mentioned last quarter, we assumed a full ownership of eight sites from our LLC partner. Our efforts thus far have been focused on upgrading needs to our standards. While we have made good amount of progress it is required a significant down time of units while the work is being performed. Our expectation is that we will bringing most of these sites back to full operating status in the next two quarters. We have also been engaged in bringing new sites online and reducing our backlog. We are pleased to report that [indiscernible] project in [indiscernible] and New York is under construction assets, a delay of several years. The site which will have a capacity of 1.5 megawatts will be our largest site to-date [indiscernible] in New York. The construction delay was a direct result of Hurricane Sandy, specifically the extensive parking damage resulted in significant building from changes in beach front areas. This process resulted in several years of permit delays in engineering changes, which is thankfully behind us. Now I want to turn the call back to Ben to conclude our discussion. Benjamin Locke Thanks, Bonnie. So looking forward to the rest of the year, I am very confident that our efforts to improve performance are existing fleet, reduce expenses wherever possible and complete our backlog to contribute revenues with good margins will result in improved financial performance for the company going forward. Also with the elimination of half our convertible debt and the expectation to eliminate the rest of the debt ADGE will be in excellent financial condition to develop strategy for additional growth. In summary I continue to strongly believe that ADGE’s business model is good, the fundamental economic drivers for our OSU models remain favorable and ADGEs business will continue to show improvement in 2016. Thank you for listening to our call and I’ll turn the call back over to the operator for questions. John N. Hatsopoulos Before we do this, can I mention something that one of the concerns that we have had is capital and we have been hesitant to expand our fleet because we are not about to raise money at the current stock price or for money for a company that when we had that kind of a debt overhanging us. The demand exists, we do have enough capital to complete our units that we have in our backlog, once we eliminated debt, we have three banks that have shown interest in loaning us money, but those at this point not till we eliminate the balance of the debt. With that, we’ll open it for questions. Question-and-Answer Session Operator [Operator Instructions] Today’s first question comes from Walter Schenker of MAZ Partners. Please go ahead. Walter Schenker If you in fact eliminate the convertible debt on terms similar to which you just did the conversion that will reduce American DG Energy’s interest in EuroSite to roughly what? Bonnie Brown 1.3%. Benjamin Locke The answer is we reduced our holding in EuroSite to about 1.3% Bonnie said. Walter Schenker Okay. So extensively the decision was made that you’re separating the company, so that [indiscernible] which has – okay so ADGE has to rise or sink as an investment in value based on its ability to grow in the U.S. market and EuroSite which already able to raise Bonnie witnessed in recent announcement and growing backlog and more government support we’ll be able to really – so you don’t believe, I’m sorry I’ll rephrase the question. You don’t believe EuroSite is in fact more attractive and that effectively what you’re doing is, is reducing the potential for American DGE pretty close and we no longer have an interest in EuroSite. John N. Hatsopoulos That’s actually true. The problem is that nobody ever gave us credit for all the shares that we owned at EuroSite and you’ve seen what has been done to the stock, which was trading well below the value of the EuroSite shares. And why this is a decision that we have to make. The second reason is that EuroSite takes a lot of attention from the ADGE management and we needed to separate it especially since their overseas and we’re here. But that’s where we are and I’m sorry Bonnie. Bonnie Brown It is the debt and in addition, we needed to – we needed to do. John N. Hatsopoulos Bonnie is right. If we don’t remove the debt, we cannot borrow money, we cannot borrow money, we cannot grow. If we do with the – and we are in a process of final negotiations to remove the part of the debt that we like to do. Then we can raise at least we’ve been told that we can raise money from bank and institutions and resume the growth of the company if we so desire. But right now $80 million, $90 million worth of debt, even though it was – its three years away, it’s in 2018, May of 2018. The banks and investors were not willing to loan us money, with this of earning. So we had to make a decision, do we want to make the company debt free to allow to borrow money if they need to or do we need to keep going and eventually selling EuroSite shares to pay the debt. Otherwise we could not over the next two years have a profit, the cash flow profit of $18 million. Walter Schenker Okay. I got it. Thank you. John N. Hatsopoulos You’re welcome. Operator And our next question comes from Mike Wuzuka [ph] of Oppenheimer. Please go ahead. Mike Wuzuka Good morning everybody. A part of my question was answered by the previous caller, but as a follow-up now. What’s the backlog for the booked projects for the remainder of this year? If you said it I missed it. Benjamin Locke Yeah, well, the backlog is a combination of ADGE and North America and EuroSite. EuroSite has a backlog and we’re on seven projects and I imagine Paul will give some detail to those on his call on Monday. So I’ll speak to the ones on ADGE side, a big portion of the backlog is project that Bonnie mentioned. A couple of buildings or five building specifically in New York that underwent tremendous construction delays and permitting problems as a result of Sandy and there was a huge knot to untangle, but we’ve been successfully able to untangle that and now construction is going on in a very brisk pace. So we’re happy about that, so the hope is that those units will come on soon. They’re not going to all come on at once, but come on sequentially, but we’ll have more updates on that. So that’s five units, we’ve got another project that’s nursing home, that is got – a unit that is very near commissioning. So that should be starting very soon. We have another project we announced the Salvation Army I know earlier this year. That is in the midst of getting construction bids to make sure that all the estimates that we put together in the OSU match was coming in from the actual contractors. And then we have a few projects with a very large location of our Stevens University as many of our systems, many of our co-gen, many of our CHP system installed. We had two CHP systems and two chillers that we’ve been planning to install there that have been stuck behind Stephen’s own construction schedules. They are knocking down buildings and putting up new buildings and so they are very good customers all of ours. So we are patiently waiting for them to get through their own construction planning before we’re able to install the backlog of systems there. So I’d say Mike, the main thing you should be looking for in terms of backlog accomplishment is certainly this large lunar project and this nursing home in New Jersey. Mike Wuzuka Well it seems to me that the future of this company is to add systems and from what I’m gleaning from the conversation today a couple of things. First of all at some point in time and Bonnie can probably address this better, we will no longer consolidate EuroSite if I’m correct in interpreting once the debt is extinguished and the EuroSite final ownership of EuroSite shares is transferred to new owners. Without the EuroSite consolidation, it seems to me that ADGE at least going into 2017 for all intensive purposes is in a caretaker status and that worries me because the future is booking systems and building systems and bringing them onto the operating fleet and I am little concerned about whether we are going to refocus our attention and adding to the fleet. Benjamin Locke Yet, Mike, so I can understand you’re feeling that way, but I don’t believe that is the case. What we’ve been doing very conscientiously is making sure that the company is in a good place before we start growing it to the next step. I think certainly before taking on a multitude of new projects, we absolutely had to make sure that all of those things that Bonnie mentioned about instrumentation, water quality, how we measure demand, how we get revenues is optimized as much as we can and we’re getting there, number one. And number two making sure that our balance sheet is strong enough to support as John mentioned getting funding to start new projects. So there is no lack of potential new project for us and in fact we’re kind of eager to start some of these new projects and continue to grow the business. But we have to be disciplined on the efforts that we’re doing right now to make sure we’re in good position to do that. John N. Hatsopoulos This is John and I want to add something to what Ben just said. We would negligent if we as a company with a huge debt that sounds, we can wake up some morning and we know we cannot pay it. On the other hand by making the company cash flow positive, then the future of the company is very positive and that’s what we decided to do. The board decided to do it. As a matter fact, we have on the confidence goals charging Maxwell was the leader of this kind of strategy. And we feel that we have – if we have a company by the end of the year that can have a future is the right thing to do. Now whether it’s caretaker or no caretaker as long as cash flow positive it’s going to be around for a long time. Mike Wuzuka Okay. Then as a follow-up there was a think piece I think on April 26 where it was announced that the state of New York and six utilities have joined into a new program, I think it’s called solar progress partnership, where the state of New York and the local utilities are going to promote solar systems and as a green energy effort, if you will. And I’m beginning to get – be a little curious as to how that might impact ADGE going forward because it seems that the state of New York now is moving toward and the local utilities, apparently six of them in the state of New York are moving toward solar projects and how will that impact ADGE and the ADGE efforts in and around New York City? Benjamin Locke Sure, Mike, I can talk about that a little bit. Certainly solar gets a lot of attention. There are I’m familiar with the project that you mentioned. But just equally there are CHP projects that the state is putting focus on as well. So I don’t think the existence of that initiative doesn’t mean that that’s the only kind of game in town indeed there are very good programs that continue to evolve for CHP, particularly in very high demand regions like in New York et cetera. So I’m not worried that that solar focus is going to take away from the focus on CHP because there’s plenty of attention there. Secondly, I will that Tecogen came out with the new product, I’m not sure if you’ve been following that, but the new Tecogen product is specifically designed to accept other types of distributed generation inputs. Its inverter, just to get a little technical here, its inverter is rated for higher, than what the CHP output is. Meaning that the CHE can be running and you can have solar imports or battery or wind, but we’re talking solar to supplement. So I think the new Tecogen product is a new tool for ADGE to look at solar as an overall system to be deployed in some of these areas. Mike Wuzuka And then as a final follow-up there have been a series of announcements in and around New York City where large companies like Johnson Controls and Honeywell and to some extent Siemens are entering the CHP market with offering for instance school districts – entire district projects in a single relationship spread over a number of years. From a competitive standpoint what’s our ability to compete with companies like Johnson Controls, Honeywell, Siemens and it’s my understanding now that even Kohler is going to be getting into some sort of combined heat and power systems. And how can we compete against these guys? Benjamin Locke Sure. Yeah, I’m familiar these large ESCOs have such large national presence that their whole business model is to send an entire city or an entire town or entire school district to do everything from insulation, window replacement, solar and now as you rightly point out CHP is a part of that. I don’t think we could compete with them, with that breadth of energy services that they provide. I think ADGE has expanded our charter a little bit, not just to be CHP and chillers, but we’re also looking at boiler work. I don’t think we’d want to compete with them for those far-reaching projects. I think our niche is a good one and that projects that are kind of a underneath the radar of these large ESCOs working again with residential, with hospitality and with healthcare and YMTAs and things of that nature is our sweet spot where we don’t rub up against these big guys. And so I think that’s the answer and I don’t think we want to compete with these guys, we stay away from their turf and they’re generally staying away from our turf. John N. Hatsopoulos But Ben, again this is John. I thought in some cases the Honeywells and the Siemens and Johnson Controls have been customers of ours. Benjamin Locke Well, they’ve been customers of the equipment. John N. Hatsopoulos Of Tecogen. Benjamin Locke Of Tecogen, yeah, but not ADGE. John N. Hatsopoulos That is correct. Mike Wuzuka Okay, well. I appreciate the update. Benjamin Locke Sure. Mike, thank you. Operator [Operator Instructions] Our next question comes from Andy Rieger [ph], a Private Investor. Andy Rieger Real quick questions for Bonnie, this is just more of just a curiosity question or just from balance sheet and cash flow. What does the pro forma liability section look like? Do we kill all of the convertible debentures spoke to the $1.5 million and the $17 million and the notes payable to the related parties or what does that long-term section look like, once all these transactions are completed. Bonnie Brown Well, some of the debentures will remain – some of them are EuroSite, so you have to remember our balance sheet is consolidated as presented here. So I can speak to ADGE, because EuroSite has not done their earnings call or released their earnings yet. So our goal is to remove all of the debt from ADGEs books. So there will be no debt on ADGEs balance sheet, which is just a convertible. John N. Hatsopoulos Andy, we said this, the consolidation adds the debt of EuroSite, so once the presentation stops ADGE will have zero debt. Andy Rieger No. I get that, I was just making sure that all I’m saying I just wanted to confirm that. Bonnie Brown Okay. Andy Rieger That’s it. Thank you. Benjamin Locke Okay. Thanks, Andy. Operator [Operator Instructions] Our next question comes from Tom Retol [ph], a Private Investor. Please go ahead. Tom Retol I’m sorry, I got disconnected, so I don’t know if this question was just asked or not, but what’s the decision made to the exchange EuroSite stock instead of ADGE stock for the reduction or the elimination of the debt? John N. Hatsopoulos We had to pay the debt somehow, so we traded the stocks of EuroSite, unfortunately because there is very little float in the marketplace, does not trade and it trades by appointment. So we couldn’t have sold shares of EuroSite in the open market without – to pay off the debt. So we had to make private deals with private investors. That’s the only to do it. Tom Retol Okay, so the debt holders would prefer to have EuroSite stock as opposed to ADGE stock? John N. Hatsopoulos We don’t want to dilute ADGE, no, no, we didn’t want to do it because if we gave $0.30 of whatever the stock is right now shares would have had to give them almost all the company to pay it off. So this is not what we thought is the best interest of our shareholders. Selling, giving shares even if there was to it, we didn’t even want to consider this kind of thing. So our goal is not to pay the debt with our ownership of the company, we don’t want to give away the ownership, the company wants get its act all together as we are planning to do will be more valuable. Tom Retol Okay. Thank you. Benjamin Locke Thank you, Tom. Operator And our next question comes from Haydn Cole of Essex Asset Management. Please go ahead. Haydn Cole Good morning, thanks for taking my question. I’m just thinking about sort of like the recent change to getting cash flow positive here in the quarter, which is I think very positive and I guess, what I’m interested in the margin even though it is kind of steadily improving 1% again this quarter. It seems like the profitability is most leverages by the utility rates. So I’m wondering like on a going forward basis, how we feel about that. You know because it seems like that if the end goal they pay their goal the shareholders is to see more value creation that maybe there’s some things that we – are you all got thinking about managing the downside risk of more deflation and utility pricing? Are you thinking about that? Benjamin Locke Yeah, I think a lot about that, and I’ll answer it in two ways, as Bonnie mentioned as energy prices go down and electric rates go down we’re hedged a little bit by the fact that our operating expenses for running the equipment also go down because the gas is going down in price, well the gas bills that we’re paying are going down. So we have a natural hedge against reduced electric rates that way. Secondly, the electric rates are not to too much of attention [ph] here but are complexed with different utilities. That I think what Bonnie described as the demand portion of an electric rate versus the basic you know what you everyone understands is that cents per kilowatt hour is very nuance and sometimes you see one go down and the other go up. And if ADGE is not in the position to take advantage of that change in tariff structure, particularly the demand component then you’re right, then we start to lose out. So I think one of the ways that we’re reacting to the changing utility structure is to make absolutely sure that we have all those things that Bonnie mentioned in terms of instrumentation, monitoring et cetera to make sure that we’re able to capture the demand component. So that if the demand component – if the cents per kilowatt goes down, but demand component goes back up, we’re able to benefit from that. So those are the two things that I think we can do. Now in general electric rates are trending upward, I think if you speak with energy, any energy analyst and certainly Mr. Maxwell is one of the best of them, will agree that over the long-terms infrastructure drives electric costs, certainly in New York that’s the case. So in the long term I think we’re going to continue to see healthy electric rates to support our business model. John N. Hatsopoulos I want to add to what Ben has just said, that one of our directors is a gentlemen called John Rowe. He was the chairman and CEO of their largest I believe nuclear facilities electric production facility in the United States. And this is his feeling also, that on the long-term basis utilities will find a way to get there bond or flesh. Benjamin Locke Yeah and then certainly as we mentioned before the influx of more solar just puts more of the cost burden of the electric utility on the other rate payers, like any analyst will substantiate that that’s the problem. It’s a problem facing the overall electric utility industry today is the promulgation of more distributed generation. That’s good for our business model. Haydn Cole Yeah, and then I guess, so I like that I cannot agree with those things and I don’t know if that’s good or not, but I feel like that we’re aligned fairly strategically on those thoughts. And I guess, the thoughts that I’m also curious about is it seems like there’s a lot of strong ties and great connective tissue obviously with Tecogen and their technologies. I wonder strategically on a going forward basis, how much more we can reasonably I guess, speculate that we’re going to benefit from their different and new technologies because the recent one if I’m not mistaken is more focused on autos and doesn’t really have an impact on utilities, on-site utilities. Benjamin Locke Yeah, that’s though completely separate from American DGE. Haydn Cole Right. But do we think about kind of what they – because we’re using their technology essentially like is there any concern that I don’t know, don’t have access to newer things that they’re developing because they’re more sort of going into another direction and not on-site direction? Benjamin Locke Yeah, I don’t think so, Tecogen’s core business model remains as CHP equipment, as well as the heat pumps and chillers and the improvements that Tecogen is making on those, I mentioned the new CHP product that’s got a lot of innovation, plus all of that is going to help out American DGE. Now the efforts that Tecogen is making on the auto emissions, that’s a different business that Tecogen is going to go after, but that doesn’t take away from their core business of making equipment. Haydn Cole Okay. All right. Thanks guys. Benjamin Locke Thanks very much. Operator And that concludes today’s question-and-answer session and today’s conference call. We thank you all for attending today’s presentation. You may now disconnect your lines and have a wonderful weekend.6 Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) 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