Management of Atlantic Power Corp (TSX: ATP, NYSE: AT) reported third-quarter and nine-month operating and financial results that in a vacuum were solid.

But management’s prepared remarks and answers to analysts’ questions during the company’s third-quarter conference call on Friday, Nov. 8, leave very open the distinct possibility of another dividend cut announcement in early 2014.

Project-adjusted earnings before interest, taxation, depreciation and amortization (EBITDA) for the third quarter were up 32.7 percent compared to the prior corresponding period to USD76.2 million, and the nine-month total was up 24.9 percent to USD213.3 million. Both figures were slightly ahead of management expectations.

Cash available for distribution for the quarter was USD37.9 million, up 33.9 percent from USD28.3 million a year ago. On a year-to-date basis distributable cash was up 8.8 percent to USD109.9 million, already topping management’s full-year guidance of USD85 million to USD100 million.

The quarterly payout ratio was 29 percent, down from 120.1 percent a year ago. For the first nine months of 2013 the payout ratio was 42.9 percent, down from 98.1 percent for the prior corresponding period.

Atlantic has also narrowed its 2013 project adjusted EBITDA guidance to USD260 million to USD275 million, at the upper end of a prior range of USD250 million to USD275 million. Distributable cash is tracking to USD85 million to USD100 million; management expects a negative figure in the fourth quarter due to the timing of interest payments and stepped-up capital expenditures.

Distributions for the year will be approximately USD60 million, for a full-year payout ratio of 75 percent to 75 percent.

As for operations, Atlantic reported an availability factor of 94.9 percent for the third quarter and 94.3 percent for the year to date, both down slightly compared to 2012 due to scheduled outages at several projects and low initial availability at the Piedmont biomass facility in Georgia, which came online in April 2013.

Generation increased 44.2 percent in the third quarter to 2,184 net megawatt-hours (MWh) and was up 40.3 percent to 6,173 MWh for the first nine months of the year due to the addition of new projects, including Canadian Hills, Meadow Creek and Piedmont.

Output from the Canadian Hills and Meadow Creek wind projects were lower than forecast for the third quarter, but management noted strong wind conditions at Canadian Hills in October.

The Curtis Palmer hydro facility reported high water levels in June that continued into the third quarter, though Mamquam experienced lower water levels and a scheduled outage. Generation from Nipigon and Morris was limited by scheduled outages.

Overall, on a year-to-date basis, generation from Atlantic’s wind, hydro and thermal facilities are slightly ahead of expectations.

The rub is that we’re dealing now with an investment thesis that’s dramatically different than the one that Atlantic Power supported as recently as November 2012, when CEO Barry Welch indicated the then-current annualized dividend rate of CAD1.15 was sustainable, based on the company’s ability to re-contract now-sold Florida projects.

The short story, including a downturn in the Ontario wholesale power market and additional re-contracting difficulties for the New York-based Selkirk project, is that in February 2013, along with its announcement of 2012 results, management cut its 2013 project-adjusted EBITDA guidance and eviscerated its dividend.

The new, lower guidance and the 65.2 percent reduction in the annualized dividend rate to CAD0.40 per share blew several holes in multiple aspects of the Atlantic Power story, most importantly destabilizing its position as a retail-investor-focused dividend payer and undermining the credibility of senior management.

At the time of the February 2013 dividend cut we identified five benchmarks that would guide our continuing evaluation of Atlantic Power and its position in the Canadian Edge and Utility Forecaster portfolios.

(Because of the payout cut we did move the stock from the UF Income Portfolio Aggressive Holdings to the Growth Portfolio Aggressive Holdings and from the CE Portfolio Conservative Holdings to the Aggressive Holdings.)

The five criteria were:

• Successful completion of the sale of the Florida plants at the stated price.
• Successful syndication of the Canadian Hills financing.
• At least one new project announcement.
• Successful completion of the Path 15 power line sale.
• Payout ratio in line with guidance.

Management has hit four of the five criteria, but, as we noted when Atlantic reported second-quarter earnings in August, there is not likely to be a new project announcement anytime soon. Management’s focus is on “optimizing” performance at existing projects, with more than 100 potential projects with investments ranging from USD10,000 up to the USD11 million project at Nipigon identified.

Atlantic plans to invest approximately USD20 million during 2013 and 2014 on these initiatives and expects an EBITDA contribution on a run-rate basis in 2015 of at least USD6 million.

With all necessary approvals in hand, Atlantic is proceeding with the aforementioned Nipigon project, which involves the upgrade of a steam generator at the 40-megawatt combined cycle project in Ontario. CAPEX for this project is budgeted at USD11 million, with approximately USD2 million of to be spent in the fourth quarter of 2013. The outage to do the majority of the work is scheduled for the early fall of 2014.

Atlantic has also committed to expediting the installation of required upgrades at its North Island project in California, which recently secured an increase in interconnection capacity from 38 megawatts to 42 megawatts. Management plans to begin cash outlays for this project during the current quarter.

All told major maintenance costs for 2013 are expected to be approximately USD40 million, up from USD30 million to USD35 million previously.

Re-contracting in New York for Selkirk and in Ontario for the Tunis project remains problematic. A proposal for the former has been submitted, and preliminary discussions on the latter have been held. Power-purchase agreements covering both projects expire in 2014.

Atlantic Power’s share price got hammered on the Toronto Stock Exchange (TSX) and the New York Stock Exchange (NYSE) last Friday and again on Monday because during management’s conference call to discuss third-quarter results, it emerged that yet another dividend cut is among the potential outcomes of management’s ongoing consideration of alternatives as it seeks to reduce debt and strengthen the balance sheet.

Management was reticent to discuss details of its still-evolving strategy to improve Atlantic’s ability, noting that it’s “considering a variety of options to address” near-term debt maturities, improve financial flexibility, reduce debt levels, optimize assets and reduce expenses.

Because they’re “still in the process of evaluating all those potential alternatives” and “do not know which, if any” they’ll be able to implement, those who participated in the call on Atlantic’s end didn’t want to reveal too much.

Management did note that one or more of the options being considered would, if implemented, result in a “significantly” higher 2014 payout ratio. The priority for management right now, however, is the balance sheet. And “these or other actions” it may take to achieve what it wants to achieve its financial objectives “could have an adverse impact on the dividend level.”

Atlantic passed on an opportunity to provide 2014 payout ratio guidance. Management did note that it expects to provide an update on its plans during the first quarter of 2014. Also, as has been disclosed during previous quarterly reports, approximately USD37 million of cash available for distribution this year is from discontinued assets and won’t recur in 2014.

Some balance-sheet flexibility could from the conversion of USD76.6 million of construction debt related to the Piedmont project to term financing before year’s end. But Atlantic management, based on discussions with its lenders, expects to have to put additional cash into the project for credit enhancement until certain issues are resolved.

Among these issues is a dispute with the project’s contractor, which is now in the discovery phase leading up to arbitration.

And following the anticipated conversion Piedmont won’t be able to distribute cash until certain reserves are fully funded. Management maintains its USD6 million-to-USD8 million guidance range for cash distributions on a run-rate basis but doesn’t’ expect cash flow from the project to be significant in 2014 due to the needs of the project to fund these reserves.

A critical point that management mentioned during the second-quarter conference call remains unresolved: the company’s outlook for compliance under its debt covenants.

Atlantic noted in August that it doesn’t expect to meet the fixed-charge coverage ratio required under a restricted payments covenant on its senior unsecured notes beginning in the third quarter of 2014. Management did note that if it was to implement one or more the options currently under consideration, its ability to remain in compliance through the third quarter of 2014 might be impacted.

Non-compliance with the covenant doesn’t constitute a default. But it does limit Atlantic’s ability to pay common dividends in the aggregate to the greater of CAD50 million or 2 percent of net assets, which is currently CAD68 million. It would be at the discretion of the board of directors to continue with dividend payments through the use of the “restricted payments basket.”

During the question-and-answer portion of the company conference call CEO Barry Welch emphasized that Atlantic hasn’t “finalized any of these plans” and hasn’t “looked at, or taken any decisions, with respect to the dividend.”

In August Mr. Welch indicated that he didn’t necessarily see the need for more dividend cuts. But management reiterated that its primary focus remains on its “high priority financial objectives,” resolving its near-term debt maturities, establishing financial flexibility and reducing overall debt levels over time.

The secondary focus is asset optimization; management is investing in projects to boost generation capacity as a means of achieving some growth. But these efforts are putting an additional strain on cash flow.

Management reported unrestricted cash of USD171 million as of the end of the third quarter, which is net of the USD75 million required cash reserve under its amended credit facility. This USD171 million is up approximately USD50 million from June 30, 2013, adjusted to exclude the USD75 million cash reserve.

Additional liquidity is provided by the entire amount of the USD25 million borrowing capacity under its senior credit facility. As of Sept. 30, 2013, Atlantic had USD91 million of letters of credit issued but not drawn, with remaining availability of USD59 million as long as no borrowings are outstanding.
Management expects year-end cash to be approximately USD145 million, building in the equity contribution to Piedmont and the cash outlays for optimization projects.

In the August 2013 Canadian Edge Portfolio Update, following management’s release and discussion of second-quarter results, we noted that  Atlantic has a solid collection of power-generation assets that could be attractive to a larger entity with a low cost of capital and low administrative expenses.

As of that writing the stock was trading at a price-to-book value of just 0.70 times. I noted that we would keep the stock in the CE Portfolio, advising investors with a long-term horizon to hold it but suggesting that those who opted to sell should do so into strength.

The stock price did bounce to as high as CAD5.43 on the TSX on Oct. 18 but has come crashing again in the wake of third-quarter results and management’s discussion about 2014. On Monday it established a 52-week low of CAD3.89 before closing at CAD3.96.

As recently as Jan. 23, 2013, Atlantic closed above CAD13 on the TSX. The price-to-book value today, however, is just 0.68.

The best outcome would be for a better-capitalized entity to scoop up the portfolio in whole.