Mercury Annual Results Analyst Briefing 2021

Mercury Annual Results Analyst Briefing 2021 17 August 2021

Start of Transcript Operator: Ladies and gentlemen, thank you for standing by and welcome to the Mercury annual results analyst briefing for 2021. At this time, all participants are just in a listen-only mode. Following the presentation, there will be some time for a question and answer session today. To ask a question, you will just need to press star one on your telephone keypad. Just please be advised that today's conference is being recorded. But I will now hand the conference over to your first speaker for today, Chief Executive Vince Hawksworth. Thank you and please go ahead, Vince.

Vince Hawksworth: Thank you and good morning, everybody, and welcome to the FY21 Mercury annual results presentation. I'm joined here this morning by William Meek, our Chief Financial Officer, and we'll work through the presentation jointly.

So turning to slide 3, I'll start there with the highlights. So EBITDAF results of $463 million was obviously down versus the prior year, reflecting the fourth-lowest inflows since 1999, and obviously also, our Kawerau plant outage. So that outage of 42 days and the low inflows, combined with the hot spot prices which occurred due to generally low inflows and also low gas deliverability, resulted in a difficult year compared with the prior one.

We have, though, been very focused internally on continuous improvement. We've talked before about our thriving focus and that continues to deliver for us as we work smarter and faster and aim to deliver the $30 million improvement that we've talked about previously.

Externally, this year we've seen us focused on creating value through mergers and acquisition opportunities. We're really pleased about the Tilt Renewables acquisition, which brought the New Zealand assets of Tilt into the Mercury stable and we're excited by the Trustpower retail transaction, which, subject to approvals, will see us increase our scale quite importantly.

We've declared a final dividend of 10.2 cents per share, which together with our interim dividend means the dividend for the year is 17 cents per share. This is the 13th consecutive year of dividend growth and represents a 7.6% increase on FY20. We're providing guidance today of $590 million at the EBITDAF level, due to contributions from Tilt Renewables and the Turitea wind farm and our continuous improvement initiatives for the FY22 year.

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I'm now going to turn to the next page, page 4, and hand over to William for the next part of the presentation.

William Meek: Thank you, Vince, and welcome to everyone on the line today. So I'm going to touch on the financial performance of some of our key financial measures here on slide 4, starting with energy margin. So as Vince has already said, generation was down 126 gigawatt hours for the year, with spot prices up around $70 a megawatt on the FY20 year.

So quite sharp increases in pricing and we did see quite low inflows, particularly in the second half of the year, seeing both the lake decline to very low levels, which impacted the flexibility of our generation position from Lake Taupō across the Waikato catchment.

As Vince has also mentioned, the outage on 7 June at Kawerau with a return to service on 20 July also took three weeks of production from that plant out at a time that prices were near record highs.

Operating expenditure, $4 million lower at $190 million than prior year. It has been restated for SaaS, Software as a Service, so Mercury has implemented those IFRS changes to our accounts, restating last year's also by a similar number, $6 million; so $194 million FY20 versus $190 million in this financial year. EBITDAF, is essentially the movement there of $27 million down, largely a combination of energy margin, operating expenditure and some slight changes to other income.

NPAT declined quite significantly to $141 million from $209 million in the prior year. The biggest movement there was around the fair value of financial instruments, mostly electricity, so we saw a negative $47 million movement there on mostly power contracts against the $22 million positive movement in the prior year. So that's the biggest impact to NPAT. We did enjoy a $41 million gain on the back of our sale of our interest in Hudson Ranch, a geothermal plant in California, back in November and we did capitalise $11 million of interest through the Turitea project, which is now going through commissioning. We also recognised a $15 million loss related to disposals of some assets at Kawerau on the back of that outage.

Operating cash flow and free cash flow I'll talk to together. So only a slight movement there in operating cash flow of $14 million down to $338 million for the year. If you look at actually the core drivers, receipts from customers less the payments to suppliers and employees actually was only $4 million different from the prior year. We did see cash Page 2 of 25

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interest $9 million lower at $51 million and cash tax is significantly higher. So cash tax is largely explaining the decline in operating free cash flow from $352 million to $338 million.

Free cash up, largely on the back of much lower CapEx expenditure. So CapEx almost half of what it was in the prior year. We had no drilling this year and we did make decisions to defer some projects on the back of the impacts of COVID-19, particularly the refurbishment of the Karāpiro hydro station, which is going through essentially a full replacement for turbines and generators. So that was delayed a year largely due to COVID-19 and concerns about factory inspection testing and the ability of an overseas contractor to deliver that well, given the challenges moving into New Zealand.

A big year of growth investment, driven mostly by Turitea at $194 million. So Turitea, $151 million spent in '21, taking total project spend to $335 million. We did make an investment into EnergySource Minerals, so that's the - this is the holding company for the project that's looking to extract lithium from the brine at Hudson Ranch.

We also invested $11 million into NOW broadband during FY21 and spent around $20 million on the Rotokawa upgrade, which should see us increase output at Rotokawa Power Station and Nga Awa Purua joint venture by five or six megawatts, which is in play now.

So a good step up there and good to see progress at Turitea.

Dividend up 7.6% on the prior year to 17 cents a share, so looking at just over $230 million of dividends declared in FY21.

Turning to the bridge of earnings, we can see we start last year at $490 million, end up at $463 million, $27 million lower. So lower generation volume is worth about $14 million.

Probably the key takeout here is the effect of spot prices. We look at the combination of fixed-price variable volume purchases plus derivative settlements. We've got a delta of about $489 million versus the impact of generation, which was positive $441 million. So that's probably the biggest in impact, particularly evident in the last couple of months of FY21.

The other big takeout here is the lifts in yield, so we're seeing around 7% lifts in customer yields. That's from mass market through C&I, so some strong growth there and a lift in actually the total sales position. So total sales up over 200 gigawatt hours in those segments, so a fairly comprehensive bridge there for our EBITDAF performance in '21. I'll hand back to Vince for slide 6.

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Vince Hawksworth: Thanks, William. So slide 6 covers our key performance indicators.

Going from the top, look, we've been really pleased with how strong the Mercury brand remains in terms of consumer awareness and that has been proven out, as we've launched our Moves campaign over the last couple of months, which has seen some retention benefits where we're not tending to lose as many customers as we were previously.

The net promote score remains firm and, as I say, we are seeing declines in churn as we have launched our Moves campaigns. With respect to our partnership column there, we're really pleased that the Climate Change Commission's final advice continues to support electrification as a way of decarbonising. That, from our point of view, is the right way to go. We see the rollout of renewables supporting wider decarbonisation as the key thing that needs to occur.

We've engaged with the New Zealand Battery Project, because we think it's important that there is a broader discussion than just a discussion about Onslow, but a discussion that considers all of the ways that as New Zealand we can decarbonise and the role that electricity plays. I note that Turitea, whilst delayed, we have now had first energy from that project. I will talk a bit more about that subsequently.

On a health and safety and employment side of things, look, we've had a good year from a health and safety, point of view, but of course, we always realise that you're only as good as your last incident. What has been really pleasing is our focus on human factors, as well as process factors.

In terms of shareholder returns, again, good shareholder returns that - a TSR above 45%.

We've talked about the dividends. But importantly we are creating a platform that will transform the future.

So turning to the health and safety slide, I think the main focus here for us is, as I said, not just the ability to have a lower TRIFR or lower incidents, but much more importantly the focus on human factors. Because as I say, as performance and process improves, people do make the difference. We'll continue to look to do that, because when you come to health and safety, the last line of defence is always the culture that you have in the business.

This year, very importantly, we’ve refreshed our strategic framework. So whilst we've retained our long term 2030 ambitions and goals we've got really focused on what our three year objectives look like.

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Last year I talked about the Thrive project that had been underway for some time and we're now starting to see the benefits of and you will see in the three-year objectives we have two halves to the centre circle there, one being Thriving Today about the activities that we will undertake to create that thriving environment, and the other being Shaping Tomorrow.

Particularly we want to draw attention to the objectives within that circle. So our Thriving Today objective is to increase the value of our business to a $700 million EBITDAF over the next three years, and the Tilt transaction obviously helps that platform. But we think it's really important in achieving those financial outcomes to enhance our licence to operate.

We are really focused on collaborating with our stakeholders, whether they be iwi or regulators or whether they be government and customers. We think this industry has a lot to offer New Zealand and Mercury can play a leading role in this space. We also want to unleash the full potential of our people and that is done through a culture where people can really participate and see the benefits that are achieved through their efforts. So that is Thriving Today.

Shaping Tomorrow is also really important. The role that this sector of Mercury will play in decarbonisation in New Zealand is critical, and that is the centrepiece of our Shaping Tomorrow strategy. If we create the executable options for growth, and we now have a platform from Tilt that will allow us to play a major role in that decarbonisation, then both New Zealand, the sector and Mercury can be successful. Of course, to do that we need to be adaptive and resilient as an organisation and responsive to future needs and our investment in people and processes will deliver that.

So that's how we see our next three years fitting in with those long-term objectives and of course, if we achieve all of that we will truly inspire New Zealanders to enjoy energy in more wonderful ways.

Moving to the next slide, and William will talk to this one.

William Meek: Thanks, Vince. We're on slide 9 now with these four charts here while I will just step through. So this really deals with the fuel supply to New Zealand and particularly the fuel supply that impacts certainly the power sector. So we're in the business of energy conversion, so we're taking essentially energy sources, be they water, gas or coal, wind, solar, and then effectively converting those to electricity.

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The first chart shows gas production. The key take-outs, you can see quite significant decreases at Pohokura, particularly over the last two years. You're looking at about 100 TJs a day from two years ago. We're looking at drilling to improve output there hopefully in the first quarter of next calendar year, but 100 TJs a day is essentially E3P and TCC base load continuously.

So it's a big impact to the energy system in New Zealand and certainly very important that we're seeing lifts across those major fields. So certainly, we're seeing some improvements at Maui and Mangahewa, which is positive.

Again, it will be common knowledge certainly that imports of coal, to drive the Rankine units at Huntly have lifted significantly. Certainly, the reliance on Huntly has been quite significant over the last calendar year but you can see that those coal prices based on the Indonesian Coal Index have lifted significantly combined with quite sharp increases in the NZ ETS prices too, which are now around $48. So those coal prices plus carbon means to run Huntly you're staring at a number that is close to $150 a megawatt hour on coal. So certainly, those fuel prices are really driving impacts into the power market.

Hydro storage, 55% of New Zealand's power comes from hydro. We can see there against historical averages and historical min and maxes in the blue shaded area in the top right chart, the yellow line skirting along through that late summer/early autumn period, the bottom, the minimum we've seen in the last 20-odd years, that did reflect back into higher power prices during that period. We did see quite a rapid recovery through May and June as wet conditions lifted South Island lakes while it remained dry in the North Island.

So a deep dive into the Waikato catchment and Lake Taupō storage, over FY21 again probably a few points to pull out of this slide on slide 10. 9th percentile in-flows in the second half of this financial year. The lake, typically we like to bring the lake up to near full over summer as that autumn period is our driest months.

So you tend to see, as you can see in the average, that Lake Taupō will traditionally fall from January through until April and May. Certainly, the climbs there in terms of lake level were sharper and coincided with, as you can see in the table, spot prices at Otahuhu trending well into the $200s, so starting February at $238 and then lifting to $295 by May. The yellow line, we got within I think about 15 centimetres from the bottom of the lake. At 10 centimetres from the lake our resource consents requires us essentially to have

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minimum flow from Karāpiro on the Waikato River. That will constrain generation on the hydro system to around 7.5 to 8 gigawatt hour days with Karāpiro at minimum flows.

Once you hit the zero operating lake range level, which is 1.4 metres of range, at that point we match outflows. Outflows from Lake Taupō will match inflows. So you will see daily generation fall to about four or five gigawatt hour days, which is quite a significant decrease if you take June, for example, where you would expect to be generating around 12.5 gig days in a normal year. So quite a significant decline. Fortunately that didn't happen and we did see some rain late in June and then into July that saw the lake start to tick up again.

We're now on to slide 11. There's a couple of things here; talking about our sales position to customers. So certainly, Mercury is aware that the impacts of the high fuel prices into the power market are impacting customers, particularly the commercial and industrial segment with repricing at circa futures levels occurring.

Mercury has committed to that market and we see that we have stepped up our sales in this chart here by about 400 gigawatt hours, ignore some of the buying contracts. So we have committed strongly to C&I and we have eased back in terms of mass markets, which I will talk to more in the next slide.

You can certainly see a market in the pricing chart around channel yields. You've got futures prices, spot prices well above the net yields that Mercury are selling into mass markets. So certainly, it's a challenging market for retailers, it's a challenging market for Mercury and with ICPs down circa 20,000 in FY21 on the back of a 28,000 decline the year before.

So we did make decisions to sign longer dated C&I contracts, the consequence of that in the front end is that they are out of the money. So that did impact profitability for FY21.

But, as the heading says, some short-term pain for longer term gain on those contracts.

Slide 12, this is really focused more on the churn and that is largely driven by our mass market business, our retail business. It still remains fiercely competitive. We're certainly seeing competition both in terms of just raw pricing but also in terms of bundled offers.

National churn remains above 20%. We are very focused on value for our customers and certainly the high price environment is creating some challenges there, as I said, a 20,000 customer loss in terms of market share during FY21, but that is more than offset by increased sales into the C&I segment.

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You will have seen certainly if you live in the city the Mercury Move campaign has been pretty bright. So the words of Coldplay and the song Yellow was certainly true here in Auckland. There's certainly a lot of yellow signs promoting the Move campaign and we're very proud to see some of the successes of that coming through in terms of decreased net churn.

So you can see the yellow line starting to tick up towards the neutral zero mark. So we're expecting to see more of the above. Also, some more targeted offers into those mass market segments helping that net churn figure. I'll hand over to Vince.

Vince Hawksworth: Thanks, William. So we're now on slide 13. So Kawerau outage, as William mentioned, from 7 June to 20 July, clearly a significant loss of 100 megawatts in our portfolio. Ultimately the result of a loss of lubrication oil to the generator and steam turbine bearings, and that really resulted in the destruction of the generator and steam turbine rotors and also the excitor.

A couple of key things really. The availability of critical spares, we've really seen the benefits of that. Our ability to bring the plant back in such a controlled and quick and safe way was down to the abilities of the team, both internally and contractually wise, and having those spares.

One issue that we did face was that we did not have a spare for the excitor and had we had to rely on an overseas manufacturer we would have seen a five month further delay in that return to service. But a small engineering company in Kawerau called Milbank, who we want to give a shout-out to, were able to manufacture a new excitor in five or six weeks, such that that didn't really become the critical path to return.

So it was a fantastic outcome that we have that sort of capability in New Zealand, and I think a bit of a lesson in this pandemic world about being able to look after yourself. We obviously have had some lessons out of this, as there always is, and we've taken actions to prevent reoccurrence of a fault of this nature, including the review of systems at other similar stations that we have and obviously also sharing this knowledge through the manufacturer as well. Insurance remains under discussion.

We also have an important relationship with Norske Skog Tasman and on the closure of the mill we've negotiated an early exit from a foundation hedge that has been in place for a long time.

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That has the result of reducing sales and a $10 million net impact expected in the coming year as part of that termination settlement. It does obviously release that load for our future use.

On carbon, we chose to exercise the ETS fixed price option, as others have done, at a total cost of $8 million in FY21 at $35 per unit versus the current price of circa $50 per unit. We also purchased 0.7 million emissions credits through the government auction process and currently have an inventory of 2.2 million credits.

Turning to Turitea, well obviously Turitea has been a challenging project, as we’ve talked about previously. We are feeling that at least with North there is some light at the end of the tunnel, some real potential to see the energy turn up and we have now started commissioning with 27 turbines erected of the 33 and we expect EBITDAF contribution to start coming as we commission that part of the wind farm, still with a target of total completion in the last quarter of this calendar year.

Turitea South, though, remains challenging from a civils perspective and those of you that are looking at the presentation will see the lower picture there and the size of some of the civil work that needs to be done. We continue to work with Vestas and their subcontractors to look for ways forward that can bring forward the completion dates from that midcalendar 2023 date. We note the Turitea spend and that the total project cost is forecast at $464 million in line with guidance.

Of course, one of the big opportunities we had in this financial year was the sale of Tilt business. I’m on slide 15. Ultimately for Mercury, our desire was to continue to see Tilt grow, but faced with the reality of the business being sold, we worked hard to find a partner that we could work with and capture the New Zealand assets. That resulted in the process we described previously in releases with an initial successful bid of $7.80 per share, subsequently increasing to $8.10 in April.

But we can feel really pleased by the contribution that that investment has made for us with our 19.9% shareholding costing $144 million selling for $608 million, adding the debt and ending up with the New Zealand assets. As I said earlier, this adds over 1100 gigawatt hours of wind generation and a development pipeline. Will make Mercury New Zealand’s largest wind generator once Turitea North is commissioned, and lift the EBITDAF in FY22 by $30 million.

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We also announced, alongside Tilt and Genesis, the PPA for Omamari, now known as Kaiwaikawe. This is, I think, a very important thing. Right at the start when we said we were acquiring the Tilt assets, we said we were taking really seriously the role that these needed to play in the decarbonisation of New Zealand and work with both competitors and others to see this pipeline rolled out. We’re really excited that we’ll be able to start that journey with Genesis and are pleased that they and Tilt and ourselves were able to get this PPA signed.

Turning to our other acquisition activity, obviously Trustpower retail acquisition; whilst we didn’t expect this to necessarily come to market when it did, we were determined to participate sensibly in this acquisition and are pleased to be successful at $441 million which gives us the retail business, an electricity supply agreement, the ISP network and is contingent on the Commerce Commission approvals, which are now in process and the restructure of the TECT rebate arrangements.

There’s still a fair way to go and the exact timing of completion of this transaction is, at this point, uncertain. However, we do forecast significant synergies on the cost side and also expect to be able to see revenue upside as we become a truly bundled offering in the retail market. The full year contribution of $50 million will be offset by $30 million of transition costs in year one, but of course we don’t yet know when year one will start.

Now going to hand back to William to talk about continuous improvement and Thrive.

William Meek: Thank you Vince. So we’re on slide 17 and really I just want to talk about “thriving today and shaping tomorrow”, which comes straight from our strategic framework. So Thrive is a continuous improvement program. A lot of it is about the way we work and certainly this slide lays out some of the initiatives and cultural changes we’re making inside Mercury to ultimately deliver that $30 million of uplift of value in FY22.

So you can see here, there’s a schematic here. This is the Digital River. This is the initiative that is now running. Essentially this is a sophisticated hydraulic model which can model generation across the Waikato system, looks to optimise unit dispatch, multi day and it’s a hugely valuable tool to help our traders and dispatchers essentially extract maximum value across the river catchment. So we’re really excited about some of the gains that that Digital River will help our people to actually run those hydro assets better.

Maraetai tail water lowering, we’ve got some operating restraints. Waipapa is the smallest station on the Waikato chain. It’s downstream with Maraetai, which is by far the largest Page 10 of 25

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and essentially, by looking very carefully at the operating constraints and ensuring that assets are protected, we can essentially deliver greater peaking from Maraetai for longer by managing those constraints better while managing the physical rest of the plant, so that’s also quite interesting in terms of how that will influence, say, GWAPs for the Waikato River.

Whakapuāwai, culture change program, so we’ve touched on there. It’s really about how we do our best work together and align essentially our culture with essentially a performance mindset.

Moving to more rapid cadence around quarterly planning, business planning, again to really allocate resources, both people and money to the things that really matter to the firm, so that’s something that we’re very focused on as a leadership team and with our senior leaders across the business and how we work better with our people.

Derivative trading looks pretty exciting to us. We think we do have a competency here, so looking about how we might leverage that outside the core products of power, potentially into carbon markets, et cetera. That’s something we’re exploring further.

Around the procurement space, some nice wins around manual meter reading. We were just reviewing who supplies that under what terms and optimising our meter reading runs, given 15% of our meters still are non-smart and some of those will never been smart. Gas meters are still manually read.

Class 3 outage reviews, so these are reasonably significant outages, certainly less than Class 4s but really moving and analysing condition-based maintenance versus time, having a really deep-dive review around scope and what actually gets done to essentially minimise both the scope and timeframes for undertaking those Class 3 outages which occur periodically over every couple of years.

So net of that is a $30 million benefit forecast in 2022, split approximately one third OpEx, two thirds revenue.

Now on slide 18, really just touching on guidance again. So EBITDAF for FY22 at $590 million, it’s reflecting hydro generation of 3900 gigawatt hours, so that’s 150 gigawatt hours less than our mean hydro, which we’re now stating at 4050, reflecting the efficiency upgrades from the refurbs that have been undertaken on the river. That does exclude any contribution from the Trustpower retail acquisition, as Vince said, the timing of that Page 11 of 25

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remains still uncertain or any insurance proceeds from Kawerau or any LDs related to the Turitea project.

Dividend guidance sitting at 20 cents, so a 17.6% uplift on FY21 or 3 cents a share, with stay-in-business CapEx of $70 million. So a pretty comprehensive and detailed bridge there, taking us from today’s actuals through to FY22 guidance at $590 million. I’ll hand back to Vince to close as part of the presentation.

Vince Hawksworth: Thanks William. I’ll just close on slide 20 and slide 20 is a photograph of the Turitea North site and I think you can see there that it’s a pretty impressive site. We just need to now bring that all to fruition and deliver those important gigawatt hours.

So that concludes our presentation, although I do want to note a couple of further things.

Over the last few weeks, we’ve been joined by Stewart Hamilton as our GM of Generation and Craig Neustroski as our GM of Customer. So we now have a fully-fledged executive team who are really all set to go and hit the opportunities that we have created within the Mercury business. We also have the benefit of Dennis Barnes joining us as a Director in September and I think that will again add to the quality of debate around the Board table, as we transition to that net carbon neutral future that we all aspire to.

So with that, I’ll close and operator, hand that back for questions.

Operator: Thank you so much. So ladies and gentlemen, we’ll now begin the Q&A session.

Just again, if you need to ask a question, you can just press star one on your telephone and just wait for your name to be announced. If at any time you need to cancel the request, just by pressing the pound or the hash key. But your first question today comes from the line of Andrew Harvey-Green from Forsyth Barr. So please ask your question Andrew.

Andrew Harvey-Green: (Forsyth Barr, Analyst) Thanks operator and morning Vince and Will. A few questions for me. First of all, just around obviously the last couple of months of the year were pretty tough given where hydrology went and wholesale prices were. Are you rethinking your risk management strategy, given the downside risks of being short in the current environment has gone up?

Vince Hawksworth: Yes. Look I think hindsight’s a wonderful thing, isn’t it and I think if you look at the graph on slide 10, if you look at that, I think the story to draw from that is some of those decisions - and you look at the pricing - some of those decisions would have had to have been made in the last quarter of the calendar year in that sort of October Page 12 of 25

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November time and we'll certainly be thinking quite carefully about that in the scenario work we do around thinking about where the lake can be. You know ultimately, I think yes, hindsight is wonderful. Would we have done something different? Yes. Will we think about those differently in the future? Yes. Andrew Harvey-Green: (Forsyth Barr, Analyst) I guess the follow-on question from that is any implications for what underlying earnings might be? If you just take a bit of risk off the table, presumably that does come with a bit of a cost.

Vince Hawksworth: Yes I think we're still comfortable that we've given guidance based on our ability to manage things.

Andrew Harvey-Green: (Forsyth Barr, Analyst) Yes sure, okay and second question is just I guess around some of that guidance and noticed we've got the Kawerau insurance and liquidated damages potentially. Are you able to give us a bit of a sense on what the potential might be across those two things? I guess sort of wrapped up in that is the extent that liquidated damages might be impacted by sort of any renegotiation on Turitea South, any sort of I guess update on those negotiations?

William Meek: William here, Andrew. Yes so both those discussions are ongoing. Turitea damages, we're still focused on getting plants running and commissioning. We keep engaging with Vestas on those. They're confidential. We're not going to talk about those in a public forum, but yes, they may not even come to fruition in FY22. Given their project actually doesn't complete, we're not expecting completion until mid-2023 anyway.

On insurance in Kawerau, same thing. It's still early days with insurers working through what that might mean and what the full extents of the claims will be. Most of that claim will relate to essentially repairs and replacement of damaged equipment. There will be a little bit of BI potentially given, a 30-day standdown for insurance and the outage was two weeks longer than that but again, those discussions are still ongoing.

Andrew Harvey-Green: (Forsyth Barr, Analyst) Okay and last question for me was just around the investment in NOW broadband and the timing of that. I'm not familiar with it so interested in I guess in terms of the scale of that business around I guess fibre connections and how that fits in strategy wise with the Trustpower transaction.

Vince Hawksworth: Yes, so the NOW investment occurred in the - well prior - around the sort of Christmas period, prior to Christmas this last year gone. Of course we made that investment without any knowledge of whether the Trustpower business would come to Page 13 of 25

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market. NOW has got sort of circa 16,000, 17,000 connections. It's got an operating base which you know, in terms of an ISP network aggregation operating centre, it has quite a well-tuned ability to deal in small to medium enterprises as well.

Our investment in that, we're not the 100% owners of that. We invested with the original investors and I guess anything that impacts on that vis-a-vis Trustpower will play out once we know the outcome of the Trustpower process. So it's kind of difficult for us to make any assumptions around that at this stage. We still sit and await the Commerce Commission process.

Andrew Harvey-Green: (Forsyth Barr, Analyst) Okay. That's all from me, thanks.

Operator: Your next question comes from the line of Grant Swanepoel from Jarden, so please ask your questions Grant.

Grant Swanepoel: (Jarden, Analyst) Morning Mercury team. First question, is Trustpower still on track to be done at the beginning of calendar year 2022?

Vince Hawksworth: Well again Grant, it's really down to the Commerce Commission and TECT process. Well we know that TECT have a court date in November. We don't know how the judge will then proceed to give his or her opinions on that and we know that the Commerce Commission process is under way. So I guess our sort of working assumption is it will be early in 2022 and - but we're not in control of that process.

Grant Swanepoel: (Jarden, Analyst) Thanks and I think it's pushed out since the deal.

Second question, the $35 million in guidance for Turitea, how many gigawatt hours are you assuming from that plant?

William Meek: It's essentially assuming full output from October. Whatever that comes to.

So that's what - nine - three quarters of 470.

Grant Swanepoel: (Jarden, Analyst) Thank you. Norske Skog that $10 million payment, is that assumed in your full cost for FY22 and is there nothing left in there for FY23?

William Meek: Yes, so you can see there's a note in our - at the back of our annual report around that deal. So essentially that just reflects the impacts in terms of earnings. So essentially that foundation contract has been terminated, but we've acquired some other positions from Norske given they've ceased operations here in New Zealand with a net effect of essentially decreasing our sales position.

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Grant Swanepoel: (Jarden, Analyst) So that just washes through in front of the uplift for FY22 as you sell it into the market.

William Meek: Correct.

Grant Swanepoel: (Jarden, Analyst) You don’t specifically disclose it in your guidance.

William Meek: No. Grant Swanepoel: (Jarden, Analyst) Thanks. The $30 million Tilt net, can you just explain to this layman on how the $14 million especially accounting for a March year end is ripped out in FY22 EBITDA? William Meek: So for Tilt, so at the moment we're recognising - we were recognising Tilt as essentially an associate. So you're recognising your share of profits and other income. So that equity accounting goes now given those - we're not a shareholder in Tilt, but essentially we recognise the uplift of essentially Tilt's revenue which is $45 million. So $45 million less the $14 million gets you to about $30 million.

Grant Swanepoel: (Jarden, Analyst) Okay maybe offline you can give me some more detail on that. Final question, that first $10 million expense in your cost line, is that an ongoing or is this a once-off?

William Meek: No essentially with software as a service where you are modifying essentially mostly cloud systems where you don't actually control the software, it's still provided by essentially a third party. While historically we would have capitalised that as IT costs, now essentially all going to OpEx. So essentially you've just got a substitution out of CapEx into operating costs. So that is ongoing but it will, depending on the level of customisation and change, it will fluctuate over time, but we're talking singles, millions, unless you're investing significantly into a cloud platform.

Vince Hawksworth: Yes we've been an early adopter of that Grant, so it'll flow through for all businesses that use software as a service cloud platforms.

William Meek: So I think you're going to get it a lot with most large New Zealand corporates, they're going to possibly most will wait until this financial year to recognise this. You will see it appear at the interims I suspect.

Grant Swanepoel: (Jarden, Analyst) Thanks Will, thanks Vince.

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Operator: Okay your next question comes from Jeremy Kincaid from UBS, so please ask your question Jeremy.

Jeremy Kincaid: (UBS, Analyst) Good morning team. Just two questions from me. The first one around the full refurb of Karāpiro, is that in the $70 million of stay-in-business CapEx or is that growth CapEx? William Meek: No, it's inside stay-in-business. It's essentially just - it's maintenance of existing stations, yes.

Vince Hawksworth: And it will flow into subsequent years.

William Meek: Because it's a five-year program.

Jeremy Kincaid: (UBS, Analyst) Sure, okay thank you. Then my other question is I'd just be interested in your thoughts of the outages of last week and obviously there's been some industry commentary around changing the market structure such as introducing capacity market or breaking up the gentailers. I'd just be interested in your thoughts around that.

Vince Hawksworth: Right, let’s start. I guess the first thing I'd say is that you know, as I think I sort of said publicly, last Monday night was an incredibly rare event. I can't recall in the last decade or so an event of that nature. I think as these various investigations get under the hood of what actually occurred, what will sort of emerge is that some of the communications that were associated with that day probably led to actions that were unnecessary and certainly in our case, we were very particular about the outages that we had that day as the day played out and brought plant back.

We had what we believe to be a record generation peak from our Waikato stations on that evening. I think we've - you've got to be really careful about conflating a meeting of a peak demand which has a number of issues playing out and some sort of other problem associated with decarbonisation and renewability. So I think you've got to sort of separate those things.

I think you've got to be really careful about reacting to one particular specific event and say that now is an indicator for major structural change. I think we need to be really aware that when you make changes that are structural, they're not quick to do because they have to be properly implemented and they're not easy to unwind. You know, if you want a completely different but parallel to that, look at the issue around low user fixed charges Page 16 of 25

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and how long that argument's been going on about unwinding those. I think in this case, we have - careful finding a solution for a problem that will I think become perfectly explainable.

Now in terms of vertical integration and things of that nature, look, right from the late '90s we've had vertically integrated businesses and we've seen lots of regulatory and market change. That has served us really well in terms of managing investment risks. It's very easy to fire a gun at vertically integrated companies, but ultimately if we stand back from this and we want to achieve electrification of New Zealand that delivers a net carbon zero outcome, then we need investors to step up with large amounts of money.

Just talking for Mercury, you know, $450 million at Turitea in a project that will run for 30 years. You look at the Omamari project or Kaiwaikawe project as we call it now, it's another investment we are proposing to make.

Look, at the refurbishment on the Waikato River to ensure that those assets are intergenerational, that sort of deployment of capital is enormous and I think the last thing we want to do is make that something that people start to get nervy about. I think we’ve got over the - we got over the Tiwai hump and we don’t need to create another hump.

Jeremy Kincaid: (UBS, Analyst) That’s very clear. Thanks very much.

Operator: Your next question comes from Stephen Hudson from Macquarie Securities so please ask your questions, Stephen.

Stephen Hudson: (Macquarie Securities, Analyst) Thank you and good morning Vince and Will. Just a couple of quick ones from me. Just in terms of slide 15 where you run through the development pipeline for Tilt. I just wondered if that was the full extent of that pipeline or whether or not there may be other prospects at less mature stages of development?

Secondly, just on the Norske hedge, is 517 gigawatt hours from 2023 the number we should be thinking of on an ongoing basis in terms of capacity late open for you to sell into the CFD market from here?

Just on Norske Skog, I just wondered, Vince, if you could give us a bit of an update on your working assumption on that asset post 2024?

Vince Hawksworth: So I’ll start with the first one, Stephen. Look, we’ve only put on this chart those that are in the public domain. You would expect us to keep some of the other

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things in there closer to our chest at this point in time and I do note that this slide 15 is about the Tilt assets.

Of course, Mercury itself has others and we’ve talked about Puketoi in the past. So if you start to add those two things together, that I think is pretty positive.

On the one about Kawerau, I’m going to throw to William in a moment. On the - in terms of the aluminium smelter, I guess I take the view that as time goes by, the energy industry in New Zealand is more able to factor in whatever that outcome is because of the certainty that we are heading towards net carbon neutral in 2050.

But look, my understanding and you’ve done far more work on this than I have, is that they’re not doing too badly at the moment and I think the observation I would make is, if we go back to the global financial crisis, everybody dumped the idea of being environmentally clean or net carbon neutral.

Or any of those things got dumped in the face of the financial pressures. We’re just experiencing a global pandemic where even in the face of that, I think most businesses now are still keeping on track to greening their position, if you like. Or being less carbon intensive.

I would have thought that that smelter will sit very importantly in Rio’s thinking around how it wants to position itself in the next decade to 20 years. I’ll pass to William for the other question.

William Meek: Yes, so on a Norske Skog deal, essentially the foundation - the long-term hedge arrangements with them were an 80 megawatt contract. So 700 gigawatt hours a year. So essentially we’ve inherited a 400-odd gigawatt hour position for this year and 200 next year.

So those numbers in slide 13 of 375 gigawatt hours and 517 gigawatt hours are essentially the big issue when you were going to hold your next position the same as it - at the same settings as it is now but that would be available to essentially sell back into the market.

Stephen Hudson: (Macquarie Securities, Analyst) That’s great. Thanks, gents.

Operator: Your next question comes from Cameron Parker from Craigs Investments so please ask your question, Cameron.

Cameron Parker: (Craigs Investments, Analyst) Thanks. Thanks, Operator. Just a couple from me, guys. Just going back to Andrew’s question with regard to risk mitigation and so Page 18 of 25

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forth. Are you or would you think about engaging with Genesis over dry year risk and single backup, given their swaps and expiries coming up in ‘22?

Vince Hawksworth: Yes, look, we’ll engage with anybody in the market to work through risk management type issues. I hope we have demonstrated with our support for their Future-gen project that we’re not taking all our toys home and playing on our own. We think this is all too big for that. So if there’s a sensible thing to be done around that, of course we’ll engage.

Cameron Parker: (Craigs Investments, Analyst) Great, thanks very much and how should we be thinking about the new PPA signed with Genesis and the commencement of that?

Also, the Tararua re-powering and so forth. How do you guys think about that? Are they mutually exclusive?

Vince Hawksworth: Well I think every - oh, look, at the end of the day, I think every deal that we choose to do stands in - it’s got to stand in its own merits. So we - ultimately we’re comfortable with the PPA that’s been signed and there’s a fair bit of work to do to breathe life into that project and we’ll get on and do that.

We’ve got the benefit of the people that came over who - you know the Tilt staff that have come to Mercury as part of this in New Zealand.

In terms of Tararua re-powering, I mean ultimately there’s a fair bit of work to do there.

It’s a real option and - but it needs to be considered as you would any of those things about the upside benefits vis-a-vis the ongoing revenue streams that come from the current installation.

We’ve got to get right underneath the bonnet of that one over the coming months and year or two. Just like all the other projects we’ve got the opportunities to do.

Cameron Parker: (Craigs Investments, Analyst) It’s definitely a good pipeline, for sure. In terms of the Turitea South, I was just wondering, there’s a little bit - in terms of slippage and so forth, there’s a little bit going on in that area at the moment. You’re thinking 2023, is it - what’s the probability of a potential further slippage of that, do you think?

Vince Hawksworth: Look, I’d say that the only certainty is whatever I say will be wrong.

Having visited the site a few times, it is a major civil undertaking. We obviously have some disputes to deal with, with our provider.

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But when you travel around that site and see the amount of material that’s been moved, I would still feel that there is some room to improve somewhat but we have to find a way through that conundrum with our contractor partnership and we haven’t resolved that yet.

So we are talking positively. Like all of these things, as William said earlier, you start with them. There’s one stream of work that says just let’s get the project finished and if everybody’s in that mindset, that’s good.

There’s another stream of work that says, well everybody’s going to get their boxing gloves on ready for the punch up if we can’t resolve the situation commercially. That’s going on as well but we are - we’re pleased to see the sort of good will the contractors are bringing to this challenge. So when there’s good will there, you can remain optimistic.

Cameron Parker: (Craigs Investments, Analyst) Great. Thanks, team. That’s all for me.

Operator: Your next question comes from Eamon Rood from Energy News. Please ask your question, Eamon.

Eamon Parker: (Energy News, Journalist) Good morning, team. Going back to Trustpower and the NOW broadband acquisition. Can you explain - maybe elaborate on what the retail strategy is going forward and those revenue upsides you alluded to earlier? What - when do you expect those to translate into an increase in earnings?

Vince Hawksworth: Yes, look, it’s a difficult question to answer for a number of reasons.

One is, we’re not in control of the closure date of the Trustpower acquisition. Because of that and because obviously it’s subject to Commerce Commission review at the moment, we don’t want to get a hold of that process. We respect that process deeply.

With respect to NOW, well we have a plan. That plan will eventuate but I don’t really want to flag that for all of our competitors on this call.

Eamon Parker: (Energy News, Journalist) Okay, thank you, Vince.

Operator: Okay and your last question comes from Nevill Gluyas from Jarden so please ask your question, Nevill.

Nevill Gluyas: (Jarden, Analyst) Good morning, guys. Three from me. The first one, just on the next generation timing. I’m assuming Kaiwaikawe, we’d be looking at FID, your decision around that this year?

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If that’s the case, should we expect you to look at another project FID next year?

Obviously you’ve got a suite of options in front of you or should we expect a pause in terms of the next investment decision, perhaps, to the following year?

Vince Hawksworth: With the Kaiwaikawe one, look, I think we have a process to get through to FID. Probably not in a position to disclose that just at the moment. I think we would want to do that in partnership with Genesis as we get - as we work through what needs to be done between now and then.

Of course, part of that is the resource consent, which is currently being considered and, as you’d well understand, Nevill, the resource consents sometimes can put a bit of a curveball into these processes. So, whilst there’s been a lot of work done, we’re not in a position to pick that one out.

But I think we all know that if we’re going to reach the big picture targets, we’re going to need projects closing every year to 18 months or so. We didn’t buy the Tilt pipeline or make the investments we have into Puketoi just to sit on our hands as the environment has changed.

So as I think everybody said, we’re sort of poised on the cusp of significant change in the sector with renewables rolling out and that’s why, I suppose I’ve been pretty clear that I wouldn’t want to see regulatory change - knee jerk changes that actually put that at risk.

Nevill Gluyas: (Jarden, Analyst) Okay, great. Thanks. I won’t get you to choose which of your children is favourite, whether or not Puketoi, Tararua are one or two but if you wanted to offer what you thought the next decision would most likely look to be? You know, which one looks most prospective next? No guarantees as to what comes.

Vince Hawksworth: Yes, you could ask - you can ask my kids, I don’t pick favourites.

Nevill Gluyas: (Jarden, Analyst) Very good. Okay, next question. Demand response. It’s been - it seems to be absent from a lot of the discussion around how you work in a highly renewable power system. One of your competitors, Contact, keen to grow a product there.

It seems to be important for the market as a whole. Do you have a product and a push there?

Vince Hawksworth: Look, again, Nevill, I think the short answer is, we haven’t done as much work as our peers Contact have done in that space and I commend them for

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bringing that forward but we do talk to our larger customers quite a lot about what they want.

So demand response is going to be important, isn’t it? As we transition over the next couple of decades. I think what’s also important in that is that organisations do also want to be focussed on their core product.

So as a business, you’d - you’re not actually in the business of demand response in most cases, you’re in the business of doing something and that’s usually pretty important. So I think there’s an important balance to be worked through there but I’m sure we will get engaged in those conversations.

Nevill Gluyas: (Jarden, Analyst) Just a quick follow up on that, I mean…

William Meek: Sorry, Nevill, just on that…

Nevill Gluyas: (Jarden, Analyst) Sorry, Will.

William Meek: We would normally - I mean, putting a commercial or industrial customer onto a spot contract creates the demand response automatically. So certainly, Mercury’s been a vocal proponent of essentially separating physical supply from hedging.

So the customer does have that incentive when prices are high, when they’re on spot, to actually make those decisions in real time themselves so you don’t need to have a special product, necessarily, for that to occur because they can enjoy the benefits…

Nevill Gluyas: (Jarden, Analyst) Yes, okay.

William Meek: …of the hedge and reduce their physical exposure and therefore reap some benefits of that as a product. I think too, the lines company is probably the - you know, hot water controller is probably not as - it’s not as focused like it used to be. It’s definitely not as prevalent.

That is a very low-cost way to essentially provide interruptible load for reserves or for demand management. So that’s probably another avenue that’s certainly worth exploring but it’s - yes, it’s certainly more cost effective for a distributor to do that than a retailer.

Nevill Gluyas: (Jarden, Analyst) All right, I guess in both cases, this may be one of the situations where it takes the nous and focus of a generator to - or generator/retailer to bring those products to fruition.

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Whereas lines companies or industrial perhaps don’t see the difficulties and perhaps don’t see a clear path to how it could be achieved and maybe not well positioned to gauge what the benefits will be out of a future electricity market but yes, we’ll wait and see.

Third question, last one. Obviously with the acquisitions, Trustpower, Tilt and Turitea - and I guess your commentary about the software as a service approach. It would be useful if you can give us an update of what we should think about in terms of sustaining business CapEx. When your population evaluation models, say for this decade, how should we think stay-inbusiness CapEx will look, assuming you get completion on Trustpower, merge everything together and operating going forward? Can you give us some figures or some parts of that?

William Meek: Yes, so obviously you’ve got a- with a changing mix of generating plant and then bringing in Trustpower, clearly your synergies, CapEx, is shared between the two retail businesses but you’ve got an ISP you currently don’t have.

Nevill Gluyas: (Jarden, Analyst) Yes. William Meek: I mean, core business is still driven by essentially large-scale refurbishments, the drilling program. Wind is - the CapEx requirements of wind, again, depending on the O&M arrangements, can be modest because they’re largely contained within the maintenance agreements.

We’re still - in terms of Mercury’s core business, still on Trustpower, we’re still looking at CapEx in the medium term of $90 million a year. But that’ll be bumpy, depending on whether you’re drilling or not.

Nevill Gluyas: (Jarden, Analyst) All right, yes, so that’s sort of averaged with the drillings averaged out. Sorry, that excludes Trustpower, did you say? The Trustpower retail business implications?

Vince Hawksworth: Yes. Nevill Gluyas: (Jarden, Analyst) Right and how do you think we should think about that?

Once you’ve got your synergies in place, I think in the past we’ve talked and it was predominantly around the systems as I recall for Trustpower for the retail business, which I imagine will be replaced by software as a service as a cost line. But I have $15 million to $20 million in mind per annum.

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William Meek: You’ve just got to be careful you’re not doubling up.

Nevill Gluyas: (Jarden, Analyst) Exactly.

William Meek: Where you’ve got costs that - well you’ve got cost synergies, sales, slide 16.

Say cost synergies are $35 million per annum after transition with - that’s cost in a dollar sense as opposed to just operating costs because clearly you’re…

Nevill Gluyas: (Jarden, Analyst) But if we…

William Meek: Clearly if you’re investing in…

Nevill Gluyas: (Jarden, Analyst) But if we…

William Meek: Carry on?

Nevill Gluyas: (Jarden, Analyst) So maybe we could assume $5 million to $10 million you think? Once synergies are in place? [Unclear].

William Meek: Yes, well both businesses are spending, let’s say round numbers, $15 million apiece in capital expenditures on IT systems.

Nevill Gluyas: (Jarden, Analyst) Yes. William Meek: So it’s going to be bigger than - the combined will be bigger than $15 million but less than $30 million.

Nevill Gluyas: (Jarden, Analyst) Yes, okay. That’s useful, thank you and the Turitea with both projects running, if we thought $5 million to $10 million, does that sound like a sensible number? It’s again averaged over the cycles of maintenance.

William Meek: Yes, it’ll be smaller than that because it’s mostly contained within the O&M. I mean, as the plants obviously age and start - you potentially get a higher CapEx profile but certainly early on in the project, it’s largely contained within the maintenance agreements with O&M. Nevill Gluyas: (Jarden, Analyst) Yes, that’s really useful. No, thank you. That’s all from me.

Operator: Okay, there are no further questions at this time so with that, I’ll hand the conference back to you, Vince, for any concluding remarks.

Vince Hawksworth: Thanks, Operator. Thanks everybody for all the questions, it’s really helpful. Hopefully we’ve cast some light on last year and also some light on what to expect

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down the track and we look forward to continuing our discussion with you all in the future.

Thanks for attending and we’ll sign out.

Operator: Ladies and gentlemen, that does conclude today’s conference call. Just once again, thank you all for participating but you may now all disconnect. Thank you.

End of Transcript

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