Dear Fellow Shareholders,

Capstone had a solid year in 2012. We delivered Adjusted EBITDA of $120.7 million, which was slightly ahead of our expectations and reflected strong operational performance across our businesses. We also took important steps to lower our risk profile and position our company for a bright future.

We set five priorities for ourselves at the start of 2012 and successfully delivered on four of them.

Priorities Addressed

De-risking our balance sheet

We refinanced or repaid nearly $200 million of debt set to mature in 2012 through a variety of initiatives, including the recapitalization of Värmevärden and our hydro power facilities, the sale of a 20% interest in Bristol Water to ITOCHU Corporation at an attractive premium, and the establishment of a new corporate credit facility. As a result, we eliminated significant risk from our balance sheet and renewed our flexibility for growth.

Establishing a new dividend

In June, we established a new dividend level of $0.30 per common share on an annualized basis. Our new dividend reflects our view on the long-term cash flow profile of our current portfolio following the expiry of Cardinal’s power purchase agreement at the end of 2014. We have also gained the flexibility to retain more cash to reinvest in new businesses that will improve the value, quality and cash-generating potential of our portfolio.

Preserving and enhancing the value of our businesses

We continuously work to maximize the operating performance of our businesses, which includes preventive maintenance, detailed planning for capital expenditures that boost their value, and finding ways to increase cash flow. In 2012, initiatives included selling renewable energy credits (RECs) at the Whitecourt biomass facility, which generated additional revenue. At Bristol Water, we worked closely with management to execute the company’s capital investment program, which is aimed at improving and expanding its network of reservoirs, treatment facilities, water mains and pipes. This capital program will drive growth in Bristol Water’s regulated capital value, and, accordingly, value for Capstone and our shareholders. And at Värmevärden, we saw improvements in plant availability and greater use of lower-cost fuels, which are key performance drivers for this business.


I am also pleased to report that our businesses continued to have strong safety records in 2012, which is one of Capstone’s key objectives and central to our success.

Continuing to build our platform for growth and diversification

In December, we established a new, complementary development capability with the formation of Capstone Power Development, a subsidiary focused on developing, acquiring and repowering clean electricity generation projects in North America with an emphasis on Western Canada and the United States. By getting more involved in early-stage development projects, we have the potential to deliver greater returns to our shareholders and to create a new pipeline of growth opportunities for Capstone.


Our Challenges

We were not successful in 2012 in achieving a new power purchase agreement for Cardinal with the Ontario Power Authority (OPA). While we made steady progress in our discussions with the OPA and various government ministries, and continued to broaden stakeholder support for a new contract, we have not yet agreed on an outcome that recognizes Cardinal’s value and its industrial, economic, social and community importance. Negotiations are continuing and we remain confident that Cardinal delivers significant value to Ontario and to ratepayers — today, tomorrow and for years to come.


While we are pleased with the operational and financial performance we achieved in 2012, we know that the uncertainty related to Cardinal’s future is concerning for shareholders. Securing a new contract for Cardinal remains our top priority for 2013.


Our Opportunities

Capstone has strong fundamentals, including a diversified and high quality portfolio, a solid balance sheet, an experienced and motivated team, and broader scope to pursue growth initiatives. In particular, our investment in Bristol Water has essentially changed Capstone’s risk profile by offering perpetual, growing cash flow and the potential for significant organic growth.


Our investment in Bristol Water has also allied us with two multinational partners, Agbar and ITOCHU, while at Värmevärden we have invested alongside a private infrastructure fund managed by Macquarie Group Limited. These associations prove our ability to forge partnerships across borders and to cultivate relationships that can help to stimulate deal flow and access to unique opportunities.


Our strategy to unearth new infrastructure investment opportunities includes:

Concentrating our business development efforts primarily on Canada, the United States, the United Kingdom and Western Europe in alignment with our focus on investing only in countries that are members of the Organization for Economic Cooperation and Development (OECD) and feature stable fiscal and political environments;


Pursuing regulated or contractually defined core infrastructure businesses, which typically generate stable cash flow throughout the economic cycle. This category includes power generation, electricity distribution and transmission, utilities, transportation and public-private partnerships;


Seeking a blend of operating infrastructure businesses and development opportunities that offer an appropriate risk-adjusted rate of return; and


Focusing on wholly-owned businesses while remaining open to collaborating with like-minded partners, an approach that has been successful for us.

We are pursuing this strategy at a time of great global demand for new infrastructure spending fuelled by fiscal austerity, large and growing government deficits, and demographic trends. Global infrastructure requirements for transport, energy, water and communications between 2013 and 2030 are estimated at more than US$57 trillion. The private sector has a vital role in improving and building the new, more sustainable infrastructure that is required to unleash renewed economic growth and an improved quality of life in Canada and internationally: better roads, greener power generation facilities; higher quality and modern water systems, and more efficient public transportation. Capstone is poised to participate in this sizable opportunity.

Creating Value

With our focus on quality, low-risk infrastructure businesses that provide essential services, Capstone offers shareholders access to a unique and growing asset class that has historically exhibited low volatility relative to the broader equity market.

In 2013, we are focused on returning to historical levels of business development activity and on creating value for shareholders, imperatives that are supported by:


An exceptionally high quality infrastructure portfolio of contractually defined, income-producing power facilities as well as utilities that deliver long-term, inflation-linked cash flow.


A significantly strengthened balance sheet and a long-term dividend payout ratio target of approximately 70% to 80%, which together provide a solid foundation to support our company’s continuing growth.


And a top-notch team with more than six decades of combined expertise in infrastructure asset and investment management, which represents a tremendous competitive advantage for Capstone.

In closing, I would like to thank our directors for their support and guidance in 2012 and our employees for their commitment to excellence in executing our strategy. The deep relationships nurtured by our employees with partners, customers, suppliers, landowners and local communities help us to operate thoughtfully, responsibly and safely, and enhance our competitive position. Our people are paramount to Capstone’s success and we are grateful for their dedication.


We have the experience and drive to successfully deliver on our strategy. We are confident in our ability to create value for you, our shareholders, and we thank you for your continuing support.










Active Management

We actively manage our operations to maximize their long-term value by working closely with our asset-level personnel to drive continuous improvement, direct capital management initiatives and establish strategic plans.



Disciplined Approach

Capstone is extremely disciplined in its approach to selecting growth opportunities to pursue because we are focused on enhancing returns for shareholders. For example, we realized an approximately 10% premium on the sale of a minority, non-controlling stake in Bristol Water, proving our ability to make smart acquisitions.



Exceptional Capabilities

Collectively, our team has decades of experience in financing and managing infrastructure businesses with strong relationships across the sector in Canada and internationally.




As we manage and grow our portfolio, it is a priority that we foster a positive culture that is respectful of our many stakeholders. We are guided by the following values:



In all we do, we act honestly, ethically and fairly, abiding by both the spirit and letter of our commitments as well as our Code of Business Conduct. We are accountable for our decisions and seek to communicate with transparency.



We are committed to managing Capstone in the best interests of our shareholders, which includes acting as a good corporate citizen in the communities where our businesses operate.



Fulfillment for our People

We foster a professional, safe work environment where our people have the tools and resources to excel and be successful and where they are recognized for their service and contributions.




As a team, we work cooperatively and constructively to build Capstone’s business and share a focus on achieving optimal performance.



Highest Standards

We strive for excellence, innovation and creativity in the management and growth of our businesses.



Strive for Profitability

We seek to manage and grow our businesses profitably so that we can deliver an attractive total return to our shareholders.



Adjusted Earnings before Interest, Taxes, Depreciation and Amortization (Adjusted EBITDA)
EBITDA is net income (loss), including that net income (loss) related to the non-controlling interest and interest income excluding interest expense, income taxes, depreciation and amortization. EBITDA represents Capstone’s continuing capacity to generate income from operations before taking into account management’s financing decisions and costs of consuming tangible capital assets and intangible assets, which vary according to their vintage, technological currency, and management’s estimate of their useful life.

Adjusted EBITDA is calculated as revenue less operating and administrative expenses plus interest income and dividends or distributions received from equity accounted investments. Amounts attributed to any non-controlling interest are deducted. Adjusted EBITDA for the investment in Bristol Water is included at Capstone’s proportionate ownership interest. Adjusted EBITDA is reconciled to EBITDA by removing equity accounted income, other gains and losses (net), foreign exchange gains and losses, and adding in dividends or distributions from equity accounted investments.

Adjusted Funds from Operations (AFFO)
Capstone’s definition of AFFO measures cash generated by its infrastructure business investments that is available for dividends and general corporate purposes. For wholly owned businesses, AFFO is equal to Adjusted EBITDA less interest paid, repayment of principal on debt, income, taxes paid and maintenance capital expenditures. For businesses that are not wholly owned, the cash generated by the business is only available to Capstone through periodic dividends. For these businesses, AFFO is equal to distributions received. Also deducted are corporate expenses and dividends on preferred shares.

Asset management plan, which is developed by water utilities in the United Kingdom every five years and approved by Ofwat.

Annual long-term average production
An average production figure based on the actual electricity production of a facility since the start of full operations.

Availability is the number of hours that a generating unit is able to provide service at full output, whether or not it is actually in service, as a percentage of total hours in the period.
Base load facility
A base load facility produces electricity at an essentially constant rate and runs continuously.
Capacity is the net amount of electricity generated by a generating unit as a percentage of the total possible generation over the period.

Cogeneration refers to the simultaneous production of electricity and thermal energy in the form of heat or steam from a single fuel source, a process that results in high efficiency and an effective use of energy.

Consumer Price Index (CPI)
The CPI is an indicator of inflation that measures the change in the cost of a fixed basket of products and services, including housing, electricity, food and transportation.

A period during which a power facility continues to operate but at less than capacity.
Direct Customer Rate (DCR)
The Direct Customer Rate, which is set by the Ontario Electricity Financial Corporation, is calculated based on a three-year average of the total market cost of electricity to industrial customers.
Gigajoule (GJ)
One GJ is equivalent to the amount of energy available from 26.1 m3 of natural gas.

Gigawatt hour (GWh)
A unit of electrical energy equal to 1,000 megawatt hours.

Green metric tonne (GMT)
A unit of weight equal to 1,000 kilograms.
The effect of precipitation and evaporation upon the occurrence and distribution of water in streams, lakes and on or below the land surface.
K Factor
The regulated annual rate by which each licenced water company can increase its charges annually on top of inflation.

Kilowatt (kW)
This commercial unit of electrical power refers to 1,000 watts of electrical power. This is the total amount of power needed to light 10 light bulbs of 100 watts each.

Thousands of pounds of steam.
Megawatt (MW)
A megawatt is 1,000 kilowatts.

Megawatt hour (MWh)
This is a measure of energy production or consumption equal to one million watts produced or consumed in one hour (total amount of power required to light 10,000 100-watt light bulbs).

Millions of litres of water per day.

A unit of heat equal to one million British thermal units. A British thermal unit is the quantity of energy necessary to raise the temperature of one pound of water by one degree Fahrenheit.
The UK Water Services Regulation Authority.

A period of time when a power generation facility does not produce any electricity.
Payout ratio
Payout ratio measures the proportion of AFFO that is paid as dividends to common shareholders. The payout ratio is calculated as dividends declared divided by AFFO.

Peaking facility
A peaking power facility is reserved for operation during the hours of highest daily, weekly or seasonal loads.

Power Purchase Agreement (PPA)
A PPA is an agreement to purchase electricity at a specified rate for a defined period of time.

Public-Private Partnership (P3)
A partnership between the public and private sectors to deliver infrastructure projects.

The regulated capital value, or capital base, that is used by Ofwat to set the prices a water utility may charge its customers in each asset management plan period.

A renewable energy credit is a certificate issued by a government agency to a power company that uses environmentally-friendly methods to generate electricity. The RECs can in turn be sold and traded to third parties or on the open market.

The Retail Price Index is a measure of inflation in the United Kingdom. The rates Bristol Water may charge its customers increase by RPI each year.
Service Incentive Mechanism, a new incentive mechanism introduced by Ofwat to reward or penalize water companies’ service performance.

Solar photovoltaic (PV) power
The generation of electricity directly from sunlight.
Total return
The total return on an investment includes income from dividends, as well as share price appreciation or depreciation, over a given time period.
A watt is the scientific unit of electric power.
Yield refers to the amount of dividends paid per share over the course of a year divided by the trading price of the common shares.

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