Otter Tail Corp (OTTR) 2012 Q4 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Otter Tail Corporation's 2012 earnings conference call. Today's call is being recorded, and there will be a question-and-answer session after the prepared remarks.

I would now like to introduce your host for today's conference, Mr. Loren Hanson. Please go ahead.

Good morning, everyone, and welcome to our call. My name is Loren Hanson, and I manage the Investor Relations area. Last night we announced our 2012 results and our 2013 earnings guidance. Please note that our complete earnings release, and slides accompanying this earnings call, are available on our website at www.ottertail.com. A replay of the call will be available on our website later today.

With me on the call today is Jim McIntyre, Otter Tail Corporation's President and CEO, and Kevin Moug, Otter Tail Corporation's Senior Vice President, Finance, and Chief Financial Officer.

Before we begin, I would like to remind you that during the course of this call, we will be making forward-looking statements. These forward-looking statements are covered under the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995, and include statements regarding Otter Tail Corporation's future financial and operating results, or other statements that are not historical facts. Please be advised that actual results could differ materially from those stated or implied by our forward-looking statements due to certain risks and uncertainties, including those described in our most recent Form 10-K and subsequent quarterly reports on Form 10-Q. Otter Tail Corporation disclaims any duty to update or revise our forward-looking statements as a result of new information, future events, developments, or otherwise.

We will also refer to non-GAAP measures because we believe they provide useful information for our investors. Yesterday's news release contains a reconciliation table to GAAP results.

For opening remarks, I would now like to turn the call over to Otter Tail Corporation's President and CEO, Mr. Jim McIntyre. Jim?

Good morning, and thanks for joining our call today. We are pleased that we ended the year with a good quarter, capping a solid performance for 2012. This will enable us to build on our success in 2013 and beyond. Otter Tail Corporation continues to transform as we execute on our strategy to derisk the Company. As shown on slide 3, since May 2011 we have divested Idaho Pacific Holdings, EW Wylie, DMS Health Technologies, DMI Industries, and last week we completed an additional strategic move with the sale of ShoreMaster, our waterfront equipment manufacturer. As we assessed which companies to divest, we relied on the portfolio criteria on slide 4 to guide our decision making.

Slide 5 shows a transformed, stronger Otter Tail Corporation, with more predictable growth, a lower risk profile, and enhanced financial stability, which helps support our ability to fund the dividend. The divestitures resulted in gross proceeds of approximately $242 million. The proceeds have been used to pay down short-term borrowings, retire long-term debt early, and to invest in significant rate-based growth opportunities in our core electric business.

To further illustrate the transformation of Otter Tail Corporation, at the end of 2010, assets in the Electric segment were 62% of the total assets. By the end of 2012, assets in the Electric segment accounted for 77% of the total assets of the Corporation.

We are encouraged by our 2012 financial performance, as our earnings per share from continuing operations before early debt retirement increased to $1.27 per share from $0.95 per share. Our Electric segment continued its strong performance. And all of our manufacturing and infrastructure businesses, with the exception of Foley, our construction company, showed improvement in net income.

Our focused, disciplined approach is making a difference in our financial and operating results. We continue to invest heavily in our electric utility opportunities, spending $102 million for utility capital expenditures this past year. Referring to slide number 6, we plan to invest an additional $811 million in the Electric segment through 2017. Approximately 43% of the $811 million capital budget will be spent on transmission projects. About one-third will be spent on environmental upgrades at our generation, and the remainder will be for normal equipment replacement. As a result, the Utility is expected to nearly double its rate base measured from 2011 through the next five years.

Additionally, it was recently announced the Minnesota Public Utilities Commission has approved our recommendation to operate our 140-megawatt coal-fired Hoot Lake plant until 2020. We plan to invest $10 million by 2015 for pollution control equipment on the plant. We expect the replacement for Hoot Lake generation will be natural gas.

In 2013, we will work to continue to improve operational and financial results from all of our businesses. The foundation of our Company is a strong, low-cost, well-run utility with exceptional customer service. The Utility is complemented by well-run strategic manufacturing infrastructure platform companies.

Our goal is to deliver between 4% and 7% annual growth in earnings per share over the next several years. The growth is expected to come from the projected increase in our regulated utility rate base, and from planned increased earnings from existing capacity at our manufacturing and infrastructure businesses. We will target approximately 75% to 85% of earnings to come from our core electric business, and 15% to 25% to come from our manufacturing and infrastructure businesses.

And we believe this earnings mix is sustainable over time, maintaining strong credit quality, dependable earnings, and manageable risk. We believe this to be the case because our manufacturing and infrastructure businesses are much more tightly clustered and generally more manufacturing based.

Additionally, the focus is on operational excellence, quality and discipline around processes that can be replicated to drive performance and create more consistent, predictable results. We plan to have managed growth within our businesses, with more focus on margin and net income growth. We have also added additional talent resources to focus on continually improving our various companies.

The portfolio criteria on slide number 4 provides the discipline to assess our businesses to ensure they are delivering the performance required by the Corporation. To the extent the companies do not fit the criteria, we will make prudent decisions and act decisively. With the continued realignment of our portfolio and focus on operational excellence, we believe Otter Tail Corporation is very well-positioned for strong earnings growth.

I will now turn it over to Kevin for a discussion of the financial results.

Thank you, Jim, and good morning. Please refer to slide number 7, as I would like to discuss with you our actual 2012 results compared to the guidance we issued in November 2012. All of our financial results have been reclassified to reflect the discontinued operations for DMI and ShoreMaster.

First, GAAP only allows for interest expense and debt retirement costs that were specifically required to be repaid by the lender to be included as part of discontinued operations. However, we used proceeds from the sale of DMI to retire early our $50 million, 8.89% note. Because of this, we believe it is appropriate to associate the debt prepayment premium and interest expense related to this note with our discontinued operations, to provide a better indication of the core earnings of our current portfolio.

For 2012, on a non-GAAP basis, adjusting for these items, Otter Tail Corporation reported earnings per share from continuing operations of $1.31. In November 2012, our guidance range was $1.06 to $1.31, not including the debt retirement premium. So, let me provide additional comments on segment performance that contributed to these results.

The Electric segment finished the year with earnings per share of $1.06, at the top of the guidance range. The Electric segment had a strong year in 2012, with net income down slightly despite mild weather conditions early in the year.

The Manufacturing segment, which includes BTD and T.O. Plastics, earned $0.29 per share compared with guidance of $0.26 to $0.30 a share. At BTD, revenues increased $17.7 million, and net income increased $1.4 million over 2011, as a result of higher sales volume due to improved customer demand for products and services. At T.O. Plastics, revenues increased $1.8 million, and net income increased $1.1 million over 2011, as a result of increased sales of industrial and medical products, productivity improvements, and more selective bidding practices.

Our Construction segment reported a loss of $0.21 per share, which was within our guidance range of a loss of $0.18 to $0.23 per share.

Foley revenues decreased $48.3 million, and its net losses increased $7.7 million as compared to 2011, due to a decrease in work volume and the effect of $14.9 million in cost overruns on eight large projects. Substantially all of these projects have been completed or were in the final stages of completion as of December 31, 2012.

Aevenia's revenues and net income increased $12.7 million and $2.2 million over 2011, mainly as the result of an increase in electrical transmission, distribution, and substation work in the oil patch in western North Dakota, and improved performance on construction projects.

Turning to Plastics, the earnings per share was $0.39, exceeding the guidance of $0.32 to $0.37 per share. The additional earnings over the guidance range was due to stronger than expected markets during the fourth quarter, as compared to what was forecasted. The increase in revenues and net income over 2011 was due to a 17% increase in pounds of pipe sold, combined with a 4.1% increase in the sales price per pound. Also positively impacting 2012 profitability was a reduction in the resin cost per pound of 6.6%, and increased productivity as fixed production costs were spread over a larger volume of pipe produced.

Now I will review the items that contributed to the discontinued operations loss of $1.22 per share, versus the guidance in a range of $0.95 to $1 per share. As indicated earlier, ShoreMaster, which lost $0.09 a share in 2012, is now included in discontinued operations. We also recorded a loss on the sale of ShoreMaster and a writedown of commercial assets that continued to be owned by Otter Tail Corporation.

Also impacting discontinued operations were additional charges recorded in connection with warranty obligations for wind towers and commercial marina projects that Otter Tail Corporation is responsible for servicing on a go-forward basis. We also wrote off $4.4 million of state net operating losses in states where we filed separate returns on companies that were sold, and lost NOLs in unitary filing states, as well as based on state tax law.

Turning to slide number 8, on October 29, 2012, we closed on five-year credit facilities for Otter Tail Corporation and Otter Tail Power. Both facilities provide for reduced costs going forward, with Otter Tail Corporation now borrowing at 1.75% over LIBOR, compared to 3.25% under the previous facility. Otter Tail Power now borrows at 1.25%, compared to 1.5% under the previous facility. Otter Tail Corporation's facility was reduced from $200 million to $150 million. The reduction in this facility is due to the reduction in working capital needed to support our businesses as a result of the divestitures.

Otter Tail Corporation and Otter Tail Power had a combined $316 million available under the credit facilities to provide for future working capital and growth at December 31, 2012. We also had $52 million in cash on hand at December 31, 2012, and expect to use the cash to fund rate-based investments in the electric utility.

On January 24, 2013, Otter Tail Power issued call notices for the 4.65% Grand County and 4.85% Mercer County pollution control bonds. And, on the same date, Otter Tail Corporation issued call notices on its four outstanding preferred issues. All of these securities will be redeemed on March 1, 2012. Otter Tail Power will be entering into a $40.9 million term loan to fund these redemptions. The lower LIBOR-based floating rate interest under the term loan is expected to bring a reduction in pretax interest expense of approximately $875,000 during 2013.

Our Board of Directors also approved the common stock dividend of $0.2975 per share, payable March 9, 2013 to shareholders of record on February 15, 2013.

Slide number 9 shows our 2013 guidance, which is expected to be in the range of $1.30 to $1.55 of diluted earnings per share. This guidance reflects the current mix of businesses owned by the Corporation. The guidance also considers the cyclical nature of some of the operating companies, and reflects plans and strategies for improving future results.

Electric segment net income is expected to increase in 2013 compared with 2012, based on rider recovery increases and an increase in AFUDC earnings related to large construction expenditures. This is offset by lower conservation improvement program incentives, and increases in operating and maintenance expenses, primarily due to higher benefit costs. Pension benefit costs for the non-contributory funded pension plan are expected to increase by $2.7 million in 2013, reflecting a change in the assumed rate of return on pension plan assets from 8% in 2012 to 7.75% in 2013, and a decrease in the estimated discount rate used to determine annual benefit costs from 5.15% in 2012 to 4.5% in 2013.

We expect earnings from the Manufacturing segment to improve in 2013 due to increased order volume and continuing improvement in economic conditions in the industry's BTD serves, along with a slight increase in earnings from T.O. Plastics. Backlog for the Manufacturing companies is approximately $124 million for 2013, compared with $115 million one year ago.

We expect higher net income from the Construction segment in 2013, primarily because we do not expect a drag on earnings from the eight large projects at Foley. These projects are now substantially completed, and Foley's internal bidding and estimating project review procedures have been improved such that we do not expect to see similar losses in 2013. Backlog in place for the construction businesses is $151 million for 2013, compared with $106 million one year ago.

The Plastics segment experienced its second-best earnings year in its history in 2012, due in part to certain market- and weather-related events that are not expected to occur in 2013. Accordingly, the 2013 net earnings expectations for Plastics are expected to be lower, based on the market and weather conditions currently being experienced.

In corporate, general and administrative costs are expected to remain relatively flat between the years. We expect capital expenditures for 2013 to be $204 million compared with $116 million last year, with the major project contributing to the increase in planned expenditures being the AQCS project for the Big Stone Plant.

We continue to invest in the transmission projects, as well. The investments in these generation and transmission projects are expected to positively impact the Corporation's earnings and returns on capital.

The five-year capital expenditure plan contains $811 million of utility projects, which accounts for 90% of the capital invested over the next five years. The five-year capital plan also includes maintenance and replacement capital for the manufacturing and infrastructure businesses.

The last few years have been challenging as we have been working on our strategy. We appreciate your patience and recognition that it would take time to realign our portfolio. We have taken a number of steps to improve our risk profile, improve on our credit metrics, and generate additional sources of cash to support the future capital expenditure plans of our Electric segment. These actions have resulted in a portfolio of operating companies that is easier to understand, and provides a pathway to support the common dividend. We have done everything we told you we were going to do. And as a result, hope you have renewed confidence in our ability to deliver shareholder value.

We are ready to take questions. After the Q&A, Jim will return with final comments. I will now ask the operator to open up the lines.

(Operator Instructions)

Michael Klein, Sidoti & Company.

Can you just talk about your outlook at the utility segment, and in terms of timing of your next rate case? And also, what your earned regulated ROE was in 2012?

In terms of our next expected rate case, it would be sometime -- right now, we are looking in the 2014 timeframe. The final ROEs from a regulated perspective are not yet completed. But the estimate for the regulated ROE in 2012 is around that 10.5% to 10.75% range, Michael.

Okay. So, given the rider recovery mechanisms that you guys have in place and the allocation of CapEx, is it safe to assume that the earned ROE would decline before your next rate case? Or would that not necessarily be the case because of the riders in place?

There would be -- there was going to be some downward pressure on that, in part because of the increasing expenses we are seeing on the pension plan.

Okay.

Yes, the rider covers the new projects, but it doesn't cover any incremental, ongoing operating expenses. So, as Kevin said, there will be some slight -- but as you know, we manage our costs pretty well. So, I expect Chuck and the guys there will work hard to deliver strong earnings in '13 and beyond.

Sure. Okay, great. Thanks a lot, guys.

Tim Yee, KeyBanc.

Just a couple of questions on your 2013 outlook, first on the Construction segment. Could you maybe talk a little bit about what is left as far as any cost overruns, and kind of how the timing of the improvements in that segment might flow this year?

The -- in terms of what is left in terms of cost overruns, we feel really good about the review that we did in the fourth quarter on these eight challenge projects, such that -- included in that $14.9 million of cost overruns are additional estimates of cost that we believe are there. We wanted to do everything we could to fully reflect the losses in 2012 and get them behind us, Tim.

And so, we have established, to the extent there were additional things in the project cost estimates that we didn't feel were appropriately addressed, we recorded additional reserves to reflect any potential other risks to those jobs. So, construction projects are unique and they have challenges, and it doesn't mean there couldn't be some things that occurred in '13. But we feel good about the processes we put in place to reflect the additional losses that could occur and flip those in 2012.

Okay. So, that is behind us. And then, on the Plastics, just want to understand a little bit. You talk about maybe a more current market and return to normal weather conditions this year. How -- I'm trying to understand a little bit more about that weather dynamic and how that helped you or how much of that -- how much weather benefit did you get in Plastics and what was that related to?

Well, where we really saw the benefit was in the first quarter last year, where the weather was so warm we were selling quite a bit of pipe into the western part of North Dakota in the oil fields. And so, they were able to continue with construction last year, where we are not expecting based on current weather that we are seeing or experiencing that they are going to be able to have the same kinds of level of infrastructure buildout in the Bakken that we did a year ago.

We also saw that to some degree in the fourth quarter this year, as well, when we talked earlier about we performed better than what we had in the forecast. Our fourth quarter, we saw some nicer weather in the fourth quarter there, as well. And so, that helped solidify or strengthen our earnings in 2012. So, we are not planning for that to occur again in 2013. If it does, we will certainly recognize it and would look to adjust either way our guidance as we are experiencing those things.

Okay. Then maybe just a question for Jim here. With your '13 guidance out now, it's -- the range is above your dividend payout. Just how you and the Board might be thinking about the dividend and going forward.

First off, it will be nice to have a 2013 year where, one, we are not expecting any divestitures to occur, and two, we won't have to wade through any discontinued ops to see the clarity of our financials. And with that, it will be particularly nice to have earnings that more than support the dividend. And that is where we are going to be going and heading forward. I think as far as our future dividend and what is maybe hidden in your question is -- when is the time for an increase? We will monitor that as we do, and we will make reviews with the Board.

But I think we have to get a little more distance underneath us and a little more experience before we would be in a near-term position to increase the dividend. That clearly is one of our goals, and not too far out of mind. But we will want to get a little more strength in our earnings behind us so that we can have a reasonable payout, even as we would make an adjustment to the dividend at some future time.

Great. Thank you.

(Operator Instructions)

Michael Bates, D.A. Davidson.

I was wondering if you could talk to us a little bit about what you have changed in the bidding process in the Construction segment that will protect you from the same headwinds that we saw in 2012.

Well, let me talk to that. Kevin has already talked to it a little bit. He referenced the significant number of changes that we put in place to have better processes around the bidding process, the -- excuse me, the estimating process, the bidding process, and the review and control of projects that are out there. In 2012, we were probably our own worst enemy, particularly with regard to those large projects. The other projects, we have not seen the challenges nor the losses. It has been constrained to what is referred to as the big eight.

We have done a lot of internal review, made a lot of internal changes to our processes and procedures. And I believe that Foley is on its way back to where it was for a long period of time -- and that is a well-performing construction company. So, I don't think -- I think there is ample opportunities for bids. I think we will see us clustered in our bids to a level more tightly around the size and experience where we have had more success than we have had with some of the larger bids. So, we have done a lot of things that I think will well position us for '13 and beyond.

Okay. And you mentioned the backlog in that business is significantly larger as we head into 2013. Can you talk a little bit about the mix of the projects currently in backlog, as well as the expected seasonality as -- just the timing of when you would expect to record those revenues over the course of the year?

The backlog, the majority of the backlog, Michael, is with Foley. Foley typically has longer-lived projects in its business, ranging anywhere -- projects can go from a year up to three years in length. And so, that is where the majority of the backlog comes from. Aevenia typically has to start over each year. It has some backlog in that number, but usually its projects are much shorter in duration. Typically, that they don't -- they cycle through, they are completed in a year, and they may pick up work later in the year that then starts to carry into the following year.

So, the majority of the backlogs at Foley, in terms of as we look at the seasonality of that work, I think the work is relatively scheduled relatively evenly throughout the year. We certainly recognize that the first quarter of '13 will be a little slow, just because we still have to -- there is a few things being wound up on these big eight projects that we talked about. And so, there is minimal revenues that will come through as we -- any of those that have to be kind of finished up. We have resources on those.

But then, once those types of things are kind of wrapped up, then we will see our revenues recognized under percentage of completion on the new projects start to come through. We do have six projects that have a pretty big impact on 2013 profitability for Foley, as a part of the processes that Jim referred to. We certainly spent a lot of time looking at those projects, as well, and doing additional takeoffs on the costs that we were estimating for those jobs, to make sure we had good assurances on the -- how those jobs would perform in 2013.

One more follow-up, if I may. As you look at the $151 million backlog in Construction, how much of that do you expect to come into 2013?

That backlog is all for 2013.

All right. Thank you very much.

(Operator Instructions)

Michael Klein, Sidoti and Company.

Just real quickly, the $52 million cash balance, is that a timing issue or -- not an issue, but is that related to timing? Or can we expect to see the cash start to build now that we have divested some of these businesses going forward?

Well, it's -- timing in part because we have sold off companies and generated $240 million -- little over $240 million of cash from these sales. And so, we have used those proceeds to pay down short-term borrowings, we have paid down long-term debt. And we also now have cash that was generated from the businesses and continuing in our core portfolio, had a good year of cash, as well. And so, the $52 million is a result of those activities.

We will expect going forward that, that cash, as we have been telling everybody for quite some time, that the result of this portfolio realignment will help us ease the need or ease the pressure on the capital markets. And that is what that -- we will certainly use that $52 million for us to, as we have told you, to invest in the rate-based expansion that the utility has.

Okay. And still thinking 2014 would be the earliest that you need to go back and raise more capital?

For equity.

Okay. Okay, thank you.

Tim Yee, KeyBanc.

It's Paul Ridzon. The Hoot Lake replacement gas plant -- is that reflected in your CapEx, and how much capital could that be?

Well, there is $10 million that we will put in place in 2015 for the environmental upgrade to get it out to 2020. And we think that is money well spent. The 2020 -- since it is a gas plant and their fairly short-term construction schedule, I don't think there is any of the capital for the gas plant in our 2017 CapEx budget.

There is not. It doesn't -- it wouldn't start -- the dollars wouldn't start to be spent until later outside that -- this current timeframe, Paul.

And this is going to be a combined-cycle plant?

I think the -- of all those processes, in terms of combined cycle or other options for gas are being weighed and looked at. This whole thing just kind of got itself finalized here over the last month or so, and we feel good about the outcome. And now, the resource planning folks will start to look at the facility and the dollars and the type of natural gas plant.

Okay. So, it's a work in progress here. Thank you.

I am showing no further questions at this time, and I would like to turn the conference back over to Mr. Jim McIntyre for any closing remarks.

Well, thank you. The recent sales of DMI and ShoreMaster reflect strategic decisions to monetize assets, further de-risk the Company, and divest companies that no longer fit our current operating plans. While remaining committed to a thoughtful diversification strategy, we will continue to assess all of our companies against our portfolio criteria.

In the end, all of our companies will have a role -- the Electric utility for its predictable earnings stream and the Manufacturing infrastructure businesses to offset periods of lower growth of the utility. To succeed at that, we must strike the right balance, and we have confidence that the strategy outlined and the related decisions we have made will help us meet our goal of producing 4% to 7% average annual earnings growth, as well as support the dividend. Finally, we will not waver in our commitment to create long-term value for our shareholders. Thank you very much for joining our call, and look forward to visiting with you throughout 2013.

Ladies and gentlemen, a replay of this conference will be available via webcast later this afternoon at www.ottertail.com/presentations. This does conclude today's conference. You may all disconnect. Have a wonderful day.