Otter Tail Corp (OTTR) 2013 Q2 法說會逐字稿

Good day, ladies and gentlemen. And welcome to the Otter Tail Corporation second quarter 2013 earnings conference call.

Today's call is being recorded, and there will be a question and answer session after the prepared remarks. I would like to introduce your host for today's conference, Mr. LorenHanson, please go ahead, sir.

Good morning, everyone, and welcome to our call. My name is Loren Hansen, and I manage the Investor Relations area of Otter Tail. Last night we announced our second quarter results. 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. Kevin Moug, Otter Tail Senior Vice President and Chief Financial Officer.

Before we begin, I'd 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 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 further reports on form T 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.

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

Good morning. And thank you for joining our call today. Overall, our 2013 second quarter results are better than expectations. The successful realignment of our portfolio continues to have a positive effect on earnings, better positioning us for stronger execution within our remaining companies.

The 33% year-to-date improvement in net income from continuing operations further indicates progress towards a successful 2013. The transformation of our company has also been recognized by Standard & Poor's, who recently upgraded Otter Tail Corporation and Otter Tail Powers Corporate and senior unsecuritized credit ratings.

And also by Fitch, who recently announced a favorable outlook change for Otter Tail Corporation in Otter Tail Power. I would now like to update you on the substantial investment opportunities over the next few years at Otter Tail power in the area of transmission, generation, and environmental upgrades. Generally speaking, all of the projects under construction have regulatory approval that are subject to some form of current recovery.

Slide four shows the treatment by each of our jurisdictions. Our transmission projects referred to as CAPEX 2020, and multivalue or MVP projects are on time, on budget, and on pace to make their expected contributions to earnings. CAPEX 2020, of which we have investment in three projects, is currently about half complete. The investments in all of the transmission projects, including the MVP projects, is expected to be approximately $400 million.

Big Stone Air quality control system, or AQCS, is also moving forward on schedule in its early stages and the project is benefiting from lower cost, as mentioned last quarter. When completed in 2016, we expect 80% to 90% reduction in suffer dioxide, nitrogen oxide, and mercury emissions.

Also, Otter Tail Power Company recently entered into a 25-year contract to purchase wind energy from the 62.4 megawatt Ashtabula Wind Farm northeast of Valley Sea, North Dakota that is owned by a subsidiary of Next Era Energy Resources. The contract includes an option for Otter Tail Power Company to own the wind farm in ten years.

The energy purchase was below the cost model in Otter Tail Power Company's biannual integrated resource plan. This purchase positions the utility immediately renewable energy obligations in the three states it serves through 2025. Wind energy will now supply about 19% of Otter Tail Power Company's retail sales.

We also have rider recovery mechanisms for all wind, transmission, and environmental projects. With these riders, cash flows are enhanced since the riders allow for more time in recovery compared to our former rate case. Also the benefits the customers by phasing costs into our rates over time, versus a rate shock at the end of the project.

The Minnesota legislature passed legislation this past session expanding the circumstances under which a public utility can seek rider recovery for emissions-related upgrades. Otter Tail Power Company had requested the Minnesota Public Utilities Commission to grant rider recoveries for its Big Stone plant, AQCS, environmental upgrade project, under this new law. Large scale generation and transmission projects are preapproved including potential canceled project recovery.

Given the current status, and the strength of recovery mechanisms, we remain confident the utility's ability to deliver earnings within our guidance, as well as provide predictable earnings growth over the next five years. Delivering earnings is noting new to Otter Tail Power. Over the last five years, Otter Tail has averaged a return on equity of 10.8%. We believe Otter Tail power will earn at or near the authorized return equity in the future as well. As I look at our manufacturing infrastructure businesses within Varistar, there has been much progress.

I would like to share a few thoughts on these companies. The reduction in the number of platforms and companies has not only reduced the overall risk of Otter Tail Corporation, but also resulted in a sharpened focus on our remaining businesses.

Regarding our manufacturing businesses, BTD and fuel plastics are both doing a better job of bringing profit to the bottom line, despite sales challenges in a tough economy. Improving margins, and better understanding costs, of making a positive difference in these manufacturing companies.

PTD's commitment to quality is paying off in the efficient use of capacity, its employees, and the proximity of its facilities to customers whose are known for having high quality standards. Among the customer base of BTD are names such as Polaris, John Deere, Komatsu, Toro, and Arctic Cat. BTD has facilities in Minnesota and Illinois, and is capable of manufacturing order parts in either location with similar high quality results.

BTD is incurring tooling costs in preparation for increased sales in the last half of the year, and into 2014. Moving on to construction, [Foley] is showing signs of recovery with enhanced bidding, project management, and increased attention to detail. Aevenia, off to a slow start due to weather and other challenges but I expect they will recover in the second half of the year.

With regard to plastics, pipe companies are both having a great year. Collectively, these companies are benefiting from low capital and operating cost, as well as strong business savvy on the part of management. And being agile and able, they capitalize on opportunities when they present themselves.

We are fortunate to have available capacity at our manufacturing plants including BTG, T.O. and our pipe companies, enabling us to expand and grow without major capital investments. Our construction segment can also ramp up for additional project opportunities. This capacity for expansion further supports our burrow of 4% to 7% top outed growth in earnings per share.

In summary, based on the year-to-date $0.15 per share, year over year improvement, we remain confident that we can deliver a strong 2013. Our portfolio of a well performing electric utility, delivering on a rate base growth strategy, and Varistar companies that are more disciplined and focused, positions us or both in near and longer term enhancement of shareholder value. I would now like to turn the call over to Kevin, who will comment further on our financial performance.

Thank you, Jim, and good morning. I'd like you to refer to slide five of the presentation as I walk through the quarter's results. Net income from continuing operations is $0.21 per share, compared with $0.19 per share for the same quarter last year. These results were consistent with our forecast for the second quarter, and included $0.02 of charges we consider infrequent but not unusual, to our operations.

These include a charge we incurred to discount a Minnesota jurisdictional share of abandoned project Big Stone Two project transmission assetsthat were transferred from construction work in progress, to a regulatory asset for future recoveryAs the initial investment was deemed prudent but potential future uses for the assets did not occur. Accounting rules also require a company to true up its deferred tax assets and deferred tax liabilities in a period of changed in tax rates occur.

So accordingly, we had a reduction in our deferred tax assets related to a decrease in the North Dakota corporate income tax rates in 2013 that went from 5.15%, to 4.35%. Now I would like to discuss highlights from our electric segment. Significant items contributed to the $3.5 million increase in electric retail revenues are as follows.

First, we experienced a $1.7 million increasein transmission costs recovery, rider revenues, due to the build out of our transmission projects. Secondly, there was a $1.1 million increase in revenue, related to colder spring weather this year, compared to 2012. Our electric operating and maintenance expenses increased $3.7 million mainly due to a $1 million increase in MISO transmission tariff charges related to our CAPEX 2020, and MVP transmission projects.

A $1.2 million increase in labor and benefit expenses, mainly due to increases in cost resulting from reductions and discount rates related to projected benefit obligations. A $1.3 million increase in general and administrative costs, mostly related to an increase in corporate costs allocated to the electric segment. Due to in part to changes in our corporate cost allocation factors resulting from the Corporation's recent divestitures. And a $700,000 discount that we recorded on the abandoned Big Stone Two Project transmission assets that we transferred from construction working process to a regulatory asset for future recovery.

There are also further variances discussed in the earnings release for the electric segment that affected the earnings as well. Moving on to manufacturing. Revenue and net income were down compared to the same quarter last year. At BTD, revenues and net income decreased to $3 million and $400,000, respectively, as a result of lower sales volume, mainly due to reduced demand from customers and end market serving the construction and energy industries.

At T.O. plastics, revenues and net income decreased slightly. Mainly as a result of the decrease of sales of packaging products. Our plastics segment continues a strong performance during the second quarter, sales volume increased as construction and housing markets continues to improve in the south central and southwest, part of the United States. These sales volume increases from those regions were partially offset by lower sales in the north central United States, due to a colder and wetter spring during the second quarter of 2013.

Our corporate expenses decreased $1 million as a result of lower interest expense related to the early redemption of the $50 million 8.89% notes. Lower insurance costs, and increased allocation of costs to the electric utility that were offset by higher labor and employer benefit expenses. Our construction segment results have improved significantly other the second quarter of 2012.

The main reason for the better financial results is continued improvement at Foley. Foley's net income improved $2.5 million between the quarters. This is because the major projects impacting results in 2012 have been largely completed and we are seeing better performance on projects impacting 2013.

The venue incurred and net loss $400,000 compared with $300,000 of net income last year, due to colder and wetter spring in 2013, which delayed the start of many of our construction projects. In 2012, there was an early start to the construction season because of extremely mild weather. Aevenia's second quarter 2012 results also included revenues and net income from the sale of Morehead Electric, one of our Avenia subsidiaries.

Moving on to liquidity and financing, our consolidated cash flow from continuing operations for the six months ended June 30, 2013, was $48.8 millioncompared with $45.6 million for the six months ended June 30, 2012. As shown on slide seven, our available liquidity under the $320 million aggregate credit facilities was $317 million at quarter end. On June 28th 2013, we priced $150 million private placement of long term debt for Otter Tail Power with two [tranches].

The $60 million tranche will bear interest at 4.68% for fifteen yearsand the $90 million tranche will bear interest at [5.7%] for 30 years. The issuance is expected to close on August 14th, 2013and to fund at the end of February 2014. A portion of the proceeds from this issuance will be used to retire the $40.9 million term loan due

June 1, 2014, with the balance of the proceeds to be used for plant utility construction program expenditures. Additional color on the rating agencies. As Jim mentioned, Standard & Poor's upgraded the issue of credit rating for Otter Tail Corporation and Otter Tail power to BBB. In addition, the senior unsecured debt for Otter Tail Corporation was upgraded to BBB minus, and the senior unsecured debt for Otter Tail Power was upgraded to BBB. Reasons for the upgrade related to our strategic focus on our core electric utility business, and divestiture of a significant portion of our unregulated businesses which has resulted in an improved risk profile.

Also, while maintaining rates, Fitch changed the outlook for Otter Tail Corporation and Otter Tail Power to stable. The rating drivers for Fitch included the strong stable performance of Otter Tail Power, the divestitures, earnings recovery at our manufacturing and infrastructure companies, and the large capital expenditure program at Otter Tail Power. As it relates to the common dividend, on August 2, 2013, the Corporation's Board of Directors declared a quarterly common stock dividend of $0..2975 per share.

The dividend is favorable September 10th, 2013, to shareholders of record, on August 15th, 2013. We are able to maintain our common dividend from 2008, through 2012, due to strong operating cash flows and liquidity, and on the belief our operating companies have the future earnings power to support the common dividend. Our planned changes to the portfolio have resulted in a company that is easier to understand,with a more predictable earnings stream.

We also demonstrated these operating companies can support the common dividend by earning $1.31 per share, from continuing operations as adjusted in 2012. Our 2013 guidance also shows the ability of these companies to sustain common dividend. 2013 continues to be a time for execution of our strategies as we move from the divestiture mode. We believe it is prudent to maintain the indicated common dividend of $1.19 per share during 2013, as we focus on execution of our operating plans and the results of the improved financial performance.

With this improvement, we be in a better position to evaluate future dividend increases as we look to a dividend payout ratio over time, in the range of 60% to 70%based on our expected mix of earnings from our electric utility and manufacturing and infrastructure businesses. I would now like you to refer to slide eight for discussion of our updated 2013 earnings guidance. Overall, we are narrowing our consolidated earnings per share from continuing operations for 2013, to be in the range of $1.30 to $1.50 per share from $1.30 to a $1.55 per share.

We are narrowing the guidance for electric segment based on increases in benefits and administrative costs. We also are modifying guidance for the manufacturing segment due to the following factors. Ordered volumes across the markets of construction, energy, and lawn and garden industries have softened for the remainder of the year, affecting BTD's customers in these industries.

Lower earnings are now expected in 2013 at T.O. Plastics, primarily to a key customer announcing plans to produce certain products in house rather than outsource the work to T.O. plastics. We are also reducing guidance for the construction segment due to disappointing results at Avenia during the first half of the year.

Construction segment net income is expected to be higher in 2013 than 2012, due to improved control processes and construction management, and select fitting with the potential for higher margins. Foley's underperforming 2012 projects were substantially completed last year, and Foley's internal bidding and estimating project review procedures have been improved, such as the corporation expected Foley to be profitable in 2013.

We are also increasing guidance for the plastic segment, based on the strength of performance in the first half of 2013. In our corporate, general and administrative costs are expected to be in line with the previous guidance. We believe our 2013 guidance positions us to achieve a 4% to 7% compounded growth rate in earnings per share, using 2012 as a base share, driven largely by the expected rate

Rate base investments at the utility, and the existing capacity and manufacturing and infrastructure platform. After the Q & A, Jim will return with a few closing remarks and, we are now ready to take your questions.

Ladies and gentlemen, (Operator Instructions). Our first question comes from Matt Tucker from Key Banc. Your line is open.

Hi, good morning. My first question is on the construction side. Can you give us a little more color on, or maybe quantify the impact of the weather, in the second quarter?With the second half -- would Avenia have been profitable if not for those delays, and could you comment a little bit on the performance so far in the third quarter.

Thank you, Matt, for the question. This is Kevin. In terms of the impact on weather in the second quarter, is the primary driver for the disappointing performance at Aevenia. The weather also impacted productivity on the jobs where they were working in terms of effencies.

But really, the weather and the slowdowns resulted from that are the primary reasons. And we're -- if it weren't for that we certainly would have seen better performance at Aevenia at the second quarter as compared to where it actually shook out. In terms of July, we are just in the process of our close procedures. Things are early and it is pretty difficult for us to comment on where the results will be for July or how things are going right now for Avenia.

Okay. Could you comment a little bit on the trends and bidding activity?Have things been picking up at all, slowing down, kind of the same? And I guess also if you can comment on pricing the, price environment on the bids you are seeing any changes there.

This is Jim McIntire. First with Avenia, just to follow on with the comment that Kevin responded to. There is plenty of work for us at Avenia. The weather has not only slowed us down, but also impacted the third party that does the engineering for the jobs.

As that engineering is done, and as the weather is better, we will have substantial work there. The margins that Avenia is able to extract from its distribution and transmission business is our solid margins. So, as I made the comment in my previous comments, we expect improvement in the third and fourth quarters. Avenia works like it did last year, when it had really strong second half performance. We have ample business opportunities. We believe we will be able to take advantage of it through the last half of the year.

With regard to Foley, I would just say this. The number of projects that we are bidding on, though numerous, but we are very disciplined in our approach. We have had some success in getting bids but there's a lot of contractors chasing still a relatively few number of projects. We are still seeing, I think, across the whole segment, a fair amount of (inaudible) the economy, as far as how much activity is going on.

Just a lot of competitors there. As Kevin has mentioned, Foley did turn profitable. I think we have had four or five months in a row now where Foley has had profitable results, so we are optimistic and feel that they made a pretty significant stride, and we do expect them to have a profitable year end for us.

Okay, thanks and just one on the manufacturing side. It sounds like you expect sales to ramp up a bit in the second half. Is that primarily based on what you had in backlog at the end of the second quarter? Or can you just give us a little more color on the outlook there.

This is Jim McIntire again. It is based on the backlog that we see when we compare the backlog to the same backlog from the end of the second quarter last year. We do see somewhat stronger backlog.

And also as I commented earlier, we are doing quite a bit of tooling in order to prepare for other customer requirements for both the balance of this year and positioning us for customer sales in 2014. So we're pleased with what we see, with regard to the opportunity for sales on both this year and the second half of this year and going into 2014.

And just a follow up to that. Is this based on discussions you are having with customers? What is giving you the confidence to prepare for higher volumes going forward.

Well, the discussions the backlog is there, and there are often lead times the tooling and the dying is the preparatory steps in order to manufacture the components that our customers request of us. So we have to get that done first. And then we end up with the business and then go from there. So the tooling is kind of an early indicator of the backlog of business that we see.

Very helpful, thank you, guys.

Thank you, our next question comes from Michael Bates of D.A. Davidson. Your line is open.

Hey, good morning.

Good morning.

The $1.3 million increase in GNA expense at the electric utility, is that tied to just -- a reallocation of corporate expenses. Do you feel like that $1.3 million is a good quarterly run rate as we look forward?

It would be reflective of the new allocation method, or the trueup allocation method based on the changes of mix in the companies between the electric and the nonelectric side. So as we sit here today in 2013, and this isn't indicative rate as we do forward.

All right. Thank you, and Otter Tail Power has a lot of opportunities to build out transmission. That will be a significant driver over the next five years. I was wondering if you could give us a little bit as far as how you are thinking about opportunities beyond what has been announced so far, both within the next five years and even looking a little bit further?

How much room for expansion is there? Compared to the current backlog of projects.

This is Jim McIntyre again. It is hard to see beyond what we have currently identified. A lot of projects the projects - CAPEX, 2020 and the MVP projects are linked to really building the whole huge infrastructure transmission grid, and that's really important. But it is also linked to where does wind go? Is there a lot of wind development here or elsewhere? And where does solar go in terms of getting it from wherever the generation may be to the actual load centers.

I think what we have for us it is $400 million between the CAPEX 2020, and the MVP projects. And we are very comfortable that we should able to deliver to those projects on time, and they do have good returns related to them. We do have a lot of knowledge about the transmission system, and how it works, interacts together in this regional area.

We don't have any projects that we are currently in negotiation for projects beyond those which we have identified and talked about in our various Q's and other documents today.

As it relates to -- this isn't transmission, but out farther beyond the spectrum, we do have the Boot Lake switch over of the having to switch that over from coal to natural gas. That's been agreed on with the Minnesota commission.

Is that's a timeframe in the 2020, 2021 period. So we know there's a project out there as we have to switch that over. That's a generation not a transmission type project.

So would it be in the next large capital project at the utility once get these transmission projects out of the way?

That's correct. Given the timetable of 2020, and the fact that it would be a natural gas.

It would be fairly significant capital expenditure. The natural gas is not as difficult to build out as is the coal takes less time, and it is proven technology. So it won't be a complex project, but it will be a nice add on, and it will further allow us to reduce our emissions and even be a better steward of the environment.

Great. One other question, if I could. With the revised guidance range, after this strong quarter in the plastics segment, and really just a strong first half of the year. Guidance implies a pretty significant downtick in that segment's earnings in the second half compared to what you have had so far.

Second half in 2012 did show slightly lower earnings in that segment, but not to the degree that is being implied in guidance. Can you give us a little bit of color as to what you are seeing there and what's driving that potential decline?

Yes, Michael, this is Kevin. As we sit here today with the forecast, the thing we have to take into account that we don't necessarily have great visibility on is what will the weather be like in the fourth quarter of 2013. Particularly here in the north central region part of the country.

And so last year we had a pretty mild -- or fall, and early winter, and saw the benefits of continued shipping of product between both companies. And when we are looking at a forecast right now for last half, we have good visibility on where we think third quarter will be. Fourth quarter we have visibility, but we know that in the past it can be swung by weather.

And so we are trying to take that into account right now, and as we get closer, we will have better visibility at the end of the year on that. By the end of the third quarter question will certainly have some better visibility.

Thank you very much.

Thank you, (Operator Instructions). And we have a follow up from Matt Tucker from Key Banc, your line is open.

Hey, gentlemen. I just have a follow up on the last question. On plastics.

I appreciate that you want to bake in some cushion in the second half for something unpredictable, like weather. But outside of unpredictable, uncontrollable factors like that, is there anything that you're seeing that would suggest that demand should slow on a fundamentals basis the second half?

This is Jim McIntyre. I think we are fairly optimistic about the second half.

One of the things that can change rather rapidly is the price of resins. And if that happens then we could see some diminished sales in profitability. But as we indicators right now, we're pretty comfortable that we should have a good second half within our plastic business.

Thank you, that's all I have.

Thank you, (Operator Instructions). I show no further questions at this time, and would like to turn the conference back to Mr. Jim McIntire for closing remarks.

Thank you, as we assess where we are mid-year, the successful realignment of our Company has really better positioned us to deliver increased earnings for both 2013 and the future. Our current success can be linked directly to the proper execution of the right strategies.

Sharper focus and execution among all of our businesses has enabled us to increase profitability, and deliver financial results in a more consistent matter. Thank you for joining our call, and for your interest in Otter Tail Corporation. We look forward to speaking with you next quarter.

And ladies and gentlemen, thank you for your participation in today's conference. This does conclude the program and you may now disconnect at this time.