Otter Tail Corp (OTTR) 2013 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Otter Tail Corporation third 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'd now like to introduce your host for today's conference, Mr. Loren Hanson, please go ahead, sir.

Good morning, everyone, and welcome to our call. My name is Loren Hansen, and I manage the Investor Relations area t Otter Tail Corporation. Last night, we announced our third 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 Corporation's 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'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 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.

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're pleased to report strong overall 2013 third quarter results, reflecting our believe that we have the Company firmly back on track, producing more predictable earnings with continuing improved performance.

We're especially pleased with results from our manufacturing and infrastructure businesses under Varistar, which had marked improvement over 2012 third quarter net income. These companies have a renewed focus on improving the financial performance, showing the positive impact of changes in our governance model, and benefiting from a more disciplined, hands-on approach to their operations.

This successful execution of a refined strategy further demonstrates their efforts to reduce risk and produce a predictable earnings stream are on course in all of our continuing operations. In addition, the transformation of Otter Tail Corporation continues to be recognized by our ratings agencies. Moody's recently announced a favorable change in outlook for both Otter Tail Corporation and Otter Tail Power, joining other rating agencies who have recently either upgraded their ratings or the outlook for both the corporation and Otter Tail Power Company.

Kevin will cover our segments in more detail, but there a few areas worth noting. Third quarter sales and net income in our electric segment were somewhat lower in this year's third quarter, impacted by weather and higher general and administrative expenses. However, it's important to keep these results in perspective. The quarterly anomalies do not reflect the growing earnings power of utility as it continues to successfully execute its rate-based growth strategy and utilize various timely regulatory recovery mechanisms.

In addition, the utility's significant environmental upgrades and transmission projects continue on schedule and within budget. The Big Stone plant air quality control system, or AQCS project, is on schedule. There's more than 250 workers on site and so far the contractors employees have completed 438,000 hours with no recordable accidents or injuries. In October, the largest crane to be used in the project was shipped from Antwerp, Belgium to Duluth and trucked in nearly 60 truckloads to the site.

Our partners in Big Stone plant are Montana Dakota Utilities, and Northwestern Energy. Total cost of the AQCS project is $405 million with Otter Tail Power Company's portion being approximately $218 million. The AQCS project will result in a 80% to 90% reduction in sulfur dioxide, nitrogen oxide, and mercury emissions when completed in 2016. Particulate emissions already are within regional haze guidelines.

Regarding our large transmission projects, the multi-value project, or MVP, known as Big Stone South to Ellendale 345 kv transmission lion saw a great deal of activity last quarter and into October. This project is jointly owned by Otter Tail Power Company and Montana Dakota Utilities at a projected total cost of $340 million. Otter Tail Power Company's portion is $170 million with an expected completion date in 2019.

A facility permit application was filed with the South Dakota Public Utilities Commission on August 23, 2013. Also, public input meetings have been held at the South Dakota PUC and the route permit application. And we initiated landowner negotiations with about one-third of the required option to being signed. Additionally, on October 18, the project team filed a combined application to the North Dakota Public Service Commission for a corridor certificate and route permit.

So as can be seen, a good deal of background work is taking place, as this and other transmission projects move forward toward completion. Generally speaking, all of the projects under construction have regulatory approval and are subject to some form of current recovery by each of our jurisdiction, as shown on slide five.

Moving onto our operating companies under Varistar, Foley, our mechanical and prime contractor on industrial projects, has made substantial progress in regard to its operations. These changes have favorably affected the way Foley does business, improving its profitability as reflected in third quarter and year to date results.

Aevenia, after being hampered by adverse weather in the first quarter of 2013, our likely contractor reported positive net income in the third quarter of 2013. We're pleased with our third quarter and year to date results. Our narrow guidance for 2013 demonstrates our further progress to achieve our stated long-term earnings growth objective of 4% to 7%.

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 everyone. Please refer to slide six as I walk you through third quarter results for earnings from continuing operations. Overall, net income from continuing operations was $0.41 per share, compared with $0.13 per share for the same quarter last year. 2012 third quarter net income was impacted by the $0.22 earnings per share after tax charge related to the early redemption of the $50 million 8.89% note.

First, our electric segment. Items contributing to the $1.9 million decrease in electric retail revenues were, one, a decrease in fuel clause adjustment revenues, as a result of lower fuel costs, combined with, two, a decrease in revenue related to milder weather in the third quarter of 2013 compared to the third quarter of 2012, and three, a decrease in revenue from various environmental renewable regulatory, and conservation costs recovery related items.

This particular decline was offset by related increases in other revenues or reductions in costs that are components of these alternative revenue recovery mechanisms. These declines in revenues were offset by an increase in transmission cost recovery rider revenues, due to the continued build out of our transmission projects.

Electric operating, and maintenance expenses increased $2.2 million, mainly due to an increase in MISO transmission tariff charges related to increasing investments in CapEx 20/20 and multi-value transmission projects, an increase in general and administrative expenses, due to an increase in corporate costs allocated to the utility, due in part to changes in allocation factors resulting from our most recent divestitures, and an increase in property tax expense related to higher property values in Minnesota and South Dakota.

Our manufacturing segment revenues and net income increased compared to the same quarter last year. Revenues increased at BTD as a result of higher sales volume, mainly due to increased demand from customers and end markets serving the recreational equipment and agricultural industries. BTD's net income also increased $800,000 as a result of the increase in sales revenue and the recording of $500,000 in research and development tax credits recorded in conjunction with the filing of the corporation's 2012 federal tax return. The research and development tax credit expired at the end of 2011 and had not been extended as of December 31, 2012. The American Taxpayer Relief Act of 2012, signed into law in January of 2013, extended the credits retroactively through the end of 2013.

Revenues and net income in TO Plastics also increased slightly as a result of increased product sales and tooling revenues. The plastics segment continues to perform well with increased revenues and net income. Sales volume increased as construction in housing markets continued to improve in the South Central and Southwest part of the United States. Construction activity also increased in the North Central United States as more favorable weather allowed contractors to catch up from the slow start in 2013 due to a colder and wetter spring.

Our margins in the third quarter of 2013 were lower than the third quarter of 2012 due to an increase in the cost of PVC resin. The higher resin prices were driven by increased global demand and an increase in the cost of ethylene, a key ingredient in the production of PVC resin.

Our construction segment showed significant improvement over third quarter 2012. Foley continues to show improved profitability as a result of strong performance on current year products and not having the drag on earnings resulting from cost overruns and losses incurred on certain major projects and progress during the third quarter of 2012. Aevenia's revenue and net income was down between the quarters. The reduced revenue at Aevenia is due to a planned reduction in the volume of telecommunication jobs pursued this year and a delay in securing and initiating new substation construction projects. Aevenia's third quarter 2012 results also included revenues and net income from the sale of Moorhead Electric, one of Aevenia's subsidiaries. And our corporate expenses decreased $7.2 million, mainly related to the early redemption of the $15 million 8.89% note in the third quarter of 2012.

As it relates to our liquidity and financing, our consolidated cash flow from continuing operations for the nine months ended September 30, 2013 was $95.8 million compared with $100.7 million for the nine months ended September 30, 2012. Slide eight details our available liquidity under the $320 million of aggregate credit facilities. There is $278 million of available borrowings at September 30, 2013. Otter Tail Power Company did utilize the line of credit during the third quarter to fund capital expenditures for Big Stone's AQCS project and for two major CapEx 20/20 transmission lines being constructed in Minnesota and Eastern Dakotas. We also closed on the delayed draw of private placement of $150 million in long-term debt with two tranches on August 14, 2013. The $60 million tranche will bear interest at 4.68% for 15 years and the $90 million tranche will bear interest at 5.47% for 30 years.

Proceeds from the issuance, which are scheduled to be funded in February 2014, will be used to retire the $40.9 million term loan due January 15, 2015, as well as pay down Otter Tail Power Company's line of credit and planned expenditures to the utility construction program. We also recently amended both of our credit facilities to extend the expiration dates by one year from October 29, 2017 to October 29, 2018. There were no changes in interest rates or other terms of the borrowing agreements.

Slide nine shows our current senior unsecured credit ratings. Moody's upgraded the ratings outlook for both Otter Tail Corporation and Otter Tail Power Company during the third quarter. Otter Tail Corporation's outlook was upgraded from stable to positive and Otter Tail Power Company's outlook was upgraded from negative to stable. The change in outlook for Otter Tail Corporation is a result of, one, our ongoing strategy to realign the Company, focusing on the core electric utility business and the divestiture of a significant portion of our non-regulated businesses, resulting in less business risk, our renewed focus on enhancing the financial performance of our remaining non-regulated businesses and lastly, the strong and stable performance of Otter Tail Power Company.

The improved outlook for Otter Tail Power Company includes support of regulatory environments under which the utility operates, recovery mechanisms that provide timely recovery of prudent costs and investments, and slight reduction in the capital expenditure program related to the AQCS project.

As it relates to the common dividend, on November 4, 2013, the Corporation's Board of Directors declared a quarterly common stock dividend of $0.2975 per share. This dividend is payable December 10, 2013 to shareholders of record on November 15, 2013.

I talked about this last quarter, but believe it is worth of discussion again. We maintained our $1.19 per share common dividend through 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 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 the common dividend.

2013 continues to be a time for execution of our strategies as we move from the divestiture mode. Our strong third quarter results are indicative of the strategies we are working on. This is further evidence by our trailing 12-month earnings per share from continuing operations of $1.48 ended September 30, 2013, as shown on slide 10. With this improvement, we will 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%, supported by our expected mix of earnings from our electric utility, and manufacturing, and infrastructure businesses.

I would like you to refer to slide 11 for a discussion of our updated 2013 earnings guidance. First, we are narrowing our consolidated earnings per share from continuing operations for 2013 to be in the range of $1.38 to $1.50 per share from $1.30 to $1.50 per share. We are narrowing the previous 2013 guidance range for our electric utility segment based on current third quarter results as well as present expectations for the fourth quarter earnings.

We're narrowing and increasing the guidance range for the manufacturing segment due to the following factors. Increasing productivity improvements, better than expected third quarter results, and the expectation of recording additional research and development credits for the 2013 tax year during the fourth quarter at BTD, and stronger than expected third quarter results at TO Plastics. We are narrowing the earnings guidance for the construction segment. Segment net income is expected to be higher in 2013 than 2013 due to improved cost control processes in construction management and selective bidding on projects 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 that the corporation expects Foley to be profitable in 2013. The change in guidance also reflects improved business conditions at Aevenia.

We are also increasing and narrowing the guidance for the plastics segment, based on the strength of its year to date performance in 2013, and our corporate, general, and administrative costs are expected to modestly increase in the fourth quarter as reflected in the updated 2013 guidance.

We believe our 2013 guidance further positions us to achieve a 4% to 7% compounded growth rate in earnings per share, using 2012 as a base year, driven largely by the expected rate base investment at the utility and the existing manufacturing capacity within our manufacturing and infrastructure companies.

After the Q&A, Jim will return with a few closing remarks and we are now ready to take questions.

(Operator Instructions) And our first question comes from Matt Tucker from KeyBanc Capital Markets.

Congrats on a nice quarter.

Thanks, Matt.

The first question is on the construction side. Your margins there recovered very nicely and look to be probably the strongest you've seen in several years. Was hoping you could comment on kind of where those margins fall in terms of your expected range going forward.

Yes, Matt, it's Kevin. I would tell you that the margins that we're seeing now in construction are more indicative of what we would expect to see in this business. Foley has really shown, as I discussed, some real improvements in their projects. They have six projects that have significant impact in 2013. A non-deductible those projects are performing in line with where we had originally expected them to be. And then with Aevenia, a couple things what's happened here is there a comment that I refer to in terms of less telecommunications work. And that was a plan because we were seeing our telecommunications work and jobs not being as profitable. And so we did specifically kind of look to reduce that as a part of where we wanted to move the business.

And then we are just seeing better performance in our construction projects at Aevenia than we did same time a year ago, and so -- or same time last year. And so we would -- and that's evidenced. I mean we had a $6 million drop in revenues quarter-over-quarter but our net profits were down only $200,000. So we're seeing much better execution on those jobs and would say that the margins in this quarter are more indicative of what we would expect going forward.

Thanks. And so would the margins in your backlog and/or on the work that you're currently bidding be pretty similar then to the margins we saw in the third quarter?

Yes.

Thanks. And then just a bigger picture question. You all obviously made several divestitures in non-core businesses over the past two or three years. Haven't done anything in a few quarters though. Was hoping you could just update us on how you are looking at the current business model and why or if you think that the whole is worth more than the sum of the parts currently.

Matt, this is Jim. Thanks for the question and again, thanks for (inaudible). We made substantial divestitures, as you commented, and generally right now, we're working to improve all of our businesses. And as I mentioned in my prepared remarks, we're very comfortable with the progress that is being made. We'll continue to assess all of our companies against our portfolio criteria as we do from time to time. A non-deductible so that's an ongoing process.

But I do think we've got all the companies performing well. It's nice to have that and as I look at where we're at and how they're performing, I am pleased with the changes that have been made and where our current performance is. And I guess, again, just to finish it up off where I started, we'll continue to assess the companies against our portfolio criteria.

Thank you. And just one other small item. The expected R&D tax credits in the fourth quarter, should we assume a similar level as we saw in the third quarter or something different?

No, Matt. Kevin here, and we would expect that it's going to be, based on current estimates, around another $500,000.

Thanks, guys. I'll jump back in the queue.

(Operator Instructions) And we have a follow-up from Matt Tucker.

Just keep going here. Back to the construction side. Was hoping you could comment a little bit about what end markets or geographies you're seeing the best opportunities in or most bidding activity?

Well, I think looking first to Aevenia, I mean clearly our most opportunistic or geographical area right now is in support of the infrastructure build out regarding the oil and gas production in Western North Dakota. There's a substantial amount of work going on there and that's close to us, which is always helpful. In addition, doing transmission work for other regional utilities and co-ops because there's quite a bit of lower voltage transmission. We don't do the very high 245 or 345 kv transmission work, but the 230 and lower, we do that kind of work and there's a lot of that work that's available. So that's a key source there and we are targeting those types of business opportunities where we can create higher margins and that's been working out pretty well as we kind of changed a little bit midcourse in 2013.

Over on the Foley side, there are some projects that are kind of in our sweet spot having to do with some of the environmental upgrades or changes in power plant work where we've got some work going on there. Those are places where we can -- we also have had productive experience in the past. Also, there's some wastewater and other projects that we have done. And Foley, we like to keep closer to Kansas City, if we can, where those markets are well known. But we also have a fair amount of business in basically the Tennessee markets for [Sight] as well.

Kevin, you want to add to that?

I think that pretty well covers it. I mean I would say that Foley also is, as it relates to Jim's comment, is looking as we head forward to do more commercial and industrial kinds of projects. We've had some challenges in the wastewater treatment area. And so we as look forward, we would probably see them be -- more of their mix coming in that commercial and industrial area.

Thanks, guys. That's very helpful. Shifting to plastics, had a strong year last year and initially expected this year to be down quite a bit, but it keeps surprising with upside. You keep raising your guidance. Could you talk a little bit about what's been so surprising about the strength this year, what the key driver has been, and do you see any signs, at this point, of slowing down?

Matt, the key drivers I think were really discussed in the press release and our text. I mean we continue to see strong markets in the Southwest and South Central part of the United States. Clearly, we're still seeing the benefit of what's going on up here in the North Central part of the country as well and those markets are continuing to be pretty robust in driving the volumes that we're seeing and the year we're having.

We did see an uptick in resin pricing here quarter-over-quarter of about $0.04 a pound. And so there's -- that is clearly going to have some impact here on the rest of the year. We're forecasting the rest of the year to be more kind of normal type levels. Last year, fourth quarter the plastics was clearly benefitted by some favorable weather. If we have that happen, that's a plus but we're really planning towards more normal kinds of weather conditions here in the second quarter. I mean if you looked at where we're at through September and say, well, where's your guidance for the rest of the year, we're basically telling you we've got about a $0.04 quarter that we're expecting in the fourth quarter here at '13. Last year was a $0.09 quarter. Clearly, a very healthy quarter. I think probably the strong quarter we've ever had. If you look back beyond that, our quarters were kind of a $0.02 to $0.03 type quarter from 2009 to 2011.

So we're expecting I'd say something more normal here in the fourth quarter and as we look to 2014, additions are -- we continue to keep an eye on the export markets in terms of what's happening with resin, how that's impacting our markets here and our pricing. We know there's some announced expansion of PVC resin plants coming online in the last half of 2014, and so we're going to have to look to see how that effects our year as well.

Have resin prices continued to move up here month into the fourth quarter? Or just kind of hanging onto the gains they saw in the third quarter?

They're pretty much hanging on right now, Matt.

Let me just add a little bit to what Kevin has said, and then, Matt, as both of these companies have relatively low existing fixed costs, they've got low operating costs. So we've been able to compete and we're comfortable that they will be able to compete and do well, so long as there is a market. We have, as we explained in the past, we've seen some increased marketability with regard to the housing support in the Southwest region. And in both cases, both companies have been able to kind of increase their market share because they're low price in terms of their operating costs and fixed costs. So we've been picking up some market share as well, which is always good.

So we remain optimistic, but again, there to a certain extent, a result of the overarching market demand for plastic pipe and as well as the resin price. So two good great companies.

That's great. Thanks. And finally, are you able to quantify the earnings impact and impact on retail sales volumes of the milder weather in the third quarter?

We did not quantify it, Matt. I mean we talked about it in terms of quarter-over-quarter what the impact was of the milder weather.

Got it. Was there -- I mean I'm sorry if I missed it. Did you kind of quantify that or just give kind of the directional impact?

Well, I just, I'm pulling up the press release here. We came out and we basically said that it had a 29% decrease in heating degree days and a 15% decrease in cooling degree days between the quarter. And so that was about $1 million in revenues relating to that.

Got it. Do you have an estimate of what the temperature normalized retail sales growth would have been?

I don't have that with me, Matt.

Okay. Fair enough. Thanks, guys. That's all I had.

(Operator Instructions) And I see no further questions.

Well, thank you for your questions and thank you for your interest in our Company. We believe our efforts to reduce risk and deliver financial results in a more consistent manner are working, as exemplified by our strong third quarter and year to date results, as well as approved credit ratings and outlooks recently assigned by rating agencies. Also, our renewed focus on enhancing the financial performance of our manufacturing infrastructure companies is bearing fruit with marked improvement over their 2012 results.

The improved performance of these companies support our goal of our diversification strategy, which is to offset future periods of lower growth from the utility. Executing our strategy to have a strong, well-managed utility that has low rates, a strong reliability, non-deductible outstanding customer service coupled with selected diversified companies with a more hands-on operational governance model is the right path for our Company.

I'm pleased with our execution of this strategy to date, as we continue to prepare the Company for an even better future. Thank you for joining our call today and for your interest in Otter Tail Corporation. We look forward to speaking with you next quarter.

Ladies and gentlemen, this does conclude today's call. Thank you for your attendance. You may all disconnect. Have a great day.