Otter Tail Corp (OTTR) 2014 Q1 法說會逐字稿

Good morning and welcome to Otter Tail Corporation's first-quarter 2014 earnings conference call. Today's call is being recorded and there will be a question-and-answer session after the repaired remarks. I would now like to turn the call over to Mr. Loren Hanson. Mr. Hansen, you may begin.

Good morning, everyone, and welcome to our call. My name is Loren Hanson and I manage the investor relations area of Otter Tail. Last night we announced our first quarter 2014 results. 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 CEO; Chuck MacFarlane, Otter Tail Corporation's President and Chief Operating Officer; Kevin Moug, Otter Tail Corporation's Senior Vice President Finance 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 provision 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.

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

Good morning, and thanks for joining our call today. As we said in our news release yesterday, with consolidated net income from continuing operations up over 40% compared to the first quarter last year, we are more than pleased with our 2014 first-quarter results. Our strategy to grow the utilities rate base and to improve the operational and financial performance of the manufacturing infrastructure of companies under Varistar is paying off. I'll leave it to our new President and Chief Operating Officer, Chuck MacFarlane, and to our CFO, Kevin Moug, to provide some detail on that.

What I want to emphasize is that we've done a much better job the last few years of developing and executing our strategy. And we've done a better job of creating alignment among the Board of Directors, the executive management team and our respective operating companies. As a result, we see a commitment among employees and all companies to continuously drive performance and to move toward our goals even as they encounter challenges.

We see it in the utility's safety and customer satisfaction records, the pipe company's growing market share, the manufacturing company's partnerships with our customers, and the construction company's return to profitability. At our recent Annual Meeting of Shareholders I talked about how critical our employees are in executing our strategies. Improved alignment is helping our employees see themselves as critical to their Company's successes. It's helping them see their can Company's successes as critical to the Corporation's success and vice versa. That level of employee understanding and engagement makes strategy more fruitful.

Thanks to employee efforts on all fronts, I can summarize the Corporation's strategic outlook like this: we have a high-performing electric utility with improved rate base growth for at least five years, supportive regulatory treatment, solid management in place, and a history of excellence. We also have a more focused set of manufacturing and infrastructure companies under Varistar, providing an emphasis on precision and continuous improvement, incremental earnings flow and a premium return.

We are delivering on our strategy. 2013 results bore that out. First-quarter 2014 results are further proof. We are seeing the uplift in earnings from rate base growth at the utility that we have been talking about with you for two years or more. And we are enhancing the discipline in the manufacturing and infrastructure companies under Varistar, which will be especially valuable as we wrap up large projects at the utility and rate base growth levels off several years from now.

With that, I will invite Chuck to provide some detail on Company operations, and I will be available at the end of the call if you have questions. You met Chuck on this call in February. He's the former President and CEO of Otter Tail Power Company. After an annual shareholder meeting and Board meeting in April, he assumed the role of President and Chief Operating Officer of the Corporation. We expect he will replace me when I retire as CEO next April, and I have every confidence in him. Chuck?

Thanks, Jim. It's a privilege to step into this corporate role. We have a high performing team and we've made good headway on the strategy, as Jim discussed. For example, the 40% increase in earnings at the utility this quarter compared to last year is primarily a result of the cost recovery mechanism that took effect in January of this year. They allow us to earn a return during the construction of our environmental upgrade at the Big Stone Plant, a project that will meet environmental standards and help us to continue to serve our customers with low-cost energy.

We are also earning a return during development and construction of the MISO Multi-Value Projects and CapX2020 transmission projects. These projects are providing necessary regional infrastructure to support electrical system reliability and enable additional renewable energy development. There are also opportunities to grow the utility's rate base, as we have been discussing with you on previous calls. The majority of these projects will be completed between 2016 and 2019, and although the utility has several other rate base projects coming up, which I will discuss in a moment, the Corporation will look to the manufacturing and infrastructure companies under Varistar to provide incremental growth. That's why we continue to hold and plan to develop these companies.

That's also why, in my new role at the Corporation and in addition to keeping an eye on the large utility projects, one of my first priorities is to expand my understanding of each of our operating companies. They remain important to our overall strategy. My other priorities during the first six months are to work on the leadership transition with Jim, build relationships with investors and analysts, and onboard the new utility President. As you are probably aware, Tim Rogelstad replace me as President of Otter Tail Power and Senior Vice President of the Electric Platform for Otter Tail Corporation.

Tim is an electrical engineer and has been with our Company for more than 25 years. He most recently served as our Vice President of Asset Management, overseeing our system operations, transmission assets, delivery engineering and the utility's capital prioritization process. Over the years, Tim has been a key leader in many of the utility's accomplishments and projects, including the large, multicompany transmission projects and our early entry into wind energy. Tim is an excellent thinker and negotiator, and I have every confidence he will maintain and even increase the positive momentum within the utility. I anticipate a virtually seamless transition.

Before I turn it over to Kevin for a financial review, I want to briefly discuss a few items. First, I want to point out that a colder than normal winter boosted electric sales, but the majority of the increased earnings in the first quarter related to rider recovery, and that's important because the utility will see $657 million in capital expenditure during the next five years, much of it related to environmental upgrades and transmission projects I mentioned earlier. As you can see on slide 4, this significant investment results in a projected 80% increase in rate base and a 10% compound annual growth rate between 2012 and 2018. The majority of these investments are under established riders.

You can see from our cost recovery mechanisms on slide 5 historic renewable projects, excluding South Dakota, transmission projects, i.e., the CapX and MVP projects; environmental, i.e., the Big Stone Plant AQCS; and the fuel clause adjustments are covered by riders. We believe we can serve our customers and provide a fair return to our shareholders without a rate case for the next 1 to 2 years.

Slide 6 lists generation projects, including two that are outside the five-year capital budget forecast. You first see the Big Stone AQCS project, which is over 40% complete. The $204 million estimate is 20% lower than the original budget used in the advanced determination of prudence filings approved by Minnesota and North Dakota commissions. We are also studying how to provide a least-cost, long-term resource to replace Hoot Lake Plant's generation because we plan to retire Hoot Lake as a coal facility in 2020. Hoot Lake is our only coal facility impacted by the recent US Supreme Court ruling on CSAPR. And we anticipate limited impact due to Hoot Lake's planned retirement.

There are several major natural gas supply lines within our three-state system, and many locations provide good sites for new natural gas generation. We are working to find the best alternative for our customers. The existing Hoot Lake site remains a candidate, although it would need significant gas line construction into the site. Whichever alternative we choose, we estimate an approximate $200 million expenditure in the 2020 to 2022 timeframe.

On this slide you will also see a potential expenditure for a wind farm. About a year ago, Otter Tail Power entered into a 25-year contract to purchase wind energy from the existing Ashtabula III wind farm northeast of Valley City, North Dakota. It's a 62.5-megawatt farm owned by a subsidiary of NextEra Energy, and the contract includes an option for us to purchase the wind farm after 10 years. If we choose to do so, it would add about $50 million to our rate base in 2023. Neither of these last two capital expenditures is included in the previously reported $657 million, five-year capital budget.

Slide 7 lists transmission projects we are involved with. Otter Tail Power was the lead developer in the Bemidji to Grand Rapids 230 kV line which was energized in 2012. We cross part of the Chippewa National Forest, which is a bald eagle nesting habitat. Our employees did a good job of managing this environmentally and culturally sensitive project. I am pleased to report that it is one of the finalist for EEI's annual Edison Award. Next is the Fargo to St. Cloud 345-kV project, which should be in service early next year. Xcel is leading this project. The Brookings County to Hampton project is also rejected to be in service next year, and Great River Energy has been the lead on that.

We are a 50-50 owner with Xcel in the Big Stone South of Brookings, which is both a CapX2020 and MISO MVP project. Xcel is leading that effort, and we have received a route permit from the South Dakota PUC, and construction activity should start in the third quarter of this year. We are also a 50-50 owner with MDU in the Big Stone South to Ellendale project. We hope to receive a route permit during 2014.

As for the manufacturing and infrastructure companies under Varistar, earnings for all six companies were generally in line with expectations this quarter. We continue to focus on improving operations and reducing costs in this narrow portfolio of companies. During the next several years, we will concentrate on organic growth and potential acquisitions, particularly in the manufacturing segment. Our goal is to maintain the approximate 15% to 25% total earnings contribution from Varistar even as Otter Tail Power's rate-based-related investments occur.

Kevin has detail on the financial performance, so I'll turn it over to Kevin at this time.

Well, good morning. Please refer to slide 8 as I discuss our first-quarter results. Our electric segment had a strong first quarter, with revenues up nearly 18% and net income up 40% compared to the first quarter a year ago. These results are consistent with our earnings expectations from this segment. The increase in earnings were primarily a result of our rate-based investment strategy as we are seeing the impact on our financial results from environmental and transmission cost recovery riders, as the utility continues to build out infrastructure projects, as Chuck previously discussed.

The impact from the colder than normal weather in the first quarter was $0.03 a share. Our manufacturing segment earnings were down slightly from first quarter 2013, primarily due to increased material cost, support wages and product handling costs to support anticipated sales growth in 2014 at BTD, and lower revenues at T.O. Plastics due to an expected reduction in revenues due to a product a customer began producing on its own in 2014.

Our plastics segment earnings decreased $400,000 between the quarters, mainly attributable to lower margins from increased costs of PVC resin and slightly higher operating costs. Our construction segment continues to improve their profitability despite slightly lower revenues compared to the first quarter of 2013. Foley's improved earnings are directly attributable to a more selective bidding process, as well as improved cost controls which have enhanced their margins.

Aevenia's improved earnings between the quarters is due to the sale of its data communication business in January 2014, resulting in a $200,000 after-tax gain. Our corporate expenses decreased $1.8 million, mainly as a result of lower interest expense related to the early redemption of the $48 million, 9% notes, lower employee benefit costs, and a $0.5 million after-tax gain from the sale of an investment in low income housing property.

On May 2, 2014, the Corporation's Board of Directors declared a quarterly dividend of $0.3025 per share. The dividend is payable to shareholders of record on May 15, 2014. This represents the 302nd consecutive quarter we have paid common dividends to our shareholders.

Slide 10 shows we are increasing our earnings guidance in 2014 to be in the range of $1.60 to $1.80 of earnings per share from $1.55 to $1.75 of earnings per share. We are increasing the previous 2014 guidance for the electric segment based on strong first-quarter results from the colder than normal weather, as well as current expectations for the remainder of the year.

As we discussed in our February 2014 earnings call, items contributing to the electric segment net earnings increase over 2013 results include rider recovery increases, including environmental riders in Minnesota and North Dakota related to Big Stone AQCS US environmental upgrades; lower pension benefit costs of approximately $2 million as a result of an increase in the discount rate from 4.5% to 5.3%. These items are offset by an increase in interest costs as a result of the $150 million of fixed-rate long-term debt that was put in place in the first quarter of this year to finance the electric segment's transmission projects and Big Stone AQCS, and an increase in operating and maintenance costs primarily for increased labor and the planned outage at the Hoot Lake Plant.

We are maintaining our original 2014 guidance for our manufacturing segment, and our backlog for this segment is $115 million as of March 31, 2014, compared with $97 million as of March 31, 2013. We are increasing the previous 2014 guidance for the plastics segment due to a stronger-than-expected first quarter and we are maintaining the original 2014 guidance for the construction segment. We continue to see improvement from better cost controls and more selective bidding on projects with the potential for higher profit margins.

Our backlog in place for the construction business is $85 million as of March 31, 2014, compared with $100 million as of March 31, 2013. Our corporate costs are now expected to be lower than the original 2014 guidance. This is mainly due to the sale of the low income housing rental property, which was not expected when original guidance was given, along with lower expected employee benefit costs.

We are pleased with our first-quarter results. Strong results in the electric utility, plastics and corporate cost areas are supportive of our increase in 2014 earnings guidance to be in a range of $1.60 to $1.80 per share. We continue to execute on our strategies, the results of which are reflected in our first quarter and revised 2014 earnings guidance.

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

(Operator Instructions) Matt Tucker with KeyBanc Capital Markets.

First question, on the sale of Aevenia's data communications business, could you just provide a little color on the rationale for the sale and, if possible, if you can give us any sense of what that business has been contributing in terms of revenue and/or earnings?

Sure. The rationale behind the sale, Matt, was that it really wasn't a strategic fit within the venue business for us to continue to commit resources as a result of the business that it was in. It just -- in terms of the fit, it wasn't there. In terms of the revenues or maybe just from an earnings standpoint, it wasn't a significant contributor. So I think as you look forward the business is reflective of the existing business with Aevenia in, and it wasn't a real significant contributor from an earnings standpoint. And so it allows us to move away from that business and focus on the core business that Aevenia is in.

Got it, thanks. And then just on the low income housing sale, how much, if any, legacy real estate assets like that do you still have on the books? And if there are any, does this sale encourage you in terms of the prospects for unloading the rest of that in the near-term?

Yes. We still have I think it's somewhere about 5 to 7 investments in low income housing on the books. We've written those investments down to zero by now, so to the extent that there are potential to sell those in the future, there's opportunities for some gains there. Clearly, this one was -- the sale of this was a little more healthy from the sales price than what we've seen in the past. And as we look forward, like I said, there's at least 5 to 7 that are left. And we really don't expect there's going to be significant amounts of earnings that get generated from these. They will certainly help, but this was a little over $0.01 a share.

Got it, thanks. And just one last one, if I may. On the Hoot Lake replacement, clearly that's a ways out in terms of timing, but can you give us a sense of when we could expect more detail on your choice for the type of replacement or just the timeline for how that process will unfold?

Yes, Matt, this is Chuck. In Minnesota we filed an integrated resource plan. Our last plan that went in, in 2013, essentially specified a certain number of megawatts but did not define the location or combustion cycle versus CT, those types of things. That's under review now before the Minnesota DOC. Upon completion of that, we anticipate that they will approve the amount but will not be specified a location or anything. Our following IRP, which is due in another year and a half, would have the details where we would provide a location and if we are going to partner and those types of things.

Got it. Thanks, guys. I will jump back in the queue.

(Operator Instructions). Matt Tucker with KeyBanc Capital Markets.

Just a few more here. At the utility, it looked like O&M was up quite a bit year-over-year. How much of that was attributable to the extreme weather? And should we expect similar increases throughout the rest of the year? Or again, is just the sum of that just attributable to the weather?

This is Chuck. Very, very little of the O&M would be attributable to the weather. The major differentiator is we have not had a plant outage. We have a very significant plant overhaul going on at Hoot Lake, probably about the last one that it will have. And that is driving the major O&M increase year over year.

Got it, thanks. Then the plastics segment, you guys mentioned pricing per pound was down a bit in the quarter and cost per pound was up a bit. Can you comment on how those metrics have trended now here into the second quarter? Or where you see them going for the rest of the year, I guess?

Yes, Matt, this is Kevin. In the first quarter, our resin suppliers had announced about $0.09 of price increases that they were looking to get from raw materials. A majority of that held, and there weren't a lot of -- we weren't able to pass those full resin price increases through to the customers. And as we look, we currently would still expect a similar type view through the rest of -- we have uplifted the guidance here for the rest of the year, but we still continue to see a market where the resin manufacturers are looking to get some higher prices from the resin and it's becoming a little more difficult right now to get all of those prices passed on to the end customer.

Got it. So would it be fair to say that your outlook for quarters two through four hasn't really changed, and the guidance revision mostly reflects the first quarter coming in above your expectations?

That's correct.

Thank you. And then manufacturing, specifically T.O. Plastics, do you see opportunities for them to replace the business they lost with the customer that decided to in-source? Or do you foresee that being a continued headwind for the remainder of the year?

They are looking to replace that revenue. We mentioned, I believe, in the third or fourth quarter earnings call, that T.O. was now looking to -- had entered into the food packaging markets. And so they continue to make inroads into that food packaging market, but we do not expect to see that fully offset in 2014 as they continue to build in those food packaging markets. But we fully expect it's going to take them a year or so to ramp up and develop relationships with new customers there.

Thank you. And sorry for jumping around here, but on the transmission projects, the Big Stone projects, I believe you mentioned you are still waiting for a permit on the second one, the Ellendale project. Any other hurdles that you can see to starting construction on either of those projects? Or is it essentially just that one permit you need for the second project to move forward?

Matt, this is Chuck. We need a North Dakota and a -- so there is a small part of the second line in North Dakota we anticipate, because we have essentially settled with all the land owners in North Dakota, a fairly smooth permitting process there. But the major hurdle on the second line is the South Dakota permitting process. And we continue to work with land owners on that and we will have hearings and whatnot before the South Dakota Commission, I believe, in June. And we would expect an order on the permit before the end of 2014.

Okay, great. Thanks, Chuck, and thanks, Kevin. That's all I had.

(Operator Instructions). I'm not showing any further questions. Please proceed with any closing remarks.

Thank you. Our first-quarter performance and our outlook for 2014 reflects the increased transparency of the utility capital projects' pipeline and related cost recovery through various approved riders. Additionally, the improved operational and financial performance of our manufacturing and infrastructure companies under Varistar contributed to our overall strategy.

We believe our strong first-quarter results are evidence that we are delivering on our strategy and it has better positioned us to deliver increased earnings for 2014 and beyond. Thank you for joining our call and for your interest in Otter Tail Corporation. We look forward to speaking with you next quarter.

Thank you. Ladies and gentlemen, this does conclude the call and you may all disconnect. Everyone have a great day.