Otter Tail Corp (OTTR) 2014 Q2 法說會逐字稿

Good morning and welcome to the Otter Tail Corporation's second-quarter 2014 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 turn the conference over to your post, 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 at Otter Tail.

Last night we announced our second-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 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 includes 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 to call over to Otter Tail Corporation's CEO, Mr. Jim McIntyre. Jim?

Good morning and thanks for joining our call today.

As I pointed out in our news release yesterday, our strong 2014 first-quarter performance has continued in the second quarter. Consolidated net income from continuing operations is up more than 30% this quarter compared with second quarter last year, and you will recall that it was up 40% in the first quarter compared with the first quarter last year.

Consistent execution of our strategy to grow the utilities rate base and to improve the operational and financial performance of the manufacturing in and infrastructure companies under Varistar is paying off. We intend to build on that strategy.

Since we talked with you in May, we have completed our annual strategic planning work. It's another step on the strategic journey that brought us from $0.95 per share from continuing operations in 2011 as slide 4 shows to a non-GAAP basis of $1.31 in 2012 and $1.54 in 2013 and reflects the recent current analyst consensus of $1.75 for 2014.

For the past several years, our strategy is focused on rebuilding and better aligning our businesses, achieving operational excellence and developing our talent. That has been an incremental process as this slide shows and has resulted in a markedly different, revitalized Corporation. It better reflects our targeted overall moderate risk profile and our shareholder base. We have dramatically improved earnings per share, we have made operational excellence a central focus in all of our operating companies, and we have made good progress in developing our talent.

Rather than fixing problems from the past week, we have turned to optimizing opportunities in the future. We intend to achieve a 4% to 7% average annual growth rate earnings based on 2013 non-GAAP results of $1.54 per share. We have two platforms: Otter Tail Power Company and the manufacturing and infrastructure companies under Varistar. Both are healthy. Both are growing. Both are important.

We will only be successful, however, if our corporate strategic objectives drive strategic objectives of Otter Tail Power and the manufacturing and infrastructure companies. The strategic objectives of all three must align, and we believe they do.

We also will only be successful if we have strong leadership. I call this leadership connection, and you will see it on slide 5. Every good business has a strategy, and many businesses have a focus on operational excellence. The strategy in operations can only produce consistently strong results if they are brought together by good leadership. At Otter Tail Corporation, we view all of our employees as leaders. We are intentional about developing our people, we consider them to be assets, and we believe that they have the ability, interest, and capacity to deliver value to our shareholders.

With our talent development programs in place, we are confident that as we continue the current leadership transition at the CEO level and other top management positions, others will be ready to lead throughout the organization.

Otter Tail Corporation also has a strong Board of Directors, a cohesive executive team, a veteran leadership team at the power company, and solid support for the manufacturing and infrastructure companies through dedicated Varistar staff. We have operating company presidents and leadership teams who know their businesses. Working together with the talented employees at all levels of each of our companies, consistent execution of our strategy, as I said earlier, is paying off.

With that, I'll turn it over to Chuck MacFarlane, our President and Chief Operating Officer, to provide some color on what's happened at the utility and the manufacturing infrastructure companies during second quarter. Chief Financial Officer Kevin Moug will follow with a financial perspective. Chuck?

Thanks, Jim.

As Jim said, we continue to see excellent results from our capital investments at the utility and strategic focus on operational excellence in the manufacturing infrastructure companies under Varistar. Allow me to provide second-quarter highlights from each of the two platforms.

We have talked with you in previous quarters about our capital investment to grow rate base at the utilities. Slide 7 provides a preview for the next five years. Investments are in replacement projects, RX transmission projects, and environmental upgrades at our power plant.

We have also previously shared slide 8. It shows that we have the benefit of a constructive regulatory environment that provides for timely recovery of our investments and fair return.

In fact, we expect two-thirds of our five-year capital expenditures to be recovered through riders. The remaining one-third is maintenance capital expenditures, the majority of which is effectively in rate base at current depreciation levels.

I won't outline each of the projects shown on slide 9 today because we've discussed each of them last quarter, but here is an update on a few of the projects. The North Dakota Public Service Commission has granted a route permit for the North Dakota section of the 345 KB Big Stone area transmission project called Big Stone South to Ellendale. This is one of two projects we are involved with that has been deemed a multi-value project by MISO, the Midcontinent Independent System Operator. We expect to receive our ruling on our request for route permit for the South Dakota portion in early August. Construction activities should start in the first quarter of 2015. Work is proceeding as planned on other transmission projects.

Slide 10 identifies our generation projects. Construction of the nearly $400 million air-quality control system at Big Stone Plant to meet the EPA's regional haze rules surpassed the halfway mark in June. Otter Tail's share of this project is just over $200 million. Rider recovery is in effect in both Minnesota and North Dakota for this project.

The second environmental upgrade project not on this list is the Emissions Reduction project at Hoot Lake to meet the EPA's new math standards. Construction is finished, and the project will go through final commissioning when this year's maintenance outage is complete. The project will be in service by March 15, 2015, which is the EPA's compliance date. It came in at just under $8 million, which is $2 million less than estimated in the baseload diversification study, which was approved by the Minnesota PUC.

Also of note this quarter is Otter Tail Power Company's work with other stakeholders to prepare comments to the EPA on its proposed rule to reduce carbon dioxide emissions under 111(d) of the Clean Air Act.

As you may know, on June 2, the EPA proposed emissions reduction targets for each state based on each state's assumed ability to use four building blocks, starting with the 2012 baseline.

Slide 11 identifies those building blocks. Without further regulation, Otter Tail Power Company has been on track to reduce carbon dioxide emissions 19% from 2005 levels by 2020. The EPA's proposed rule targets a 30% reduction by 2030.

Slide 12 shows the present change targets for the three states we serve. The targets are set primarily in terms of carbon dioxide intensity, which is the amount of carbon dioxide emitted per megawatt hour of electricity generated. This slide also shows the potential impacts to our Company based on our initial assessment.

Minnesota will require to make a larger than average change, but because we are retiring Hoot Lake Plant by 2020, we likely have little risk for stranded investment in that state.

We also see little risk for stranded investment in North Dakota, which has a much smaller target to achieve.

South Dakota is of greater concern because the Big Stone Plant is the only coal plant in South Dakota. We are working with supportive South Dakota agencies to file comments with the EPA seeking a modification to the rule. It will be a long process before the rules are final. EPA is taking comments through November this year and is scheduled to issue a final rule next June. States will have another year to submit their state implementation plans, and the EPA will require at least a year to review and approve those plans. We likely will be working through this issue for the next four to six years.

Now allow me to make a few observations about the manufacturing infrastructure companies under Varistar. You'll see them on the organizational chart on slide 13. We continue to see positive results from strategic focus on operational excellence at these companies. I'm especially pleased with Foley and Aevenia, our construction companies, as they continue to improve. Foley did particularly well with a $1 million improvement in gross margins compared to second quarter last year. As we have stated previously, this is in large part due to more selective bidding on projects and improved construction management.

In addition, both Foley and Aevenia are benefiting from increased construction activity in general.

T.O. Plastics, our company that provides thermoformed products, received its AIB certification to manufacture food packaging products. This is a new market for TOP. It produced and shipped its first move package quarter, containers for cherry tomatoes, in April. And since then, the Company has produced several additional orders.

BTD, our metal and parts manufacturer, earned two customer awards this quarter. One was a service award from Kawasaki. BTD was the only metal fabricator to have received the Kawasaki service award. The other was a preferred supplier award from Home & Hearth Technologies, which is one of the largest manufacturers of fireplaces in the nation. BTD earned one of 12 awards out of the 150 worldwide suppliers to Home & Hearth. This is the fifth consecutive year BTD has won the Home & Hearth Preferred Supplier Award.

The PVC pipe companies have continued strong sales in an increasingly competitive market.

In summary, all manufacturing infrastructure company results were in line with expectations this quarter. Orders from new customers, awards from existing customers, and growth in competitive markets are further confirmation to me that our focus on operational excellence is paying off. Since taking on this larger role as Chief Operating Officer, I have become more familiar with each of the companies. I believe they are well-positioned to deliver shareholder value and provide a premium return compared to a stand-alone utility.

With that, I will turn it over to CFO Kevin Moug for a financial perspective.

Well, good morning. Please refer to slide 15 as I discuss our second-quarter results.

Our electric segment continued to perform well in the second quarter with revenues up 12% and net income up 44% compared with the same quarter a year ago. The increase in earnings is primarily a result of environmental and transmission costs recovery riders as we continue to see positive financial impact from our rate-based investment strategy.

Electric segment revenues and earnings also increased due to increased sales to pipeline and commercial customers. Over the past three years, the utility has experienced a growth rate in retail electric sales of about 1.3% and is projected to grow around 1.7% over the next three to four years. This growth is driven in part by increased sales to industrial customers, primarily the pipelines.

Increase in operating and maintenance expenses and interest costs are fully explained in the earnings release. Our manufacturing segment revenues and earnings increased from the second quarter of 2013 due to increased revenues at BTD as a result of higher sales to energy-related, recreational and lawn and garden end-markets. While BTD experienced a growth in gross margin dollars quarter over quarter, they were impacted by additional tooling costs incurred to repair and refurbish several dies.

Fuel plastics earnings continue to be impacted as a result of a customer electing to produce a product on its own, starting in 2014.

Our plastic segment earnings decreased $500,000 between the quarters. This was mainly attributable to lower margins from increased cost of PVC resin and slightly higher operating costs. The increased resin costs were not able to be fully passed on in sales prices due to competitive market conditions.

Our construction segment continues to see significant improvement with increased revenues and earnings over the second quarter of 2013. Foley's earnings continue to improve due to increased construction activity, as well as improved margins resulting from a more selective bidding process and better cost controls. And Aevenia's improved earnings are mainly due to additional work in the Bakken area, as well as lower operating expenses.

Our corporate expenses increased $800,000 during the second quarter, resulting from a $1.5 million charge for the early termination of an airplane lease. Our recent divestitures have alleviated the need for the airplanes. The early termination charge is partially offset by a $700,000 decrease in interest expense due to the early retirement of the $48 million of the 9% notes in the fourth quarter of 2013.

On August 1, 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 August 15, 2014. This represents the 303 consecutive quarter that we have paid dividends to our shareholders.

We have disclosed previously that equity financing is needed during the 2014 to 2018 timeframe, in part to support the rate-based expansion plans of our electric segment. We started using our aftermarket offering program in the second quarter of 2014 and entered into sales transactions for approximately 87,000 shares of common stock with net proceeds of $2.5 million.

Slide 17 shows we are narrowing our earnings guidance for 2014 to be in the range of $1.65 to $1.80 earnings per share from our May guidance of $1.60 to $1.80 of earnings per share. We are raising our 2014 net income expectations for the electric segment primarily due to colder than normal weather in the first quarter of this year. We are narrowing our February 2014 guidance for our manufacturing segment, and this guidance is in line with 2013 results. Our backlog for this segment is $86 million as of June 30, 2014 compared with $76 million one year ago.

We are lowering the May 2014 guidance for the plastic segment due to an expected continued increase in PVC resin costs. Based on current market conditions, we don't expect these costs to be fully recovered through higher sales prices for PVC pipe.

We are also increasing the February 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. The backlog in place for the construction businesses is $64 million as of June 30, 2014 compared with $74 million the same time a year ago.

We are narrowing the May range from corporate costs for 2014. This results from lower interest costs, the sale on investment and low income housing rental property and lower expected employee benefit costs. We still expect corporate costs to be lower than in 2013, in spite of the charge recorded to exit the airplane lease early. This revised range reflects estimated EPS growth of 7% to 17% off our non-GAAP 2013 earnings per share of $1.54.

I encourage you to read the investment highlights on slide 18. We are pleased with our strong second-quarter results and year-to-date performance.

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

(Operator Instructions). Matt Tucker, KeyBanc Capital.

Good morning. Congrats on a strong quarter. First question on the EPA regulations, I realize it is pretty early and there aren't a lot of moving parts, but it seems like you've identified some capital opportunities tied to that. Could these opportunities present an upside to your current five-year rate-based growth guidance?

Matt, this is Chuck. We have not identified any capital additions due to the EPA in our five-year forecast. We do foresee the replacement for Hoot Lake, which is said to close in 2020.

Beyond the five-year timeframe in here, we anticipate that that will be in natural gas resource coming in service in the spring of 2022, but that was planned prior to any of the EPA rules proposals.

Okay. I guess you did mention some potential for additional renewables. Would those potentially fall within the five-year plan, or are they just not probably large enough to move the needle?

Well, from a basis of what we are required under our renewable standard in Minnesota and renewable objectives, out through 2025, we need to only add about approximately 20 megawatts of wind to meet those requirements. Should the carbon rules come down based on if you can get credit for additional renewables, we will, of course, put that into our next integrated resource plan calculations. That's a plan we do for the commissions every two to three years. But it's unlikely we would suggest that until we see the final rules.

In addition, we do anticipate we will be adding some solar late in the period due to the 1.5% renewable solar standard in the state of Minnesota.

Got it. Thanks. On the plastics side, you mentioned you would expect the PVC resin prices to continue growing. It seems like demand has been pretty strong year to date. You've seen pretty strong revenue growth. Do you expect the revenue growth to remain strong in the second half of the year or to kind of moderate? And I guess does the outlook for increased resin prices kind of go hand-in-hand with demand remaining strong?

Matt, this is Kevin. The demand, the volumes that we are expecting to see in the last half of the year continue to be strong. What we are seeing happening right now is there has been now another $0.02 per pound price increase announced for resin here as we head into the last half of the year. That's on top of resin price increases that occurred in the first six months of the year.

And so really the volumes are strong, but in terms of we're just not given the conditions we are in, not able to get the full price of those resin increases passed on in the sales. We are certainly trying to do what we can, but competitive market conditions will ultimately dictate what we can get passed through. So that's what's really driving the somewhat softening of the guidance from last quarter.

Okay. Thanks. And on manufacturing, could you talk about the extent to which the stronger guidance reflects the first-half results coming in stronger than you expected, as opposed to stronger outlook for the second half, or is it the combination of both?

Matt, Kevin, again. It's probably a combination of both, but probably a little more so towards the stronger first-half results.

Got it. And maybe a little color on specifically what's been driving the stronger than expected results?

BTD has seen particularly in the second quarter good strong revenue growth coming from the end-markets that we talked about in my scripted comments. And as BTD looks out through the rest of the year, they continue to see good strong performance in those end-markets.

As it relates to T.O., we are basically holding T.O. kind of to where they were originally expected to be at the beginning of the year and into the first quarter of the year just based on where they are at in their current business cycle and in the end-markets that they are serving.

Got it. Thanks, guys. That's all for now.

(Operator Instructions). Matt Tucker, KeyBanc Capital.

I just saved one on the construction side. If you could just talk a little bit about the end markets where you are seeing the most activity and where you've been successful recently, I know you kind of called out at Aevenia the North Dakota TND work. So I guess maybe specifically at Foley, what's been contributing to the better results there?

Sure. In terms of we did talk about Aevenia in the Bakken and the continued growth that we see in that region, as it relates to the Foley, we continue to seek work in industrial type projects across our mix of the businesses that we look at there. We certainly do water, we do wastewater, we do industrial, power plants, some hospital work, and we are seeing a fair amount of work on the industrial side this year.

Got it. Thanks, and your backlog in the construction segment was down a bit sequentially and year over year. Based on bidding activity, do you think that that could be higher by year end?

You know, there is potential that it could be higher based on the activity that we are seeing and working on in terms of bids. And even though the backlog is down $10 million, when we look at the first half of the year of actual revenues at Foley and then look at what they have in their backlog last half of the year, we are pretty comfortable with the revenue forecasts that we are looking at to support the guidance that we have for Foley.

And I'd make a similar comment for Aevenia as well. Aevenia's backlogs typically do not -- we typically only have backlog for the current year that we are doing work in. But there's a fair amount of time and materials work that Aevenia is doing as well. And so collectively across the segment, we feel good about the backlog and to support the revenue forecast for 2014.

Okay. Thanks for the color, guys. That's all I had.

Thank you and I'm not showing any further questions. Mr. McIntyre, please proceed with any closing remarks.

Well, I just would make a couple of additional comments. You know, we are pleased with our first quarter. The second quarter -- we had to do strong quarters back to back, and we are positioned to deliver another year of increased earnings and profitability to our shareholders with capital investments and the utility and a strategic focus of operational excellence at our manufacturing and infrastructure companies.

The visibility of our earnings from the utility as well as from our manufacturing and infrastructure companies is becoming increasingly apparent to us, and then we are pleased that our quarterly reports and our calls with you are more routine in that regard in that there's few surprises and that we are able to have some consistency of earnings that we are sharing with you. We do think we are poised to have a good solid second half of the year and continue to work hard not only this year but to position ourselves for success in 2015 and beyond.

With that, unless there's any further questions, I would thank you for joining our call and for your interest in Otter Tail Corporation. We look forward to speaking with you next quarter.

Ladies and gentlemen, this concludes today's conference. Thank you for your participation, and have a wonderful day.