Otter Tail Corp (OTTR) 2014 Q4 法說會逐字稿

Good morning, and welcome to Otter Tail Corporation's 2014 earnings conference call. Today's call is being recorded and there will be a question-and- answer session after the prepared remarks. I would now like to turn the call over to Mr. Loren Hanson at Otter Tail. Please go ahead.

Well, good morning, everyone, and welcome to our call. My name is Loren Hanson and I manage the investor relation's area of Otter Tail. Last night we announced our 2014 results and also increased 2015 earnings guidance. 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; and 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 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 applied by our forward-looking statements. 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?

Thank you for joining us on the call this morning. We've had a very good 2014 and are eager to talk about it with you. Chuck will hit some of the high points of the year. And he'll explain how the pending divesture of our construction companies is consistent with our strategy. Kevin, of course, will address the financials.

I'd like to use my time to talk about the pride I have in this corporation and my belief in its future. As you know, I'll be retiring as CEO in April. This is the last time I'll join you on an earnings call in this capacity. So I'd like to use the time to summarize something I've talked with you about in prior calls, our strategic journey. It may be helpful to refer to slide 4 as a strong reminder of what our strategy entails.

When I came aboard as CEO in late 2011, Otter Tail Corporation was dealing with a very slowly improving national economy after a widespread downturn, as were most companies. We had identified a strategy that would narrow our portfolio of businesses; tighten and enhance oversight in our operations; and allow us to pursue investment opportunities in electric utility.

In the three years that followed, I had the privilege of working with an engaged board, a talented leadership team, and committed employees throughout the Company to bring this strategy to fruition. We reduced risk by divesting companies that no longer fit our strategy. We invested in power plant environmental upgrades and reasonable transmission projects. We worked through legislative and regulatory processes to achieve approval for environmental upgrade and transmission cost recovery riders that provide more certainty for investors and lower cost for customers.

We removed unnecessary debt, stabilized and increased earnings and saw an upgrade in all our corporate credit ratings. We supplemented operations and talent management resources at our companies. And we implemented a corporate-wide leadership development program, including a robust succession planning process.

Our commitment to shareholders never waned. We maintained a dividend through the dark days. And in February 2014, following strong financial results in 2013, our Board of Directors increased the annual dividend by $0.02 a share, the first increase since 2008. Last week, the board again increased the annualized dividend $0.02 a share to an indicated annual rate of $1.23 a share, the 305th consecutive quarter we paid dividends on common stock.

In 2014, the dividend and stock appreciation combined to provide a total shareholder return of approximately 10%. That's a good return on the utility-based investment. Otter Tail Corporation is well-positioned for sustainable success. Internal and external clarity and transparency exists as to its strategic plan. Enhanced management systems and practices are in place to support more predictable results. The Corporation has an engaged workforce and strong leaders and is intentionally taking actions to expand overall leadership.

The incoming CEO is battle-tested, both in the utility and in the Varistar businesses and a supportive Board has strong governance practices in place. While challenges will always exist, Otter Tail Corporation's people and systems are more than capable of successfully meeting them. I appreciate the time I have had with this organization.

And now, I'll turn it over to Chuck for specific comments on 2014 and for his insight into 2015. Chuck?

Jim won't say it, but, of course, he's had a strong hand in achieving the results we are reviewing with you today. We thank him for that and we aren't letting him go just yet. He's CEO through the first quarter and will serve as a consultant for our strategic planning process in the second quarter. So, no goodbyes just yet.

And he'll be available to take your questions at the conclusion of the call. I do appreciate Jim's confidence in our organization and I share it. The 2014 results demonstrate we are delivering shareholder value.

Consolidated revenues increased 8%. Consolidated net income and diluted earnings per share from continuing operations both improved more than 16% and utility net income was 14% higher than in 2013. The improvement in utility net income is primarily related to cost recovery riders for the environmental upgrade project at Big Stone Plant and major transmission projects. All three states the utility serves, approved or implemented riders in 2014.

Just a quick update on the environmental project. It's nearly 90% complete. It's maintaining an excellent safety record. And we'll begin the four-month process of putting the environmental controls into service at the end of this month. You will recall that we now expect the project to cost $384 million, which is 22% less than the original estimate used in our advanced determination of prudence proceedings. Our share of the project is $207 million.

Utility is also earning a return during the development and construction of the Midcontinent Independent System Operator multi-value and CapX2020 transmission projects. Two of the four projects in which we are participating will be completed in 2015. The remaining two will be completed in the 2017 to 2019 timeframe. Those two projects, Big Stone South to Brookings and Big Stone South to Ellendale, have received their South Dakota state permits and Otter Tail Power has assumed project management duties for the Ellendale project.

Slide 5 shows all of our current rate-based projects and the percent of completion. Slide 6 shows the various cost recovery mechanisms we have for each of them in the states we serve.

Now before I turn our attention to our manufacturing infrastructure companies, I'd like to provide an update on three other utility items. First, Coyote Station, the jointly owned 427 Megawatt mine mount plant we operate in North Dakota, suffered a major mechanical failure in one of its steam driven boiler feed pumps and tripped offline on December 4th. Lube oil lines ruptured, resulting in a fire. Thankfully no one was hurt, but the plant sustained major damage to the failed pump as well as damage to the roof, cabling, and other nearby equipment.

Crews had the plant back online at half load 18 days later. But it will take some months before we can rebuild the failed pump and return the plant to full service. A vast majority of the equipment repairs will be covered by insurance. Until then, Otter Tail Power has made alternative arrangements for energy.

I also want to update you on the rail delivery of coal to our power plants. Since our last call, train cycle times have improved. So the Big Stone Plant lifted the coal conservation mode on January 1. Deliveries are keeping up with use.

The last item is an update on our discussion of the EPA's proposed rule to reduce carbon dioxide emissions from existing power plants. You'll recall that the EPA proposed state-by-state emission reduction targets. And that the South Dakota targets were concerning because Big Stone Plant is the only coal plant in the state. This is a concern because under the proposed rule, South Dakota's only combined cycle natural cycle gas plant, which was brought online in August of 2012, is assumed to increase to a 70% capacity factor resulting in a corresponding decrease in the output at the only coal-fired plant in the state, Big Stone.

We continued to work with the South Dakota agencies and other stakeholders as we reported in the third quarter, including the congressional delegation from Minnesota, North Dakota, South Dakota, Montana, to file comments in December. We also filed comments as a Company. And in reading the various filings, we're gratified to see the support for our specific concern. We are seeking a modification to the final rule, which is effective sometime this summer.

Now, to the manufacturing infrastructure companies. As you know, we've moved the construction companies, Aevenia and Foley, to discontinued operations. The two companies performed very well in 2014. But, as Jim explained during our third quarter calls, we continually assess the companies' fit with our portfolio criteria and strategic plan. Through that assessment, we determined that we'd best be able to strengthen our overall diversified operations by investing exclusively in manufacturing-based companies. It will allow us to focus on a similar set of businesses.

Also, some aspects of the construction segment did not align with our investors' expectation for predictable earnings based on a moderate risk profile. We now have signed letters of intent for Aevenia and Foley and expect to close on the respective transactions by the end of the first quarter of this year.

We recorded a goodwill impairment on Foley at the end of 2014 based on Foley's indicated market price. And we expect to record a gain on Aevenia when the transaction closes in 2015. These sales will conclude our migration of companies under Varistar from a highly diversified platform to one that is composed entirely of manufacturing companies.

Sufficient diversity remains in the Angeles markets, within a platform, to provide a measure of protection against specific market downturns. During the next several years, we will concentrate on organic growth and acquisition within these companies or alongside them.

The other companies are doing well. T.O. Plastics strengthened its management and sales team in 2014. And saw a 12% increase in sales of horticultural containers. Horticulture is the Company's primary market and now accounts for more than 50% of T.O.'s total sales. Continuing to emphasize this market, T.O. launched a new line of products, specialized plug trays, called SureRoots ELITE. The Company designed them in collaboration with distributors and growers and makes them with 100% reclaimed material.

BTD revenues were up. But because the increased sales didn't translate to improved net income, BTD has initiated several actions that should help reduce costs and improve margin. They've hired a new Chief Operating Officer, a new Human Resources Officer, and a new manager at the Washington Illinois plant. These strategic hires will help focus on efficiency. In addition, the facilities expansion plan we discussed in the third quarter call will put Lakeville operations under one roof, significantly reducing logistics cost.

The PVC pipe companies, Vinyltech and Northern Pipe Products, had a strong year in 2014. Their earnings were affected by increased resin prices throughout the year, so results aren't as strong as in 2013. But sales were excellent. In fact, Northern Pipe Products had a record year, shipping its most pounds ever.

The pipe companies are very competitive with low conversion of fixed costs. Their outlook is solid. I'm pleased with the progress of all of our companies. I've had the operating company presidents report directly to me since last spring. This has given me a better opportunity to assess their businesses and best determine how to proceed.

To that end, we're pleased to announce that John Abbott has accepted the role of Varistar President and he begins work tomorrow. John has strong sales, marketing, and operating experience. He has successfully overseen multiple P&L presidents in his previous roles and he has significant manufacturing company acquisition and integration experience. This is another strategic hire to further enhance the performance of our manufacturing segment.

I'll summarize by saying the utility had a strong 2014, both financially and operationally. It had an excellent OSHA safety record, good electric service reliability, and a customer satisfaction rating among the top in the nation. Our decision to invest in utility rate base projects has improved the income and this will continue for the foreseeable future as demonstrated on slide 7.

The manufacturing and infrastructure companies under Varistar also had a strong year financially and operationally. Northern Pipe and Vinyltech have low capital costs and operating costs. They are agile and able and provide excellent customer service. They have strong earnings, strong cash flow, and are highly competitive.

T.O. Plastics is growing its for-horticulture container business. It has a more focused strategy and has enhanced talent with good earnings in 2014. BTD is a high quality, full service, fast-growing metal fabricator, serving a highly desirable base of household-name customers. The combination of continued growth in BTD's sales, a focus on increasing the return on sales, and the addition of talent, provides confidence for BTD. Together, they exceeded the return on invested capital targets. And under the guidance of John Abbott, the new Varistar President, I anticipate an even stronger 2015.

Slide 8 shows our remaining businesses have provided shareholder value. We will continue to target a compounded annual growth rate of 4% to 7%.

Now, I'll turn it over to Kevin for the financial perspective.

Well, good morning. Please move to slide 9 for an overview of 2014. As part of discussing our financial results for 2014, it's important to note we signed letters of intent to sell Aevenia and Foley, companies in our construction segment. The segment meets the criteria to be classified as held for sale, and, as such, is being reported as discontinued operations as of December 31, 2014. I will discuss this later in my comments.

But with that backdrop, let me move on to our results from continuing operations. 2014, was another year of executing on our strategies. Our consolidated revenues increased across the electric, manufacturing, and plastics segments. We raised $25.6 million in equity under our at-the-market dividend reinvestment and other employee stock plans. And we expect to continue to use these programs as equity financing as needed during the 2015 to 2019 timeframe. Our strong 2014 performance and 2015 outlook, allowed the Board of Directors to increase our indicated annualized dividend rate from a $1.21 a common share to $1.23 a common share in 2015.

Now, move to slide 10 for an overview of 2014 earnings from continuing operations. The electric segment had strong performance in 2014, earning $1.19 per share. Revenue increased 9.2%, primarily due to continued rate base investments in transmission and environmental upgrade to our Big Stone Plant, and from increased pipeline and commercial sales. The $5.4 million increase in net earnings is reflective of our continued execution of the rate-based growth strategies.

Our manufacturing segment's earnings were $0.25 a share in 2014, compared with $0.32 a share in 2013. BTD's revenues increased nearly 12% year over year, due to higher sales to energy-related recreational and lawn and garden end markets. Earnings at BTD were down year over year due to, one, an after-tax charge of $1.7 million, or $0.05 a share related to the exit of leased facilities at our [Odd Seigel] location.

Two, increased product handling costs, freight inventory reserves, and tooling costs to repair and refurbish dies. These costs reduced gross margins by 2%, and, three, increased operating expenses. T.O. Plastics revenues and earnings decreased in 2014, mainly as a result of reduced sales of packaging products produced for a customer prior to 2014. And while the revenues declined related to this, T.O. Plastics' product mix improved, resulting in higher gross margin percentages year over year.

Our plastic segment earned $0.33 a share in 2014, compared to $0.38 a share in 2013. Revenues increased, based on stronger sales volumes and higher prices for pipes sold. However, earnings were down year over year due to an increase in cost per pound of pipes sold, primarily related to higher PVC resin costs. The increase in resin costs could not be fully recovered through increased pipe prices, due to competitive market conditions.

Corporate costs were $0.22 a share, compared with $0.42 a share in 2013. The components of this change are discussed in the press release. Our earnings per share from continuing operations on a GAAP basis was $1.55 in 2014. This reflects $0.09 a share of infrequent charges.

Our 2014 earnings per share from continuing operations on a non-GAAP basis is $1.64, adjusting for this amount. The $1.64 a share reflects the base earnings capability of our electric and manufacturing platforms.

Let's move to slide 11 to discuss discontinued operations. We have been successful in marketing the construction segment and have signed letters of intent to sell these businesses by the end of the first quarter 2015. We did recognize an impairment loss in the fourth quarter for Foley, based on the indicated market price we have agreed to sell the company for. And we do expect to recognize a gain on the sale of Aevenia at closing.

Please move to slide 13 for a discussion of our 2015 business outlook. Our 2015 earnings guidance is expected to be in the range of $1.65 to $1.80 of earnings per share. This guidance reflects the current mix of businesses owned by the corporation. This guidance also considers the cyclical nature of some of the operating companies and strategies for improving future results.

Our electric segment earnings per share is expected to increase in 2015 based on the following items. One, rider recovery increases, including riders in Minnesota and North Dakota related to the Big Stone AQCS environmental upgrade; two, increased volumes from pipeline and commercial customers; and, three, a decrease in plant overall costs.

These items are offset by an increase in pension costs as it resulted in an increase in projected benefit expenses based on a decrease in the discount rate from 5.3% to 4.35% and the adoption of a new mortality tables with longer life-expectancy assumptions; higher depreciation in property taxes; tax expense due to large transmission projects being put into service; and higher short-term interest costs to fund major projects being worked on.

We expect earnings from both BTD and T.O. Plastics, our manufacturing segment, to increase in 2015. At BTD, revenues are expected to increase as follows: Growth and market share, and breadth of services with existing customers. Our paint line capabilities are expected to be in service by June of 2015 and will also contribute to additional revenues and earnings growth. We also expect earnings to improve as a result of our facilities expansion and optimization plan, and expected cost reductions at our Illinois facility.

T.O. Plastics is also expected to increase earnings in 2015, based on expected volume increases in its horticultural business line through market share growth and product line expansion, as well as growth in the various industrial end markets it serves. Backlog for this segment is approximately $140 million for 2015, compared with $136 million, one year ago.

We expect plastics net income to be down from 2014. Sales volumes are projected to be slightly up over 2014. Operating margins are expected to be lower due to tighter spreads between resin costs and sales prices along with increased labor and freight. And we expect corporate costs to be flat in 2015 compared to 2014.

Let me provide an overview as shown on slide 14 of our capital expenditure plans. We expect capital expenditures for 2015 to be $183 million, compared with $164 million last year. We continue to invest in various transmission projects as well as the completion of the Big Stone AQCS project. The investments in these environmental and transmission projects positively impact the Corporation's earnings and returns on capital.

Also contributing to the increase in planned expenditures for 2015 is the BTD expansion at its two Minnesota locations, Lakeville and Detroit Lakes. The five-year capital expenditure plan calls for $665 million in utility projects and also includes $110 million for the manufacturing and plastics businesses.

We believe our 2015 guidance further positions us to achieve a 4% to 7% compounded annual growth rate in earnings per share using 2013, $1.50 a share, as adjusted, for the base year. This is driven largely by the approved projects and related rider recovery of rate base investments at the utility and capacity available in our manufacturing and plastics companies.

2015 presents opportunities and challenges as we grow our business. We will continue to perform on our rate-based expansion projects for the utility. Success at BTD will be dependent on successful execution of the paint line and facility expansion, along with operational improvements needed to further improve our return on sales margins.

And T.O. Plastics must be successful in its strategies to grow revenues across all of the end markets it serves. And while there's volatility in our plastics segments earnings from year to year, this segment can be relied on to provide strong earnings, cash flows, and returns on invested capital.

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

(Operator Instructions)

Matt Tucker, KeyBanc Capital Markets.

Hey, guys. Congrats on a nice year. And, Jim, congrats on a nice job and on your last call here.

Well, thank you, Matt

First question, would you guys be able to give us the amounts you're receiving? Or, any evaluation metrics on the sale of the construction businesses?

Yes, Matt, this is Kevin. We're not -- you know, we're not closed. We're continuing to work on the agreements and towards closing. So, we're not yet able to disclose any metrics or expected prices on the transactions.

Okay. Looking at your guidance for the manufacturing segment, I think at the midpoint, it implies earnings growth of about 30%. Excluding the charge at BTD in the fourth quarter.

And, you've talked today, and in the past, about some of the things you're doing internally to expand the paint services. You talked a lot about market share today -- gaining market share. What gives you the confidence that you'll be able to do that this year?

Matt, this is Chuck. Just a couple of -- you know, on the changes of the increase, I think in manufacturing. Year over year, if you go to the midpoint, we have approximately a 14%, or, $0.14 improvement.

In all, what we see in that is the Otsego lease write down should improve $0.05 of that. We have logistics improvements of $0.03.

And then, with the paint line. And, returning to more historic return on sales numbers for BTD. We would envision another $0.06. To, sort of, walk you from one to the other.

The logistics costs, just to give you a feel, we had three sites in Minnesota. The one facility that's Otsego, was not near either our Lakeville or are Detroit Lakes locations. And, we were hauling finished parts and child parts and whatnot, to and from that location.

In our optimization plan, we are going to, you know, eliminate that facility. You know, we've already leased it out. And, we'll be expanding at both at the Lakeville and DL sites to cover that.

So, you know, it's not hugely dependent on a large amount of new revenue coming in to BTD. It is more a function of improving the return on sales to more historic number -- or, levels.

Thanks, that's helpful. Are you seeing growth in that market demand for the manufacturing segments? Or, is it really as you kind of said, you know, is the growth going to be more driven by what you're doing internally?

We are seeing growth in certain end markets. And, we're seeing certain end markets contract a little bit. The energy and ag markets are soft. The lawn and garden, RV, horticulture, and others are improving.

Thanks. And, would you -- do you guys have the weather impact in the fourth quarter or the degree days versus normal? At electric?

For just the fourth quarter or for the year?

Well --

Because, the year is in there. In the press release.

The year is in there. The fourth quarter would be helpful. And, then if also, for the full year, do you have an estimate for the impact on earnings or margin versus normal weather?

You know, in terms of from 2013 to 2014. You know, we would -- right now, I think there's -- weather's relatively neutral in terms of planning for normal weather compared to where we were at. Slightly below that.

And, I'm just trying to look at something here on your fourth quarter. Yes, Matt, it is in the press release in terms of fourth quarter. As well, on page 4.

Okay. Thanks. Sorry I missed that. One more from me.

Are you -- you cited strong growth from pipeline and commercial customers at electric in 2014. Are you seeing any impact on demand from your pipeline customers, in particular? Since the decline in energy prices began?

Matt, this is Chuck. We -- the majority of our pipeline sales are associated with, you know, Canadian oil. While we think production is maintaining its level.

One thing we watch is the differential between the Brent and the West Texas pricing. And, if there's a significant premium to the Brent, that allows more rail flexibility, if you will. And as those come closer together, we are seeing strong, or continued, load on the pipeline pumping.

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

(Operator Instructions)

And, we have a follow up from Matt Tucker. Please proceed with your follow up.

Hey, guys. Just a couple more. It looked like the 2014 electric CapEx came in a little bit lower than anticipated. And, I think 2015 moved up a bit. Could you just touch on the movement there?

The 2014 was primarily driven by low -- projects coming in lower than expected. We had contingencies built into that capital budget and that has been lowered. We have not seen a significant delay in any of those.

We will be starting the large Big Stone to Ellendale and Big Stone South to Brookings projects. Are slightly behind, but, there hasn't been a lot of capital expended. If you see that slide, that's percent complete, I think you would look.

We didn't mention a number in there because they're still in development. But, those are probably in the area of 5% of the capital dollars have been spent on those two. But, it's primarily the reduction in 2014. Is projects coming in lower than expected cost.

Great. And, could you please comment on 2014 utility customer growth? And, your expectations for customer growth going forward?

Yes, the expectation going forward is we have approximately 2.5% revenue growth. That is largely, or almost all, driven by known industrial and commercial additions. The year-over-year residential growth is essentially flat. It was up slightly in 2014.

But, we don't expect a lot of growth, sort of, in the base amount. It is just known, industrial and commercial customers in 2015.

Great. Thanks. And then just, in terms of your plastics outlook. You know, you've talked about, you know, seeing some margin pressure. And, I think you've been talking about that for a while.

Does your guidance assume that margins continue to get squeezed? Or, is it -- kind of, assume the current margins for the rest of the year?

Yes, Matt, I mean it -- this is Kevin. And, as we head into 2015, you know, we certainly will expect that there is, kind of, where we're at to slightly declining. As we head into 2015.

How do you see the decline in energy prices impacting the plastics segment? Either from a demand perspective? Or, from a cost perspective?

Yes, you know, from a demand perspective, we do see slightly increased volumes here in 2015 as we head into the year. From a pricing perspective, either, you know, as we head into the year, there's been some announcements around potential increases in resin prices again. Whether, you know, there looks to be that they may not fully take effect.

But, you know, there's really -- you know, we're expecting, you know, increased volume. Slightly increased volumes year over year. And, then, kind of, given where we finished the year in terms of our resin pricing. And, as we head into the year, we expect those margins, as we said, to kind of, continue to be tightened. Like, we finished the year and potentially there's additional risks that could tighten up further.

Great. Thanks a lot, guys. That's all I had.

(Operator Instructions)

And, with no further questions in the queue, I would like to turn the call over to Jim McIntyre for closing remarks.

Well, thank you, Nicholas. Planning, people, processes, and operational excellence drive our performance. Over the last 3-plus years, we successfully executed our strategy. And, accomplished what we said we're going to do and more.

We've rationalized our business strategy. And, made it simpler, easier to understand, with far less risk. And, have successfully delivered increasing shareholder value for each of those years.

The lessons learned from the past served Otter Tail Corporation well, and will not be easily displaced or forgotten. I'm optimistic about Otter Tail's performance, not only in 2015 but, in the years to follow.

I have confidence in Chuck MacFarlane's leadership as the incoming CEO. And, in the organization based on the strength of its people and commitment to excellence.

While this is my last call, on behalf of the corporation, we appreciate your continued interest and look forward to your joining us for second quarter call. Thank you very much.

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program and you may all disconnect. Have a good day, everyone.