Otter Tail Corp (OTTR) 2015 Q2 法說會逐字稿

Good morning, and welcome to Otter Tail Corporation's Second Quarter 2015 Earnings Conference Call. Today's call is being recorded, and there will be a question-and-answer session after the prepared remarks. And now, I turn the conference over to the Company.

Good morning everyone, and welcome to our call. My name is Loren Hanson, and I manage the Investor Relations at Otter Tail. Last night, we announced our Second Quarter 2015 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 are Chuck MacFarlane, Otter Tail Corporation's President and CEO, 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 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 information, future events, developments, or otherwise.

For opening remarks, I will now turn the call over to Otter Tail Corporation's President and CEO, Mr. Chuck McFarlane. Chuck?

Thanks, Loren. Good morning, and thanks for joining our call. We have a good news story this quarter, at $0.36 earnings per share from continuing operations were stronger than planned. Last quarter, I predicted improvement in performance during the remaining quarters of the year, and that's what we've begun to see. In addition to continued rate-based cost recovery this quarter, we were able to reduce operating expenses significantly. We saw a $3 million quarter-over-quarter improvement in the electric segment net income, and we saw less than a $0.5 million decrease in the manufacturing segment, which is tackling challenges in the oil and gas, and agricultural equipment markets. And, we saw an $800,000 increase in net income in the plastics segments. In addition, corporate expenses were down.

Last quarter, we reported that we had completed the sale of our construction companies, the last step in our narrowing to just two Otter Tail Corporation platforms -- electric, and manufacturing. We are now concentrating on operational excellence, talent development, and growth, in these more focused set of companies, and our short-term results are encouraging. We expect that we will hit the top half of our guidance this year.

Before Kevin addresses the financials in greater detail, allow me to provide second quarter highlights for each of our two platforms. I'll start with a few items at the utility.

The CapX 2020 Transmission Line from Alexandria, Minnesota to the substation west of Fargo, North Dakota, was closed in for the first time on April 2. This completely energized the Fargo-to-St. Cloud project. Otter Tail has a 13% ownership share and an $81 million investment in this 345-kv regional transmission project.

Otter Tail Power and MDU signed project agreements for the Big Stone South-to-Ellendale project in June. The agreements cover all aspects of the project, from funding, construction, operations and maintenance, to transmission capacity, for the life of the line. Our ownership share is 50%, which is a $184 million investment. Otter Tail Power is the construction manager, and in 2015 the project team is conducting field surveys, completely transmission align design, and acquiring land easements and obtaining necessary county and township permits. We will start construction during the summer of 2016, and expect completion by 2019.

Enbridge Energy has completed Phase 2 of the Alberta Clipper expansion, which added intermediate stations to a pipeline installed in 2009 that runs from Alberta, Canada, to Superior, Wisconsin. This pipeline ships crude oil, specifically diluted, heavy oil, from their oil sands production area in western Canada. The first phase, completed in 2009, included expansion of two existing pumping stations that Otter Tail Power Company serves. Phase 2 includes expansions of pumping capability at other sites that our company serves. These expansions will allow the pipeline to reach its full capacity.

Big Stone Plant planned outage, during which the air quality control system, or AQCS, was to be tied into the plant, was extended due to unexpected repairs to the existing plant's steam turbine. Crews found rotor blade damage during the 10-year inspection that took place during the outage. The blades weren't off-the-shelf materials, and they had to be built by the original equipment manufacturer. This created a nine-week delay. But, start-up operations are under way. The AQCS commercial operation date has moved from October 1 to December 1, which is well before our April 2016 compliance deadline.

Remember, the state-of-the-art control system will reduce emissions of nitrogen oxide, sulfur dioxide, and mercury by 80% to 90% to meet the EPA's regional haze and MATS requirements. Otter Tail's share of this investment is $207 million.

Safety remains outstanding. The project has only one lost-time injury during more than 2 million hours worked by hundreds of workers who were on-site for two years. Speaking of outstanding safety records, I should also mention that in the second quarter, Coyote Station employees achieved 14 years, or more than 2.3 million hours, worked without a lost-time incident.

Coyote continues to be at half load, following the mechanical failure of one of its boiler feed pumps in December. We expect all parts to be to the plant by mid-September, and estimate a four-week installation time and startup.

We continue to have a constructive regulatory framework for our rate-based projects. These projects are listed on slide 5, and our regulatory framework by state is shown on slide 6. This enables a compound growth rate of better than 8.5% for our rate-based investments, as shown on slide 7.

Before I turn to the manufacturing platform, I want to update you on the EPA Clean Power Plan. Yesterday, President Obama and the Environmental Protection Agency released the final rule. It limits carbon dioxide emissions from power plants. The final rule is a major change from the proposed rule, and we'll need time to digest it.

Our initial reaction is that the two-year delay on interim compliance and the phase to [end life path] over the 2022 to 2029 time frame are positive. The adjustment to the South Dakota 2012 baseline is positive. The change significantly reduces our concern about continued operations at Big Stone Plant. And, we are working to understand the significantly more stringent changes to the North Dakota [target].

Otter Tail Power has a 145 megawatt share of the low-cost coal-fired Coyote Station. In addition, we have nearly 250 megawatts of renewable wind located in the state. We will need to analyze the potential impacts of a rate or mass-based approach in North Dakota.

Minnesota's target was adjusted to account for a major plant that was offline in 2012. This is positive. With the return of Hoot Lake Plant, Otter Tail will likely have no facilities regulated under the Clean Power Plan in Minnesota after 2021. Otter Tail Power is already making significant investments in an ever-more-balanced energy portfolio. In 2013, Otter Tail Power announced the retirement of 138 megawatts of coal generation at the Hoot Lake Plant by 2021. This is 25% of the utility's coal-fired capacity. We have plans to replace this with a natural gas plant that would emit approximately half of the carbon dioxide per megawatt hour.

Since 2007, we have invested more than $300 million in wind energy. Otter Tail Power owns or purchases more than 248 megawatts of wind energy, or 19% of the utility's retail sales. And, we have an approval from the Minnesota regulators to add up to 300 megawatts more.

So, as we work through the EPA's Clean Power Plan, we will build onto steps we have already taken and we will continue to meet with states we serve to discuss potential approaches to state implementation plans. But, our major concern with the proposed rule impacting Big Stone Plant appears to have been positively addressed in the final rule.

Another ruling that's been in the news is the Supreme Court's finding that the EPA erred in not initially considering compliance costs in its Mercury and Air Toxin Standards, or MATS, regulation. As you know, the Supreme Court did not vacate the rule, but remanded it to the DC Circuit Court that upheld the MATS rule in April last year. The Supreme Court ruling has little to no impact on Otter Tail Power. Both Coyote Station and Hoot Lake Plant were required to be compliant with MATS by April 16 this last Spring, and the Big Stone Plant received an extension of the deadline so they could comply with the MATS rule when it completed the regional haze controls with the AQCS project later this year. So, in our case, the investments have already been made. Some people are asking whether this ruling will affect the Clean Power Plan. That remains to be seen. If nothing else, the ruling demonstrates that a majority of the Supreme Court will be scrutinizing EPA rulemakings that impose high compliance costs.

Now, let me update you on BTD, the largest company in our manufacturing platform. Sales challenges in the agriculture and oil and gas equipment markets continued, but we saw a number of positives this quarter. The Washington, Illinois plant picked up a major order from the wind energy industry. The paint system at the new plant in Lakeville, Minnesota produced its first round of painted sample parts, and for the second year in a row, BTD was identified as the third-largest metal fabricator in the 2014 Fab 40. This is based on revenue and projected growth.

BTD has a comprehensive, strategic plan. Its Minnesota optimization plan is generally on-budget and on-schedule. Combined with related equipment costs and lease agreements, BTD's total investment is $33 million. The plan incorporates expansions in the Detroit Lakes and Lakeville plants, and it reduces logistics costs and balances work volume between the two Minnesota locations. We may have underestimated the disruption of simultaneous major facility expansions at all BTD's Minnesota facilities, but things are coming together.

Construction is nearly complete in Detroit Lakes. Only the new parking lot and street remain to be finished. BTD began moving into the new space in May. BTD's new Lakeville expansion is progressing. The paint line components are installed and operational. Employees have run the first test panels to start the customer qualification process, and the customers who have seen the line have said that it is a major addition to BTD's services.

Significant declines in oil prices caused a dramatic reduction in volume of fracking-related parts produced by BTD's Illinois plant, disrupting an otherwise solid plan for improvement at that facility. But, a cost reduction plan is in place, and volume recovery efforts are under way, as evidenced by the pick-up on wind energy equipment orders. A new director of Illinois operations, and BTD's new Chief Operating Officer, are guiding these efforts. BTD is moving in the right direction.

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

Well, good morning. Slide 9 explains the quarterly variances on an earnings-per-share basis. Our utility net earnings increased $3 million quarter-over-quarter. The main drivers of this change are increased revenues from environmental cost recovery riders relating to our AQCS project at Big Stone, and higher MISO transmission tariff revenue from increased investments in regional transmission lines. Both the AQCS and transmission investments are a part of our rate base growth strategy.

Also contributing to the quarter-over-quarter earnings improvement were lower operating expenses, primarily due to lower plant maintenance costs incurred as part of the Big Stone shutdown in the second quarter of 2015. These costs were less than the additional maintenance expense incurred with the spring outage of our Coyote and Hoot Lake plant in the second quarter of 2014.

Additional items affecting the quarter-over-quarter earnings are noted in the earnings release and slide 9 of the presentation. Manufacturing segment revenues decreased $2.1 million from continued softness in sales to customers in oil and gas end markets, partially offset by stronger volumes in lawn and garden end markets, and the sales of horticultural products. Revenue from scrap metal sales was down due to a 40% reduction in prices compared to the second quarter of 2014. Our net earnings for the manufacturing segment were lower by $400,000 between the quarters, primarily due to the lower revenues.

BTD continues to make marked improvements in labor costs, with 119 fewer employees on a quarter-over-quarter basis. The majority of this reduction has been in the indirect labor area. Our plastics segment's net earnings increased $800,000 due to improved operating margins. This was primarily due to an approximate 9% decrease in the cost per pound sold related to decreased material costs stemming from lower resin prices, as compared to the same quarter a year ago. And, our corporate expenses decreased $2.3 million quarter-over-quarter, primarily due to the reduction in operating lease expense from the early termination of an airplane lease in the second quarter of 2014.

Please refer to slide 10 as I discuss our business outlook for 2015. We now expect to be in the middle-to-upper half of our earnings per share guidance range of $1.50 to $1.65 per share. This is being driven in part by the stronger-than-expected second quarter performance, along with our view of current business conditions in our respective segments.

Our backlog for the manufacturing segment is $85 million for the remainder of 2015. This compares with $86 million for the same time a year ago. Quoting opportunities are softer than the prior year, as agriculture, energy, mining, and oil and gas volumes are low. Our forecasts expect softening due to these changes.

Our lawn and garden end market has been strong in 2015, and we expect to see this continue when production seasonality begins in the fall of 2015. Bidding opportunities of contract parts has declined $48 million between 2014 and 2015. Our guidance by segment remains unchanged, and this guidance reflects an expected return on equity in the range of 9.5% to 10.4%.

As mentioned in our last quarter's call, we're taking steps to address this year's financial challenges. Our second quarter results reflect those efforts. We have worked hard to lower costs and improve overall performance. This has resulted in significantly higher net income from continuing operations quarter-over-quarter. And, Otter Tail Corporation currently provides 4.6% dividend yield based on our current annual indicated dividend of $1.23 per share.

We are excited about our future. A healthy balance sheet, strong investment-grade credit ratings, solid regulatory environments, and continued opportunities to invest in utility rate base and organic growth in our manufacturing platform, position us well to meet our long-term stated growth goals of 4% to 7% compounded annual growth rate of earnings per share.

I'll turn it over to the operator.

Thank you. (Operator instructions) And our first question comes from the line of Matt Tucker of KeyBanc Capital markets. Your line is now open.

Hey, good morning, guys, and congrats on a nice quarter.

Thanks, Matt.

With respect to the intact guidance range, and your expectation that you'll come in towards the upper end, could you comment on which segments you see kind of driving the results towards the high end?

Sure. You know, as we look at it, the electric and plastics segments, clearly based on the performance that they've had not only in the second quarter, but plastics for the first half of the year, are in part the reason, what's driving that middle-to-upper half of the range, Matt.

Got it, thanks. Then in electric, it looks like weather's been a little bit of a headwind year-to-date. Could you comment on the weather-normalized sales growth that you've seen so far this year, and your expectations for that going forward?

Sure. This is Chuck. Year-to-date over normal, we're about $0.02 behind on weather. If you do year-to-date, year-over-year, it's approximately $0.07.

And I guess do you have, going forward, an expectation of kind of the sales growth rate you'd expect to see in normal weather?

Well, we assume approximately three-quarters of a percent plus any of the new pipeline load, which comes on in blocks, but we'll ultimately move that number up between 1.5% and 2% for the year.

Great, thanks. And then also in electric, any kind of outsized O&M expenses, plant outages or anything like that we should be thinking about in the second half?

Matt, this is Kevin. We're pretty well through the kind of the maintenance phase of the Big Stone Plant, and there isn't any further unusual expected maintenance costs in the forecast.

Great, thanks. And then, with respect to the investments at BTD, do you expect the benefits of that to start showing up much in the second half of the year, or do you think that will become more of an impact in 2016?

Hey Matt, it's Kevin again. From the paint perspective, as Chuck mentioned in his comments, we're starting to do some first articles of paint. In a number of cases, it's about a 60-day process for a number of our customers to be in a ready -- you know, watch, look at the test of the paint that's coming out, and then say, okay, let's go. So, any benefit we expect from paint probably won't be seen until starting in the fourth quarter. Late third quarter, fourth quarter.

Great, thanks, guys. Congrats again. That's all I had.

Thanks.

Thank you. (Operator instructions) I'm showing no further questions at this time. I'd like to turn the conference back over to Mr. Chuck MacFarlane for further remarks.

Thanks. I'll summarize by saying that strong performance led to a better-than-planned earnings for the second quarter. Continued rate base cost recovery at the utility, improving performance at BTD, and good cost management throughout the corporation confirm our guidance.

We want to thank all of our employees for their hard work, and we want to thank you for joining the call and for your interest in Otter Tail Corporation. We look forward to speaking with you next quarter.

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