Otter Tail Corp (OTTR) 2015 Q3 法說會逐字稿

Good morning, and welcome to Otter Tail Corporation's third-quarter 2015 earnings conference call. Today's call is being recorded, and there will be a question-and-answer session after the prepared remarks.

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 third-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 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 will now turn the call over to Otter Tail Corporation's President and CEO, Mr. Chuck MacFarlane. Chuck?

Good morning, and thanks for joining our call.

Our overall strategy is designed to support long-term stability and organic growth through rate-based expansion and manufacturing investments. Slide 5 shows our rate-based expansion and a compound annual growth rate of 8.6%. Slide 6 shows our regulatory framework, which continues to be constructive.

Manufacturing platform [leaders] are guiding improvement in each of our businesses, including BTD's Minnesota facilities expansion and the integration of our recent acquisition, both of which I will discuss shortly.

I would like to begin with an update on the utility. Otter Tail Corporation's earnings per share from continuing operations were $0.42 this quarter, largely driven by strong performance at Otter Tail Power. The electric segment reported a $4-million quarter-over-quarter improvement in net income. More than half of this improvement came from increased rider recovery on rate-based investments and increased weather-normalized sales.

The impact of warmer weather in the third quarter led to a 51% increase in cooling-degree days quarter over quarter. This is comparatively better than last year but close to normal for the quarter.

I will now provide updates on three of the capital investments shown on slide 7. The Big Stone South to Brookings 345-kV transmission project has a total value of $212 million, and our share is $106 million.

This project held a groundbreaking ceremony and construction kickoff on September 14 in Clear Lake, South Dakota. Local and state government officials, including Governor Daugaard, attended. We are a 50-50 owner with Xcel Energy in this project, and Xcel is the project manager.

Big Stone South to Ellendale is another large regional transmission project, valued at $370 million. Our share is $185 million. This project is scheduled to begin construction in 2016, and we are a 50-50 owner with MDU. Otter Tail Power serves as construction manager. We continue to make positive progress on preparation toward the start of construction.

The environmental upgrade at Big Stone Plant is nearing completion. The total value of this project is $384 million, and our share is $207 million. We have been recovering cost through riders during the construction phase of this project. Equipment is in the testing phase, with commercial operation expected well ahead of our April 2016 compliance deadline.

While I'm discussing power plants, I should mention that Coyote Station is expected to return to full service by early December. You'll recall the plant has been running at reduced loads since it incurred a significant damage to a boiler feed pump late last year.

Also of note, Enbridge Energy increased its energy usage on the Otter Tail Power system. This is due to recent pumping-station additions in our area and elimination of downstream constraints on the Enbridge Pipeline system.

Next, I'll take a couple of minutes to expand upon the Clean Power Plan and the impact of other recent environmental rules on Otter Tail Power.

On August 3, the EPA released the final Clean Power Plan to reduce carbon dioxide emissions from power plants. The plan regulates greenhouse gas emissions from existing fossil-fuel-based power plants under Section 111(d) of the Clean Air Act.

Under this plan, states choose between rate-based goals, measured in pounds of CO2 emitted per megawatt hour generated, and mass-based goals, measured in tons of CO2. Emission reductions are phased in over the 2022 to 2029 interim period, with final targets achieved by 2030. When the plan is fully implemented, the EPA projects that the power sector will have reduced CO2 emissions by approximately one third of 2005 levels.

The final 111(d) rule is a major change from the proposed rule. In the final rule, states with a higher percentage of coal-fired generation receive more stringent targets, and those with a lower percentage of coal-fired generation generally receive less stringent targets.

In South Dakota, we're encouraged by the mass-based target increase. South Dakota was credited for a 2012 natural-gas combined cycle plant that was under construction and was also one of seven states receiving an adjustment for significant hydro resources. This is a positive for Big Stone Plant, which was our primary concern with the proposed rule.

In North Dakota, we're concerned about significant reductions in both rate- and mass-based limits and the potential impact on Coyote Station. State compliance will require adding a substantial amount of renewable energy, reducing coal generation by 40%, or a combination of both.

In Minnesota, we don't have an immediate compliance concern because we intend to retire Hoot Lake Plant by May of 2021, prior to the first compliance period started in 2022. Under a mass-based approach, we would anticipate receiving an allocation of future allowances after the Hoot Lake Plant retirement that could likely be used for compliance at Big Stone or Coyote.

We anticipate that our customers will experience cost increases due to this rule, but the extent and timing are uncertain at this early stage. We won't be able to make a meaningful estimate until the states we serve have determined the framework of their individual state implementation plans. This will likely take over two years. Otter Tail Power continues to work closely with stakeholders as states begin to develop their implementation plans.

Another environmental rule which the EPA announced on September 30 is the final rule for the [steam] Effluent Limit Guidelines, or ELGs. This is a national regulatory standard for wastewater discharge to service waters and is first significant revision of the Clean Water Act ELGs in more than 30 years.

Generally, the final rule establishes new requirements for wastewater streams from scrubbers and ash transports. We are optimistic that Otter Tail Power's units are well positioned for compliance because they currently do not discharge any ash-handling water.

The third environmental rule I will mention today is the EPA's October 1 announcement that it has tightened the National Ambient Air Quality Standards for ozone from 75 parts per billion to 70 parts per billion.

It appears that the states we serve will not have any new nonattainment counties at the 70-parts-per-billion level. But our states still could be impacted by the rule if the EPA modeling determines that they contribute to nonattainment of any downwind area.

Nonattainment areas are required to meet the standard in the 2020 to 2037 time frame, with deadlines depending on the severity of an area's ozone level. If not for the Clean Power Plan, the ash-handling and ozone rules would have been the top environmental rules for the year.

One more utility item before turning to the manufacturing platform is to let you know we expect to file a rate case in Minnesota by year end, but the amount of our request has not yet been finalized.

Turning to the manufacturing platform, the big news this quarter is the recent BTD acquisition of Impulse Manufacturing, located 30 miles north of Atlanta.

Now called BTD Georgia, the 200-plus employee plant offers a range of metal-fabrication services, such as sheet and tube laser cutting, complex weldments, assembly, and a state-of-the-art paint line. The strong customer base aligns closely with BTD's existing business. End markets served include agriculture, construction, and transportation. This acquisition allows BTD to accelerate its plan to expand into the southeast to serve its growing customer base.

Integration is well underway with an experienced integration team. Key risks, opportunities, and synergies identified in due diligence are incorporated into the integration plans.

In early October, Kevin and I toured the Georgia plant, met with employee groups to celebrate and thank them for a smooth transition, and visited BTD Georgia's largest customer, Caterpillar.

And other news at BTD is related to the Minnesota facility's expansion. Construction is complete in Detroit Lakes. The warehouse is fully operational, and BTD has implemented a more efficient process [layout].

BTD Lakeville's office and loading-dock project is complete. The first customer production jobs have run through the new paint line. The warehouse addition is complete, and finished goods are moving into this location, allowing us to close an existing offsite warehouse.

BTD is continuing to see lower sales volumes in the agriculture end markets, as well as the oil-gas end market. We're also learning about extended holiday plant closures at some of our customers' plants.

That said, BTD picked up a significant order from an agriculture-equipment manufacturer that is outsourcing some existing internal work. And we expect that the southeast expansion and investment in Minnesota facilities will enable the Company to improve sales by expanding its geographic reach and services to customers.

T.O. Plastics, Northern Pipe, and Vinyltech each met performance expectations. In fact, the plastic segment's earnings are up quarter over quarter, which is impressive, given that sales prices are declining.

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

Hello, and good morning.

Slide 8 shows quarter-over-quarter earnings per share from continuing operations increased 16.7%, from $0.36 to $0.42. We continue to deliver growing earnings from the electric segment, driven by our rate-based investments. And we are also excited to have completed the acquisition of Impulse Manufacturing.

Please move on to slide 9, as I discuss our quarterly results.

Utility net earnings increases $4.3 million quarter over quarter. The main drivers of this change were increased rider revenues from environmental cost-recovery riders, related to our AQCS project at Big Stone. Our other base electric revenues grew primarily due to more sales to pipeline customers and more revenues recoverable under the conservation incentive program riders.

Warmer weather contributed $0.02 a share quarter over quarter. Year over year, weather is a drag on earnings per share of $0.05, and the impact of weather for the third quarter and year to date is close to normal. And it is important to remember that Otter Tail Power Company is a winter-peaking utility and a summer-peaking [pool].

Lower plant-maintenance costs related to our Hoot Lake Plant, which had major maintenance done in the third quarter of 2014, also contributed to the improved quarter-over-quarter earnings. The lower maintenance costs were offset in part by higher employee-benefit costs.

Our manufacturing-segment revenue decreased $3 million quarter over quarter, mainly due to continued softness in sales to customers served by BTD in the agricultural as well as oil and gas end markets. These soft end markets have impacted earnings per share by $0.04 quarter over quarter.

Also negatively impacting BTD's earnings is lower scrap sales, due to a reduction in scrap-metal prices quarter over quarter. Slide 11 illustrates the trend in scrap prices since 2009. This softness in scrap-metal prices continues to be plagued with excess steel capacity in the US market and low-priced steel imports.

The reduced sales at BTD were mitigated in part by additional revenues from their new Georgia facility, acquired September 1, 2015. And as disclosed in our press release announcing this acquisition, we don't expect the acquisition to be profitable during the four months ending December 31, 2015.

Offsetting the lower revenues at BTD were increased sales to end markets served by T.O. Plastics. And net earnings for this segment were lower by $1.2 million, primarily due to the continued challenges in softening end markets at BTD, offset slightly by increased earnings at T.O. Plastics.

Our plastic segment's net earnings improved $400,000 quarter over quarter. Volume of pipe sold was flat between the quarters, while sales prices declined 9.4% due to declining PVC resin prices. We were able to improve operating margins in light of the declining sales prices, as the cost of PVC resin experienced a greater decline quarter over quarter.

And our corporate expenses were higher by $1 million quarter over quarter, primarily due to an upturn in employee-benefit costs and casualty-insurance expense.

Let me now talk about our updated business outlook by talking [off of] slide 12, which highlights our earnings-from-continuing-operations guidance for 2015.

We are reaffirming our overall guidance range for consolidated earnings per share from continuing operations to be in the middle to upper half of $1.50 to $1.65 per share. We are also revising our segment guidance. We are raising the electric-segment guidance to $1.26 to $1.29 per share, based on our strong year-to-date results.

The manufacturing-segment guidance is decreased to $0.15 to $0.19 a share, given the following conditions. BTD continues to experience additional softness in agriculture, energy, mining, and oil-and-gas equipment end markets; and these market conditions are now causing certain customers to announce longer-than-normal holiday plant shutdowns.

Prices for scrap metal continue to decline and are now approaching early 2009 levels. These prices have dropped even lower than we previously forecasted.

T.O. Plastics is also contributing to the downward revision in the manufacturing-segment guidance, given a pull-back in volume in the custom-products end markets. Certain customers have also experienced unsuccessful or delayed new-product launches, which is now causing lower sales levels than previously expected.

And in addition, T.O. has been notified that another customer is going to start manufacturing more of a certain product in-house and not rely as much on its supplier base.

Our backlog for the manufacturing segment is $45 million for the remainder of 2015, and this compares to $50 million at the same time a year ago. We are raising the guidance of the plastic segment, given the strong year-to-date performance, and our corporate costs continue to be in line with our expectations.

The current earnings guidance from continuing operations is based on current enacted tax law. Should the federal government change the tax law before the end of 2015, our guidance could be negatively impacted in a range of $0.02 to $0.04 per share. And our current guidance reflects an expected return on equity in the range of 9.5% to 10.4%.

We were pleased with our third-quarter results. They reflect a balanced mix of earnings from our electric and manufacturing platforms. Our electric and plastics segments are performing well, executing on growth initiatives and delivering strong earnings. These segments are providing the needed support to the sluggish earnings in our manufacturing segment.

We are especially excited about BTD's new facility in Georgia, which will allow us to better serve our growing customer base in the southeast. And we remain confident we are in the position to meet our long-term stated growth goals of 4% to 7% compounded annual growth rate of earnings per share.

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

(operator instructions) Grier Buchanan, KeyBanc Capital Markets.

Thanks for taking my question. I first wanted to touch on the Clean Power Plan. I appreciate that commentary. The question is, how involved do you expect that [your utility and peers] will be in Minnesota, and particularly in the Dakotas as states formulate their compliance plans? Will this be a pretty collaborative process? I'm mainly trying to get a sense of roughly when the generation needs outside of Hoot Lake might come into focus. Chuck, I think you mentioned around two years.

Thanks, Grier. I expect a collaborative process in all the states served. In South Dakota, it's going to be a smaller group, more likely, because there's less fossil-generating sources. There's only two companies that have facilities in South Dakota. In Minnesota, I think the MPCA has already had outreach. In North Dakota, the Department of Health has also had that.

I think people are digesting it, trying to figure it out. And then we will be in each of those states meeting as groups to discuss a basic framework for these state implementation plans that either the Department of Health or MPCA in each of the given states will start to lay out.

Okay, thanks. And then shifting over to manufacturing, could you -- sorry if I missed this, but could you remind me when you expect to complete the planned expansions, and if possible maybe speak qualitatively about which market segments you expect that might open the most to you as a result of these facilities expansions?

I'll take a crack at the expansions. In Detroit Lakes, we are within a month of being complete there with all the construction activities.

In Lakeville, it will go on through June, where we are transitioning out of another building, if you will, to get all of our facilities under one roof, with raw material coming in one end, fabrication, cutting, warehousing, paint, and assembly; and then final finished-goods storage will all be under one continuous flow, one roof. But that will take until June of 2016 to get everything moved out of the other facility.

And Grier, Kevin. In terms of your second question, I think that the expectation, particularly with the addition of paint, isn't so much new markets; it's a full expansion of being able to serve also existing customers.

We have been seeing where a number of our customers are looking to have a one-stop shop from their supplier base, inclusive of paint. And we haven't been able to provide that. We've had to outsource the paint here [until the] addition of the paint line in Lakeville.

And so we really expect to see our existing customers also -- growth opportunities open up with them as they start to move paint opportunities to us that we haven't previously experienced.

Thanks, Kevin. That was my recollection, as well. And I wasn't trying to suggest that this would open up new markets for you, just trying to get a sense of whether there were any specific market segments that -- based on your conversations with existing customers, who are for certain jobs looking for that one-stop shop, might open up to a bigger source of business as a result of these expansions. (multiple speakers) And if it's broad-based, that's fine. Like, if it's just across -- broad-based, the opportunities would be spread out across the business, that's fine. I'm just curious.

I would say that it's a pretty broad-based-type expectation. I mean, clearly there's probably more opportunities within some of the end markets to paint more than others, just depending on the type of product that we're providing for the customers and what their actual paint needs are. But there are certainly opportunities across all of our existing end markets to provide that service.

Okay, thanks. Last one for me -- is there anything in backlog associated with the agriculture and energy markets?

There is dollars in backlog. But as you can see, we are -- experienced somewhat of a downturn in the backlog when you compare it to the same time a year ago. But our backlog is reflective of the collective end markets we serve, and there is backlog in there from [ag].

How significant, if you're able to say?

We're not able to say that, Grier.

Okay, fair enough. That's it for me, guys, appreciate it.

(operator instructions) I'm showing no additional questions or comments in the queue at this time. I'd like to turn it back over to Mr. MacFarlane for any closing remarks.

Thank you. I'll summarize by saying that the electric-segment performance led to a solid earnings for the third quarter. Continued rate-based cost recovery at the utility, solid performance in our plastics segment, and good cost management throughout the corporation reaffirm 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 concludes the program. You may now disconnect. Everyone, have a wonderful day.