Otter Tail's (OTTR)' CEO Edward McIntyre on Q1 2014 Results - Earnings Call Transcript

| About: Otter Tail (OTTR)

Otter Tail Corporation (NASDAQ:OTTR)

Q1 2014 Earnings Conference Call

May 6, 2014 11:00 AM ET


Loren Hanson – Manager of Investor Relations

Edward J. McIntyre – Chief Executive Officer and Director

Charles S. MacFarlane – President and Chief Operating Officer

Kevin G. Moug – Chief Financial Officer and Senior Vice President


Matt Tucker – KeyBanc Capital Markets, Inc.


Good morning and welcome to the Otter Tail Corporation’s First Quarter 2014 Earnings Conference Call. Today’s call is being recorded and there will be a question-and-answer session after the prepared remarks.

I would now like to turn the call over Mr. Loren Hanson. Mr. Hanson, you may begin.

Loren Hanson

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 first quarter 2014 results. Our complete earnings release and slides accompanying this earnings call are available on our website at 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 President and CEO; Chuck MacFarlane, Otter Tail Corporation’s President and Chief Operating Officer, Kevin Moug, Otter Tail Corporation’s Senior Vice President of Finance 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 the call over to Otter Tail Corporation’s CEO, Mr. Jim McIntyre. Jim.

Edward J. McIntyre

Good morning and thanks for joining our call today. As we said in our news release yesterday, with consolidated net income from continuing operations up over 40% compared with the first quarter last year, we are more than pleased with our 2014 first quarter results. Our strategy to grow the utilities rate base and to improve the operational financial performance, all the manufacturing infrastructure companies under Varistar is pay off.

I’ll leave it to our new President and Chief Opertaing Officer Chuck MacFarlane and to our CFO Kevin Moug, to provide some detail on that. What I want to emphasize is that we’ve done a much better job in the last few years of developing and executing our strategy. And we’ve done a better job of creating alignment among the board of directors, the executive management team and our respective operating companies.

As a result we see a commitment among employees at all companies to continuously drive performance and to move [durables] (ph) even as they encounter challenges. We see it in the utility safety and customer satisfaction records, the pipe companies growing market share, the manufacturing company’s partnerships with their customers and the construction companies returned profitability.

At our recent annual meeting of shareholders, I talked about our critical; our employees are in executing our strategies. Improved alignment is helping our employees see themselves as critical to their company’s successes. It’s helping them see their company’s successes as critical to the corporation success and vice versa, that level of employee understanding and engagement make strategy more fruitful.

Thanks to employee efforts and all front, I can summarize the corporation strategic outlook like this. We have high performing electric utility with the approved rate base grown for at least five years, support of regulatory treatment, solid management in place and history of excellence. We also have a more focused set of manufacturing and infrastructure companies under Varistar providing an emphasis on position and continuous improvement, incremental earnings for all and premium return.

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

With that I would like Chuck to provide some detail on company operations and I will be available at the end of the call, if you have questions. You met Chuck on this call on February. He is the former President and CEO of Otter Tail Power Company. After our Annual Shareholder meeting and Board meeting in April, he assumed the role of president and Chief Operating Officer of the corporation. We expect to replace me when I retire, a CEO on next April and I have very confidence at him. Chuck.

Charles S. MacFarlane

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

We are also earnings our return during development construction of the MISO and multi-value projects and CapX2020 transmission projects. These projects are providing necessary regional infrastructure to support electrical system reliability and enable additional renewable energy develop. There are also opportunities to grow the utilities rate basis we’ve been discussing with you on previous call.

The majority of these projects will be completed between 2016 and 2019 and although the utility of several other rate based projects coming up, which I’ll discuss in a moment. The corporations will look to the manufacturing infrastructure companies under Varistar to provide incremental growth, that’s why we continue to hold and plan to develop these companies.

It’s also why I in my new role at corporation and in addition to keeping an eye on the large utility projects. One of my first priorities is to expand my understanding of each of our operating companies. They remain important to our overall strategy. My other priority is during the first six months are to work on the leadership transition with Jim, build relationship with investors and analysts and onboard of the new Utility President.

As you’re probably aware Tim Rogelstad replaced me as President of Otter Tail Power and Senior Vice President of the electric platform for Otter Tail Corporation. Tim is an electrical engineer and has been with our company for more than 25 years. He most recently, he served as our Vice President of Asset Management overseeing our system operations, transmission assets, deliver engineering and the utilities capital prioritization process.

Over the years, Tim has been a key leader in many of the utilities accomplishment of projects, including the large multi-company transmission projects in our early entry into wind energy. Tim is an excellent thinker and negotiator I have every confidence he will maintain and even increase the positive momentum within the utility. I anticipate a virtually seamless transition.

Before, I turn it over to Kevin for financial review; I want to briefly discuss a few items. First I want to point out that colder than-normal winter boosted electric sales, but the majority of the increased earnings in the first quarter were related to rider recovery and that’s important, because the utility will see $657 million in capital expenditure during the next five years. Much of it related to environmental upgrades and transmission projects I mentioned earlier.

As you can see on Slide 4, the significant investment results projected 80% increase in rate base and 10% compound annual growth rate between 2012 and 2018. The majority of these investments are under established riders.

You can see from our cost recovery mechanisms on Slide 5, historic renewable projects excluding South Dakota, transmission projects i.e. the CapX and MVP projects environmental i.e., The Big Stone Plant AQCS and the fuel clause adjustment recovered by riders. We believe we can serve our customers and provide a fair return to our shareholders without a rate case for the next one to two years.

Client six was generation projects including two that are outside the five year capital budget forecast. You first see The Bid stone AQCS project which is over 40% complete, the $204 million estimate is 20% lower than the original budget used in the Advanced Determination of Prudence filings approved by Minnesota and North-Dakota Commissions.

We are also studying how to provide a least cost, long-term resource to replace Hoot Lake plant’s generation, because we plan to retire Hoot Lake as a coal facility in 2020. Hoot Lake is our only coal facility impacted by the recent U.S. Supreme Court ruling on Casper and we anticipate limited impact due to Hoot Lake’s planned retirement. There are several major natural gas supply lines within our three state system and many locations provide good sites for new natural gas generation.

We are working to find the best alternative for customers the existing Hoot Lakes site remains a candidate although it would need significant gas line construction into the site. Whichever alternative we choose, we estimate an approximate $200 million expenditure in the 2020 to 2022 timeframe. On this slide, we also see a potential expenditure for a wind farm.

About a year ago Otter Tail Power entered into a 25 year contract to purchase wind energy from the existing Ashtabula III wind farm northeast of Valley City, North Dakota. It’s a 62.5 megawatt farm owned by subsidiary of NextEra Energy, but the contract includes an option for us to purchase the wind farm after 10 years. If we choose to do so it would add about $50 million through a rate phase 2023.

Neither of these last two capital expenditures is included in the previously reported $657 million five year capital budget. Slide 7 lists transmission projects we are involved with, Otter Tail Power was the lead developer we are in the Bemidji to Grand Rapids 230 KB line which was energized in 2012.

The cross part of Chippewa National Forest, which is above eagle nesting habitat. Our employees did a good job of managing this environmentally and culturally sensitive project. I’m pleased to report that is one of the finalist for EEI’s Annual Edison award. Next is the Fargo at St. Cloud 345 KB project which should be in service early next year. Xcel is leading this project.

The Brookings county to Hampton project is also projected to be on service next year, and Great River Energy has been a lead on that. We are a 50/50 owner with Xcel in the Big Stone South to Brookings which is both the CapEx 2020 and MISO MVP projects Xcel is leading out of that effort and we have received a route permit from the South Dakota PUC and construction activities should start in the third quarter of this year. And we are also a 50/50 owner with MVU in the Big Stone South to Ellendale project. We hope to receive a route permit during 2014, as for the manufacturing and infrastructure companies under Varistar, earnings for all six companies were generally inline with expectations this quarter.

We continue to focus on improving operations and reducing costs in this narrowed portfolio companies. During the next several years we will concentrate on organic growth and potential acquisitions particularly in the manufacturing segment. Our goal is to maintain the approximate 15% to 25% total earnings contribution from Varistar, even as Otter Tails Powers rate based related investments occur.

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

Kevin G. Moug

Well good morning. As I discuss our first quarter results. Our Electric segment had a strong first quarter with revenues up nearly 18% and net income up 40% compared to the first quarter a year ago. These results are consistent with our earnings expectations from this segment. The increase is earnings were primarily a result of our rate based investment strategy as we are seeing the impact on our financial results from environmental and transmission cost recovery riders as the utility continues to build out infrastructure projects as Chuck previously discussed. The impact from the colder than normal weather in the first quarter was $0.03 a share.

Our Manufacturing segment earnings were down slightly from first quarter 2013, primarily due to increased material cost, support wages and product handling costs anticipated sales growth in 2014 at BTD and lower revenue into the T.O. Plastics due to an expected reduction in revenues to a product a customer began producing on its own in 2014.

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

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

On May 2, 2014 the corporations Board of Directors declared quarterly dividend of $30.25 per share. The dividend is payable to shareholders are record on May 15, 2014. This represents 302 consecutive quarter, we have paid common dividends to our shareholders.

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

As we’ve discussed in our February 2014 earnings call items contributing to the Electric segment net earnings increased over 2013 results include. Rider recovery increases, including environmental riders in Minnesota and North Dakota related to the Big Stone AQCS environmental upgrades. Lower pension benefit costs of approximately $2.0 million as a result of an increase in the discount rate from 4.5% to 5.3%.

These items were offset by an increase in interest costs as a result of $150 million of fixed rate long-term debt there was put in place in the first quarter of this year to finance the Electric segments, transmission projects and Big Stone Plant AQCS and an increase in operating and maintenance costs primarily for increased labor and a planned outage at Hoot Lake Plant.

We are maintaining our original 2014 guidance for our Manufacturing segment and our backlog for the segment is $150 million as of March 31, 2014 compared with $97 million as of March 31, 2013. We are increasing the previous 2014 guidance for the Plastic segment due to a stronger than expected first quarter. And we are maintaining the original 2014 guidance for the Construction segment. We continue to see improvement from better cost controls and more selective bidding on projects with the potential for higher profit margins

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

We are pleased with our first quarter results, strong results in the electric utility plastics and corporate costs here is our support of our increase in 2014 earnings guidance to be in a range of $1.60 to $1.80 per share. We continue to execute on our strategies the results of which are reflected in our first quarter and revised 2014 earnings guidance.

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

Question-and-Answer Session


Thank you. (Operator Instructions) Our first question is from Matt Tucker with KeyBanc Capital Markets. Your line is open.

Matt Tucker – KeyBanc Capital Markets, Inc.

Hi, good morning. Thanks for taking my questions. First question on the sale of Aevenia's data communication business, I guess can you just provide a little color on the rationale for the sale and if possible – if you can given us any sense of kind of what that’s business has been contributing in terms of revenue and your earnings?

Edward J. McIntyre

Sure, the rationale behind the sale that was it really was in our strategic outlook in Aevenia business for us to continued to commit resources as a result of the business and it just in terms of said it was there. In terms of the – the revenues, you maybe just from an earning standpoint. It was a significant contributor so as I think as you look forward, the business is reflective of the existing business [indiscernible] and it was enroll significant contributor from an earning standpoint and so, it allows us to move away from that business and focus on the core business at our avenue in.

Matt Tucker – KeyBanc Capital Markets, Inc.

Got it. Thanks and then just on the low income housing sale. How much if any legacy real estate assets or like that do you still have left on the books and if there are any, does this sale encourage you in terms of the prospects for – I’m noting the rest of that in the near-term.

Edward J. McIntyre

Yes we still have, I think its some where about five and seven investments in the low income housing on the book, so we’ve written those investments down to zero by now, so to the extent that there are potential to sell those in the future and there is opportunities for some gains there.

Clearly this one was – the sale of this was a little more healthy from a sales price and what we’ve seen in the past, and as we look forward we can at Otters, I can say with these five and seven that are left and we don’t really expect there is going to be significant amounts of earnings that get generated from these, it will certainly help, but this was a little over penny of share.

Matt Tucker – KeyBanc Capital Markets, Inc.

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

Charles S. MacFarlane

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

Matt Tucker – KeyBanc Capital Markets, Inc.

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


Thank you. (Operator Instructions) And it looks like we have a follow up from Matt Tucker with KeyBanc Capital Markets.

Matt Tucker – KeyBanc Capital Markets, Inc.

Hey guys, just a few more here. At the utility, it looks like O&M was up quite bit year-over-year. I guess how much of that was attributable to the extreme weather. Should we expect similar increase throughout the rest of the year or again I guess the sum of that is just attributable to the weather?

Charles S. MacFarlane

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

Matt Tucker – KeyBanc Capital Markets, Inc.

Got it, thanks. And then the Plastic segment, you guys mentioned pricing per pound was down a bit in the quarter cost per pound was up a bit. Could you comment on how those metrics have trended now here into the second quarter, but we see them going for the rest of the year I guess.

Kevin G. Moug

Yes, Matt this is Kevin; there was in the first quarter our resin suppliers had announced about $0.09 of price increases that they were looking to get from raw materials. A majority of that held and there weren’t a lot of – weren’t able to pass those Foley resin price increases through to the customers. And their as we look we currently we are still expect to similar type view through the rest of – what was the guidance here for the rest of the year but we still continue to see the market where the resin manufactures are looking to get some higher prices from the resin and its becoming a little more difficult right now to get some of those all those prices pass on through the end customer.

Matt Tucker – KeyBanc Capital Markets, Inc.

Got it so it would be fair to say that your outlook for quarters two to four how its really changed in the guidance revision really – mostly reflects the first quarter come in about your expectations.

Edward J. McIntyre

That’s correct.

Matt Tucker – KeyBanc Capital Markets, Inc.

Thank you. And then it manufacturing its specifically T.O. Plastics do you see opportunities for them to replace the business thing lost with the customer to decide in source or do you proceed that being kind of continued headwinds for the reminder of the year.

Edward J. McIntyre

They are looking to replace that revenue, we mentioned I believe in the third and fourth quarter, earnings call that T.O. was now looking to enter into the food packaging markets. And so there, they continue to make inroads into that food packaging market, but we don’t expect to see that fully offset in 2014 as they continue to build in those food packaging markets that we fully expect its going taken you know a year so to ramp up and develop relationships with customers there.

Matt Tucker – KeyBanc Capital Markets, Inc.

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

Charles S. MacFarlane

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

Matt Tucker – KeyBanc Capital Markets, Inc.

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

Kevin G. Moug

Thanks Matt.


Thank you. (Operator Instructions) I’m not showing any further questions; please proceed with any closing remarks.

Edward J. McIntyre

Thank you. Our first quarter performance in our outlook for 2014 reflects the increased transparency of the Utility capital project’s pipeline, and related cost recovery through various approved Riders. Additionally, the improved operational ad financial performance of our manufacturing and infrastructure companies under Varistar contribute to our overall strategy. We believe our strong first quarter results are evidence that we’re delivering on our strategy and in it has better positioned us to deliver increased earnings for 2014 and beyond. Thank you for joining our call and for your interest in Otter Tail Corporation. We look forward to speaking with you next quarter.


Thank you, ladies and gentlemen. This does conclude the call. And you may all disconnect. Everyone have a great day.

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