Otter Tail Corporation (NASDAQ:OTTR)
Q2 2014 Earnings Conference Call
August 5, 2014 11:00 a.m. ET
Loren Hanson – Manager of Investor Relations
Jim McIntyre – Chief Executive Officer
Charles MacFarlane – President and Chief Operating Officer
Kevin Moug – Chief Financial Officer and Senior Vice President
Matt Tucker – KeyBanc Capital Markets
Good morning and welcome to the Otter Tail Corporation’s Second Quarter 2014 Conference Call. Today’s call is being recorded and there will be a question-and-answer session after the prepared remarks.
I would now like to turn the conference over to your host Mr. Loren Hanson. Mr. Hanson, you may begin.
Good morning everyone and welcome to our call. My name is Loren Hanson and I manage the Investor Relations area at Otter Tail. Last night, we announced our second quarter 2014 results. Our complete earnings release and slides accompanying this earnings call are available on our website at www.ottertail.com. A replay of the call will be available on our website later today.
With me on the call today is Jim McIntyre, Otter Tail Corporation’s CEO; Chuck MacFarlane, Otter Tail Corporation’s President and Chief Operating Officer, Kevin Moug, Otter Tail Corporation’s Senior Vice President and Chief Financial Officer.
Before we begin, I would like to remind you that during the course of this call, we will be making forward-looking statements. These forward-looking statements are covered under the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995 and includes statements regarding Otter Tail Corporation’s future financial and operating results, or other statements that are not historical facts. Please be advised that actual results could differ materially from those stated or implied by our forward-looking statements, due to certain risks and uncertainties, including those described in our most recent Form 10-K and subsequent quarterly reports on Form 10-Q. Otter Tail Corporation disclaims any duty to update or revise our forward-looking statements, as a result of new information, future events, developments or otherwise.
For opening remarks, I would now like to turn the call over to Otter Tail Corporation’s CEO, Mr. Jim McIntyre. Jim?
Good morning and thanks for joining our call today. As I pointed out in our news release yesterday, our strong 2014 first quarter performance has continued in the second quarter. Consolidated net income from continuing operations is up more than 30% this year compared with second quarter last year. And you recall that it was up 40% the first quarter compared with first quarter last year.
Consistent execution of our strategy to grow the utilities rate base and to improve the operational and financial performance of the manufacturing and infrastructure companies under Varistar is paying off. We intend to build on that strategy.
Since we talked with you in May, we’ve completed our annual strategic planning work. It’s another step in the strategic journey that brought us from $0.95 per share from continuing operations in 2011, as Slide 4 shows, to a non-GAAP basis of $1.31 in 2012 and $1.54 in 2013, and reflects the recent current analyst consensus of $1.75 for 2014.
For the past several years, our strategy is focused on rebuilding and better aligning our businesses, achieving operational excellence and developing our talent. It has been an incremental process, as the slide shows, and has resulted in a markedly different revitalized Corporation. It better reflects our targeted overall moderate risk profile and our shareholder base.
We've dramatically improved earnings-per-share. We’ve made operational excellence a central focus in all of our operating companies and we've made good progress in developing our talent. Rather than fixing problems from the past, we have turned to optimizing opportunities in the future. We intend to achieve a 4% to 7% average annual growth rate earnings based on 2013 non-GAAP results of $1.54 per share.
We have two platforms - Otter Tail Power Company and the manufacturing and infrastructure companies under Varistar. Both are healthy, both are growing, both are important. We will only be successful, however, if our corporate strategic objectives drive the strategic objectives of Otter Tail Power and the manufacturing and infrastructure companies. The strategic objectives of all three must align and we believe they do.
We also will only be successful if we have strong leadership. I call this Leadership Connection. And you will see on Slide 5, every good business has a strategy and many businesses have a focus on operational excellence. The strategy in operations can only produce consistently strong results if they are brought together by good leadership.
In Otter Tail Corporation we view all of our employees as leaders. We are intentional about developing our people. We consider them to be assets, and we believe they have the ability, interest, capacity to deliver value to our shareholders.
With our talent development programs in place, we're confident that as we continue the current leadership transition at the CEO level and other top management positions, others will be ready to lead throughout the organization.
Otter Tail Corporation also has a strong Board of Directors, a cohesive executive team, a veteran leadership team at the power company and solid support for the manufacturing and infrastructure companies through dedicated Varistar staff. We have operating company presidents and leadership teams who know their businesses. Working together with the talented employees at all levels of each of our companies, consistent execution of our strategy, as I said earlier, is paying off.
With that, I will turn it over to Chuck MacFarlane, our President and Chief Operating Officer to provide some color on what's happened at the utility and manufacturing infrastructure companies during second quarter. Chief Financial Officer Kevin Moug will follow with the financial perspective. Chuck?
Thanks, Jim. As Jim said, we continue to see excellent results from our capital investments at the utility and strategic focus on operational excellence at the manufacturing infrastructure companies under Varistar.
Allow me to provide second quarter highlights from each of the two platforms. We've talked with you in previous quarters about our capital investment to grow rate base at the utilities.
Slide 7 provides a review for the next five years. Investments are in replacement projects, large transmission projects, environmental upgrades at our power plant. We’ve also previously shared Slide 8. It shows that we have the benefit of a constructive regulatory environment that provides retirement recovery of our investments in fair return. In fact, we expect two-thirds of our five-year capital expenditures to be recovered through riders. The remaining one-third is maintenance capital expenditures, the majority of which is effectively in rate base at current depreciation level.
I won’t outline each of the projects shown on Slide 9 today because we discussed each of them last quarter. But here's an update on a few of the projects. North Dakota Public Service Commission has granted a route permit for the North Dakota section of the 345 KV Big Stone area transmission project, called Big Stone South to Ellendale. This is one of two projects we are involved with that has been deemed the multi-value project by MISO, the Midcontinent Independent System Operator. We expect to receive our ruling on our request for route permit for the South Dakota in early August. Construction activities should start in the first quarter of 2015. Work is proceeding as planned on other transmission projects.
Slide 10 identifies our generation projects. Construction of the nearly $400 million air quality control system at Big Stone plant to meet EPA's regional haze rules surpassed the halfway mark in June. Otter Tail share of this project is just over 200 million, rider recovery is in effect in both Minnesota and North Dakota for this project.
The second environmental upgrade project, not on this list, is the emissions reduction project at Hoot Lake to meet EPA's new math standards. Construction is finished and the project will go through a final commissioning when this year’s maintenance outage is complete. The project will be in service by March 15, 2015 which is EPA's compliance date. It came in at just under $8 million which is $2 million less than estimated in the base-load diversification study, which was approved by the Minnesota PUC.
Also of note this quarter is Otter Tail Power Company worked with other stakeholders to prepare comments to the EPA on its proposed rule to reduce carbon dioxide emissions under 111D of the Clean Air Act. As you may know on June 2, EPA proposed emissions reduction targets for each state based on each state’s assumed ability to use four building blocks starting with 2012 baseline. Slide 11 identifies those building blocks.
Without further regulation, Otter Tail Power Company has been on track to reduce carbon dioxide emissions 19% from 2005 levels by 2020. The EPA's proposed rule targets a 30% reduction by 2030.
Slide 12 shows the present change targets for the three states we serve. The targets are set primarily in terms of carbon dioxide intensity, which is the amount of carbon dioxide emitted per megawatt hour of electricity generated. This slide also shows the potential impacts to our company based on our initial assessment.
Minnesota will require that we make a larger than average change but because we are retiring Hoot Lake plant by 2020, we’ll likely have little risk for stranded investment in that state. We also see little risk for stranded investment in North Dakota which has a much smaller target to achieve. South Dakota is of greater concern because the Big Stone plant is the only coal plant in South Dakota. We're working with supportive South Dakota agencies to file comments with the EPA seeking a modification to the rule. It will be a long process before the rules are filed. EPA is taking comments through November this year and is scheduled to issue a final rule next June. States will have another year to submit their state implementation plans and the EPA will require at least a year to review and approve those plans. We likely will be working through this issue for the next four to six years.
Now allow me to make a few observations about the manufacturing and infrastructure companies under Varistar. You see them on the organizational chart on Slide 13. We continue to see positive results from strategic focus on operational excellence at these companies. I am especially pleased with Foley and Aevenia, our construction companies as they continue to improve. Foley did particularly well with a $1 million improvement in gross margins compared to second quarter last year.
As we stated previously, this is in large part due to more selective bidding on projects and improved construction management. In addition, both Foley and Aevenia are benefiting from increased construction activity in general.
T.O. Plastics, our company that provides thermoformed products received its AIB certification to manufacture food packaging product. This is a new market for TOP. It produced and shipped its first food package order, containers for cherry tomatoes in April. And since then the company has produced several additional orders.
BTD, our metal parts manufacturer, earned two customer awards this quarter. One was a service award from Kawasaki. BTD was the only metal fabricator to receive the Kawasaki service award. The other was a preferred supplier award from Home & Hearth Technologies, which is one of the largest manufacturers of fireplaces in the nation. BTD earned one of 12 awards out of the 150 worldwide suppliers to Home & Hearth. This is the fifth consecutive year BTD has won the Home & Hearth preferred supplier award. The PVC pipe companies have continued strong sales in an increasingly competitive market.
In summary, all manufacturing and infrastructure company results were in line with expectations this quarter. Orders from new customers, awards from existing customers and growth in competitive markets are further confirmation to me that our focus on operational excellence is paying off.
Since taking on this larger role as Chief Operating Officer, I’ve become more familiar with each of the company. I believe they are well-positioned to deliver shareholder value and provide a premium return compared to a standalone utility.
With that, I'll turn it over to CFO Kevin Moug for a financial perspective.
Well good morning. Please refer to Slide 15 as I discuss our second quarter results. Our electric segment continued to perform well in the second quarter with revenues up 12% and net income up 44% compared with the same quarter a year ago. The increase in earnings is primarily a result of environmental and transmission cost recovery riders as we continue to see the positive financial impact from our rate base investment strategy.
Electric segment revenues and earnings also increased due to increased sales to pipeline and commercial customers. Over the past three years, the utility has experienced a growth rate in retail electric sales of about 1.3%, and is projected to grow around 1.7% over the next 3 to 4 years. This growth is driven in part by increased sales to industrial customers, primarily the pipelines.
Increase in operating and maintenance expenses and interest costs are fully explained in the earnings release.
Our manufacturing segment revenues and earnings increased from the second quarter of 2013 due to increased revenues at BTD as a result of higher sales to energy-related recreational and lawn and garden end-markets. While BTD experienced a growth in gross margin dollars quarter over quarter, they were impacted by additional tooling costs incurred to repair and refurbish several dies.
T.O. Plastics earnings continued to be impacted as a result of a customer electing to produce a product on its own starting in 2014. Our plastic segment earnings decreased $500,000 between the quarters. This was mainly attributable to lower margins from increased cost of PVC resin and slightly higher operating costs. The increased resin costs were not able to be fully passed on in sales prices due to competitive market conditions.
Our construction segment continues to see significant improvement with increased revenues and earnings over the second quarter of 2013. All these earnings continued to improve due to increased construction activity as well as improved margins resulting from a more selective bidding process and better cost controls. And Aevenia's improved earnings are mainly due to additional work in the Bakken area as well as lower operating expenses.
Our corporate expenses increased $800,000 during the second quarter, resulting from a $1.5 million charge for the early termination of an airplane lease. Our recent divestitures have alleviated the need for the airplane. The early termination charge was partially offset by a $700,000 decrease in interest expense due to the early retirement of the $48 million of the 9% notes in the fourth quarter of 2013.
On August 1, 2014 the Corporation’s Board of Directors declared a quarterly dividend of $0.3025 per share. The dividend is payable to shareholders of record on August 15, 2014. This represents the 303rd consecutive quarter that we have paid dividends to our shareholders.
We have disclosed previously that equity financing is needed during the 2014 to 2018 timeframe in part to support the rate base expansion plans of our electric segment. We started using our aftermarket offering program in the second quarter of 2014 and entered into sales transactions for approximately 87,000 shares of common stock with net proceeds of $2.5 million dollars.
Slide 17 shows we're narrowing our earnings guidance for 2014 to be in the range of $1.65 to $1.80 earnings-per-share from our May guidance of $1.60 to $1.80 of earnings-per-share. We're raising our 2014 net income expectations for the electric segment primarily due to colder than normal weather in the first quarter of this year. We're narrowing our February 2014 guidance for our manufacturing segment and this guidance is in line with 2013 results. Our backlog for this segment is $86 million as of June 30, 2014 compared with $76 million one year ago.
We are lowering the May 2014 guidance for the plastic segment due to an expected continued increase in PVC resin costs. Based on current market conditions, we don't expect these costs to be fully recovered through higher sales prices for PVC pipe.
We are also increasing the February 2014 guidance for the construction segment. We continue to see improvement from better cost controls and more selective bidding on projects with the potential for higher profit margins. The backlog in place for the construction business is $64 million as of June 30, 2014 compared with 74 million the same time a year ago.
We're narrowing the May range for corporate costs for 2014. This results from lower interest costs, the sale of an investment and low-income housing rental property and lower expected employee benefit costs. We still expect corporate costs to be lower than in 2013 in spite of the charge recorded to exit the airplane leased early. This revised range reflects estimated EPS growth of 7% to 17% off our non-GAAP 2013 earnings per share of $1.54.
I encourage you to read the investment highlights on Slide 18. We are pleased with our strong second quarter results and year-to-date performance.
We're now ready to take your questions. After the Q&A, Jim will return with a few closing remarks.
(Operator Instructions) Our first question is from Matt Tucker with KeyBanc Capital.
Matt Tucker – KeyBanc Capital Markets
Hey guys, good morning. Congrats on a strong quarter. First question on the EPA regulations, I realize it’s pretty early and there aren't a lot of moving parts. But it seems like you've identified some capital opportunities tied to that. Could these opportunities present an upside to your current five-year rate base growth guidance?
Matt, this is Chuck. We have not identified any capital additions due to the EPA in our five-year forecast. We do foresee the replacement for Hoot Lake which is set to close in 2020, beyond the five year timeframe in here, we anticipate that will be a natural gas resource out coming in service in the spring of 2022. But that was planned prior to any of the EPA rules -- proposed rules.
Matt Tucker – KeyBanc Capital Markets
I guess you did mention some potential for additional renewables. Would those potentially fall within the five-year plan, or are they just not probably large enough to move the needle?
Well, from a basis of what we’re required under a renewable standard in Minnesota renewable objective, out through 2025 we need to only add about approximately another 20 MW of wind to meet those requirements. Should the carbon rules come down based on -- if you can get credit for additional renewables we will of course put that in our next integrated resource plan calculations, it’s a plan we do for commissions every two to three years. But it's unlikely we would adjust that until we see the final rules. In addition, we do anticipate we will be adding some solar late in the period due to the 1.5% renewable -- solar standard in the state of Minnesota.
Matt Tucker – KeyBanc Capital Markets
On the plastics side, you mentioned you would expect the PVC resin prices to continue growing. It seems like demand has been pretty strong year to date. You've seen pretty strong revenue growth. Do you expect the revenue growth to remain strong in the second half of the year or to kind of moderate? And I guess does the outlook for increased resin prices kind of go hand-in-hand with demand remaining strong?
Yeah, Matt, this is Kevin. The demand, the volumes that we’re expecting to see in the last half of the year continue to be strong. What we’re seeing happening right now is there has been a now and other $0.02 per pound of price increase announced for resin here as we head into the last half of the year. That's on top of the resin price increases incurred -- that occurred in the first six months of the year. And so really the volumes are strong, in terms of we’re just not -- given the conditions we’re in, not able to get the full price of those resin increases passed on into sales. We’re certainly trying to do what we can but competitive market conditions will ultimately dictate what we can get pass-through. So that's what's really driving the somewhat softening of the guidance from last quarter.
Matt Tucker – KeyBanc Capital Markets
And then on manufacturing, could you talk about the extent to which the stronger guidance reflects the first-half results coming in stronger than you expected, as opposed to stronger outlook for the second half, or is it the combination of both?
Kevin again, it's probably a combination of both, that’s probably little or so towards the stronger first half results.
Matt Tucker – KeyBanc Capital Markets
And maybe a little color on specifically what's been driving the stronger than expected results?
BTD has seen particularly in the second quarter a good strong revenue growth coming from our – the end markets that we talked about in my scripted comments. As BTD looks out through the rest of the year, they continue to see good strong performance in those end markets. As it relates to TO, we’re basically holding TO kind of to where they were originally expected to be at the beginning of the year and end of the first quarter of the year is based on where they are at in their current business cycle and within the end markets that they are serving.
(Operator Instructions) And it looks like we have a follow-up question from Mr. Matt Tucker with KeyBanc.
Matt Tucker – KeyBanc Capital Markets
I just saved one on the construction side. If you could just talk a little bit about the end markets where you are seeing the most activity and where you've been successful recently, I know you kind of called out at Aevenia the North Dakota T&D work. So I guess maybe specifically at Foley, what's been contributing to the better results there?
Sure, in terms of -- we did talk about Aevenia in the Bakken, the continued growth that we see in that region, as it relates to the Foley we continue to see work in industrial type projects across our mix of businesses that we look at there and we certainly do water – wastewater, we do industrial, power plants, some hospital work, we’re seeing a fair amount of work on the industrial side this year.
Matt Tucker – KeyBanc Capital Markets
Thanks, and your backlog in the construction segment was down a bit sequentially and year over year. Based on bidding activity, do you think that that could be higher by year end?
Yeah, there is a potential that it could be higher based on the activity that we’re seeing and working on in terms of bids. Even though the backlog is down 10 million, when we look at the first half of the year of actual revenues at Foley and then look at what they have in their backlog the last half of the year, we’re pretty comfortable with the revenue forecasts that are on -- that we’re looking at to support the guidance that we have for Foley. And I’d make a similar comment for Aevenia as well. Aevenia’s backlogs typically do not – we typically only have backlog for the current year that we’re doing work in but there's a fair amount of time and materials work that Aevenia is doing as well, and so collectively and across this segment we feel good about the backlog and to support the revenue forecast for 2014.
Thank you. I am not showing any further questions. Mr. McIntyre, please proceed with any closing remarks.
Well I just would make a couple additional comments. We are pleased with our first quarter and the second quarter, we had two strong quarters back to back. And we are positioned to deliver another year of increased earnings and profitability to our shareholders, with the capital investments at the utility and a strategic focus of operational excellence at our manufacturing and infrastructure companies. The visibility of our earnings from utility as well as from our manufacturing and infrastructure companies is becoming increasingly apparent to us and we’re pleased that our quarterly reports and our calls with you, are more routine in that regard and that there's few surprises and that we’re able to have a consistency of earnings that we’re sharing with you. But we do think we’re poised to have a good solid second half of the year and we continue to work hard to not only this year but position ourselves for success into 2015 and beyond. With that, unless there is any further questions, I would thank you for joining our call and for your interest in Otter Tail Corporation. We look forward to speaking with you next quarter.
Ladies and gentlemen, this concludes today's conference. Thank you for your participation and have a wonderful day.
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