Otter Tail Corporation
Q2 2015 Earnings Call Transcript

Published: 4 Aug 2015

[Operator:]

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. I would now like to turn the conference over to the company.

[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 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 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 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 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?

[Chuck MacFarlane:]

Thanks Loren. Good morning and thanks for joining our call. We have good news story this quarter a $0.36 per share earnings -- earnings per share from continuing operations were stronger than flat. Last quarter I predicted improvement in performance during the remaining quarters of the year and that's what we have begun to see. In addition to continued rate base cost recovery this quarter we were able to reduce operating expenses significantly. We saw 3 million quarter-over-quarter improvement in the electric segment net income and was less than 0.5 million decreases 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 segment. In addition corporate expenses were down. Last quarter we reported that we had completed the sale of our construction companies, our 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 will start with a few items of utility. The CapX2020 transmission line from Alexandria, Minnesota to the substation west of Fargo, North Dakota was closed in for the first time on April 2nd. This completely energized the Fargo to St. Cloud project. Otter Tail has a 13% ownership share and $81 million investment in this 345 Kv regional transmission project. 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 completing transmission line 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. Despite line ship crude oils specifically diluted heavy oil in the oil sands production area in Western Canada. The first phase completed in 2009 include expansion of two existing pumping stations that Otter Tail Power Company serves. Phase 2 included expansions of pumping capability at other sites that our company serves. These expansions will allow the pipeline to reach its full capacity. Big Stone planned outage during which the Air Quality Control System or AQCS was to be tied into the plant was extended due to an 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 underway. The AQCS commercial operation date has moved from October 1st to December 1st which is well April 2016 compliance deadline. Remember the state-of-the-art control system will reduce emission of nitrogen oxides, sulfur dioxide and mercury by 80% to 90% to meet the EPA's regional haze and mast requirement. 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 100s of workers who were onsite for two years. Speaking of outstanding safety records I should also mention that in the second quarter titled station employees achieved 14 years on more than 2.3 million hours worked without a lost time incident. Coyote continues to be at half load following the mechanical barrier 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 start up. We continue to have a constructive regulatory frame work for our rate base projects. These projects are listed on slide 5 and our regulatory frame work by state is shown on slide 7 -- or 6. This enables a compound growth rate of better than 8.5% for our rate base investments on 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 plant. Final rule is a major change from the proposed rule and in meantime digest it. Our initial reaction is that the two year delay on interim compliance and the phased in glide path over the 2022 to 2029 time frame are positive. The adjustment to the South Dakota 2012 base line is positive. The change significantly reduces our concern of our continued operations at Big Stone plant. And we are working to understand that significantly more stringent changes to the North Dakota. 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 of mast based approach in North Dakota. This target was adjusted to account for major plant that was offline in 2012. This is positive. With the retirement of Hoot Lake plant Otter Tail will likely have no facility 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 Trail Power announced a retirement of 138 megawatt coal generation of the Hoot Lake plant by 2021. This is a 25% of the utilities coal-fired capacity. We have plan to replace this with 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 and purchases more than 248 megawatts of wind energy, a 19% of the utilities retails sales. And we have approval from the Minnesota regulators to add up to 300 megawatts more. So when we work through the EPA's Clean Power Plan we will build on our steps we've already taken and we will continue to meet with states to be served 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 planning of the EPA in not initially considering compliance cost in its mercury and air toxin standards or mast regulation. As you know the Supreme Court did not vacate the rule but reminded it to the DC Circuit Court that have held the mast 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 mast by April 16 this last spring. And the base town plant received an extension of the deadline so that could comply with the mast 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 ruling makings and impose high compliance cost. 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. Our 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 runs 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 cost and lease agreements, BTD's total investment is 33 million. The plan incorporates expansions in the Detroit Lakes and Lakeville plants and reduced its logistics cost 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 completed in Detroit Lakes only the new parking lot and street remains to be finished. BTD began moving into the new space in May. BTD's new Lakeville expansion is progressing, the paint line performance are installed and are operational. Employees have run the first test panels and started customer qualification process. And the customers are seen the line and 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 in the BTD's Illinois plant, disrupting another live solid plant for improvement at that facility. But a cost reduction plan is in place and volume recovery efforts are underway, as evidenced by the pick up on the 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 will turn it over to Kevin for the financial perspective.

[Kevin Moug:]

Well, good morning. Slide 9 explains the quarterly variances on earnings per share basis. Our utility net earnings increased $3 million quarter-over-quarter. The main drivers of these changes 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 shut down in the second quarter of 2015. These costs were less than the additional maintenance expense incurred with the spring outage of Otter Tail at 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 and markets partially offset by stronger volumes in lawn and garden and markets and the sales of horticultural products. Revenue from scrap metal sales was down due to a 40% reduction in prices compared to second quarter 2014. Our net earnings for the manufacturing segment were lower by $400,000 between the quarters primarily due to the lower revenues. And BTD continues to make marked improvements in labor costs with a 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 cost 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 our operating lease expense from early termination of an airplane lease into 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. Coating opportunities were softer than the prior year as agriculture, energy, mining and oil and gas volumes were low. Our forecast expect softening due to these changes. Our lawn and garden end market has been strong in 2015 and we expect to see this continue and production seasonality begins in the fall 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 are 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 of 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. Now I will turn it over to the operator.

[Operator:]

[Operator Instructions]. And our first question comes from the line of Matt Tucker of KeyBanc Capital Markets. Your line is now open.

[Matt Tucker:]

Hey good morning guys. Congrats on a nice quarter.

[Chuck MacFarlane:]

Thanks Matt.

[Kevin Moug:]

Thank you.'

[Matt Tucker:]

With respect to the intact guidance range and your expectation you are coming towards the upper end. Could you comment on which segments you see kind of driving the results towards the high end?

[Kevin Moug:]

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

[Matt Tucker:]

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

[Chuck MacFarlane:]

Sure, it's 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.

[Matt Tucker:]

And then I guess do you have going forward an expectation of kind of the sales growth rate you would expect to see assuming normal weather?

[Chuck MacFarlane:]

We assume approximately three quarters of a percent plus any of the new pipeline low which comes on in blocks but we will ultimately move that number up between 1.5% and 2% for the year.

[Matt Tucker:]

Great. Thanks. And then also at electric, any outsize O&M expenses planned outages or anything like that we should be thinking about in the second half?

[Kevin Moug:]

Matt this is Kevin. We are pretty well through the kind of the maintenance phase of the Big Stone plant and there isn’t a further unusual expected maintenance cost in the forecast.

[Matt Tucker:]

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?

[Kevin Moug:]

Hey Matt it's Kevin again. From a paint perspective as Chuck mentioned in his comments we are 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 kind of ready to look at the test of the paint that's coming out and say okay what's goes. So any benefit we expect from paint probably won't we see until starting in the fourth quarter, late third quarter, fourth quarter.

[Matt Tucker:]

Great. Thanks guys. Congrats again. That's all I had.

[Chuck MacFarlane:]

Thanks.

[Kevin Moug:]

Thanks.

[Operator:]

[Operator Instructions]. And I am showing no further questions at this time. I would like to turn the conference back over to Mr. Chuck MacFarlane for further remarks.

[Chuck MacFarlane:]

Thanks, I'll summarize by saying that strong performance lead to a better than planned earnings for second quarter. Continued rate based cost recovery of utility, improving performance of 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.

[Operator:]

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.