Aug 6, 2013
Executives
Loren Hanson – IR Jim McIntyre – President and CEO Kevin Moug – SVP and CFO
Analysts
Matt Tucker – KeyBanc Capital Markets Michael Bates – D.A. Davidson
Operator
Good day, ladies and gentlemen and welcome to the Otter Tail Corporation’s Second Quarter 2013 Earnings Conference Call. Today’s call is being recorded and there will be a question-and-answer session after the prepared remarks.
I would like to introduce your host for today’s conference, Mr. Loren Hanson.
Please go ahead, sir.
Loren Hanson
Good morning, everyone and welcome to our call. My name is Loren Hanson I manage the Investor Relations area at Otter Tail.
Last night, we announced our second quarter results. Please note that 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 President and CEO; 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 would now like to turn the call over to Otter Tail Corporation’s President and CEO, Mr. Jim McIntyre.
Jim?
Jim McIntyre
Good morning and thanks for joining our call today. Overall, our 2013 second quarter results met our expectations.
A successful realignment of our portfolio continues to have a positive effect on earnings, better positioning us for stronger execution within our remaining companies. The 33% year-to-date improvement in net income from continuing operations further indicates progress towards a successful 2013.
The transformation of our company has also been recognized by Standard & Poor’s, who recently updated Otter Tail Corporation and Otter Tail Power’s senior unsecured credit ratings. And, also by Fitch, who recently announced the favorable outlook change for Otter Tail Corporation and Otter Tail Power.
I would now like to update you on the substantial investment opportunities over the next few years at Otter Tail Power in the areas of transmission, generation and environmental upgrades. Generally speaking, all of the projects under construction have regulatory approval and are subject to some form of current recovery.
Slide four, shows the treatment by each of our jurisdictions. Our transmission projects referred to as CapX2020 and Multi Value or MVP projects are on time, on budget and on pace to make their expected contributions to earnings.
CapX2020 which we have investment in three projects, is currently about half complete. The investments in all of the transmission projects including the MVP project, is expected to be approximately $400 million.
Big Stone air quality control system AQCS, is also moving forward on schedule, in its early stages and the project is benefiting from lower cost as mentioned last quarter. When completed in 2016, we expect 80% to 90% reduction in sulfur dioxide, nitrogen oxide and mercury emissions.
Also Otter Tail Power Company recently entered into a 25 year contract, to purchase wind energy from the 62.4-megawatt Ashtabula III wind farm, northeast of Valley City North Dakota, that’s owned by a subsidiary, NextEra Energy Resources. The contract includes an option for Otter Tal Power Company to own the wind farm in 10 years.
This energy purchase was below the cost modeled and Otter Tail Power Company’s annual integrated resource plan. This purchase positions the utility to meet its renewable energy obligations in the three states it serves through 2025.
Wind energy, will now supply about 19% Otter Tail Power Company retail sales. We also have rider recovery mechanisms systems available for all wind, transmission and environmental projects.
With these riders, cash flows are enhanced since the riders allow for more timely recovery compared to a formal rate case. It also benefits our customers by phasing cost into our rates over time versus the rate shock at the end of the project.
The Minnesota legislature passed – legislation past session expanding the circumstances under which a public utility can seek rider recovery for emissions related upgrades. Otter Tail Power Company had requested the Minnesota Public Utilities Commission to grant rider recovery for its Big Stone Plant, AQCS and environmental upgrade project under this new law.
Large scale generation and transmission projects are pre-approved including potential canceled project recovery. Given their current status and the strength of recovery mechanisms, we remain confident in the utility’s ability to deliver earnings within our guidance, as well as provide predictable earnings growth over the next five years.
Delivering earnings is nothing new to Otter Tail Power. Over the last five years, Otter Tail Power has averaged return on equity of 10.8%.
We believe Otter Tail Power were at or very near the authorized return equity in the future as well. As I look at our manufacture and infrastructure businesses within Varistar, they are at a much progress.
I’d like to share a few thoughts in these companies. The reduction in the number of platforms and companies has not only reduced the overall risk of Otter Tail Corporation, but has also resulted in the sharpened focus on our remaining businesses.
Regarding our manufacturing businesses, BTD and T.O. Plastics are both doing a better job of bringing profit to the bottom line, despite sales challenges in a tough economy.
Improving margins and better understanding cost were making a positive difference in these manufacturing companies. BTD’s commitment to quality is paying off in the efficient use of capacity, its employees and the proximity of its facilities to customers who are known for having high quality standards.
Among the customer base of BTD, are named such as Polaris, John Deere, Komatsu, Toro and Arctic Cat. BTD has facilities in Minnesota and Illinois, and is capable of manufacture ordered parts in either location with similar high quality results.
BTD is incurring tooling cost in preparation for increased sales in the last half of the year and in 2014. Moving on into construction, Foley is showing signs of recovery with enhanced bidding, project management and increased attention to detail.
Aevenia is off to a slow start, due to weather and other challenges but expect they’ll recover during the second half of the year. With regard to plastics, pipe companies are both having a great year.
Collectively, these companies are (inaudible) from low capital and operating cost as well as strong business savvy on the part of management, and being agile and able to capitalize on opportunities when they present themselves. We are fortunate to have available capacity at our manufacturing plants including BTD, T.O.
plastics and our pipe companies, enabling us to expand and grow with our major capital investments. Our construction segment can also ramp up for additional project opportunities.
This capacity for expansion further supports our goal of 4% to 7% compounded growth and earnings per share. In summary, based on the year-to-date $0.15 per share, year-over-year improvement, we remain confident that we can deliver a strong 2013.
Our portfolio of well performing electric utility, delivering on its rate based growth strategy and Varistar companies that are more disciplined and focused, positions us for both the near and longer term enhancement of shareholder value. I would now like to turn the call over to Kevin, who will comment further on our financial performance.
Kevin Moug
Thank you, Jim and good morning. I’d like you to refer to slide five of the presentation as I walk through the quarter’s results.
Net income from continuing operations was $0.21 per share, compared with $0.19 per share for the same quarter last year. These results were consistent with our forecast for the second quarter and included $0.02 of charges we consider infrequent but not unusual, to our operations.
These include, a charge we incurred to discount the Minnesota jurisdictional share of abandoned Big Stone II project transmission assets that were transferred from construction work in process to a regulatory asset for future recovery, as the initial investment was deemed prudent but potential future uses for the assets did not occur. And also, accounting rules require a company to chew up its deferred assets and deferred tax liabilities in the period of change and tax rates occur.
So accordingly, we had a reduction in our deferred tax assets related to a decrease in the North Dakota corporate income tax rates in 2013 that went from 5.15% to 4.35%. And now I’d like to discuss highlights from our electric segment.
Significant items contributing to the $3.5 million increase in electric retail revenues are as follows; first, we experienced a $1.7 million increase in transmission cost, recovery rider revenues, due to the build out of our transmission projects. Secondly, there was a $1.1 million increase in revenue related to colder spring weather this year compared to 2012.
Our electric operating and maintenance expenses increased $3.7 million mainly due to $1 million increase in MISO transmission tariff charges related to our increasing investments in CapX2020 and MVP transmission projects; $1.2 million increase in labor and benefit expenses mainly due to increases in cost resulting from reductions and the discount rates related to projected benefit obligations; a $1.3 million increase in general and administrative cost, mostly related to an increase in corporate cost allocated to the electric segment due impart to changes in our cost allocation factors resulting from the Corporation’s recent divestitures. And $700,000 discount that we recorded on the abandoned Big Stone II project transmission assets that we transferred from construction work in process to regulatory assets for future recovery.
There are also further variances discussed in the earnings release for the electric segment that affected the earnings as well. Moving on to manufacturing, revenues and net incomes were down compared to the same quarter last year.
At BTD, revenues and net income decreased $3 million and $400,000 respectively, as a result of lower sales volume mainly due to reduced demand from customers and market serving the construction and energy industries. At T.O.
Plastics, revenues and net income decreased slightly, mainly as a result of the decrease in sales of packaging products. Our plastic segment continued its strong performance during the second quarter.
Sales volume increased as construction and housing markets continue to improve in the South Central and the Southwest part of the United States. These sales volume increases from those regions were partially offset by lower sales in the North Central United States due to a colder and a wetter spring during the second quarter of 2013.
Our corporate expenses decreased to $1 million, as a result of lower interest expense related to earlier redemption of the 50 million 8.89% notes, lower insurance cost and increased allocation of cost to the electric utility that were offset by higher labor and employee benefit expenses. Our construction segment results had improved significantly over the second quarter of 2012.
The main reason for the better financial results is continued improvement in Foley. Foley’s net income improved $2.5 million between the quarters.
This is because the major projects impacting results in 2012 have been largely completed, and we are seeing better performance on projects impacting 2013. Aevenia incurred a net loss $400,000 compared with $300,000 in net income last year due to colder and wetter spring in 2013 which delayed the start of many of our projects.
In 2012, there was an early start to the construction season because of extremely mild weather. Aevenia second quarter 2012 results also included revenues and net income from the sale of Moorhead Electric, one of Aevenia’s subsidiaries.
Moving on to liquidity and financing, our consolidated cash flow from continuing operations for the six months ended June 30, 2013, was 48.8 million compared with 45.6 million for the six months ended June 30, 2012. As shown on slide seven, our available liquidity under the $320 million aggregate credit facilities, was $317 million at quarter end.
On June 28, 2013, we priced $150 million private placement of long-term debt for Otter Tail Power with two tranches. The $60 million tranche will bear interest at 4.68% for 15 years and the $90 million tranche will bear interest at 5.47% for 30 years.
The issuance is expected to close on August 14, 2013 and to fund at the end of February, 2014. A portion of the proceeds from this issuance will be used to retire the $40.9 million term loan due June 01, 2014, with the balance of the proceeds to be used for planned utility construction program expenditures.
Additional color on the rating agencies, as Jim mentioned, Standard & Poor’s upgraded the issuer credit rating for Otter Tail Corporation and Otter Tail Power to BBB. In addition, the senior unsecured debt for Otter Tail Corporation was upgraded to BBB- and the senior unsecured debt for Otter Tail Power was upgraded to BBB.
Reasons for the upgrade relate to our strategic focus on our core electric utility business and the divestiture of the significant portion of our unregulated businesses, which has resulted in an improved risk profile. Also, while maintaining rates, Fitch changed the outlook for Otter Tail Corporation and Otter Tail Power to stable.
The rating drivers for Fitch included the strong stable performance Otter Tail Power, the recent divestitures, earnings recovery at our manufacturing and infrastructure companies and the large capital expenditure program at Otter Tail Power. As it relates to the common dividend, on August 02, 2013 the Corporation’s Board of Directors declared a quarterly common stock dividend of $0.2975 per share.
The dividend is payable September 10, 2013 to shareholders at record, on August 15, 2013. We were able to maintain our common dividend from 2008 through 2012 due to strong operating cash flows and liquidity and on the belief our operating companies have the future earnings power to support the common dividend.
Our plan changes to the portfolio that resulted in a company, that is easier to understand with a more predictable earnings stream. We also demonstrated these operating companies can support the common dividend, by earning $1.31 per share from continuing operations as adjusted in 2012.
Our 2013 guidance also shows the ability of these companies to sustain the common dividend. 2013 continues to be a time for execution of our strategies as we move from the divestiture mode.
We believe it is prudent to maintain the indicated common dividend of $1.19 per share during 2013, as we focus on execution of our operating plans and the resultant improved financial performance. With this improvement, we will be in a better position to evaluate future dividend increases, as we look to a dividend payout ratio over time in the range of 60% to 70%, based on our expected mix of earnings from our electric utility and manufacturing and infrastructure businesses.
I would now like you to refer to slide eight for a discussion of our updated 2013 earnings guidance. Overall, we are narrowing our consolidated earnings per share from continuing operations for 2013, to be in the range of $1.30 per share to $1.50 per share, to $1.30 per share to $.155 per share.
We’re narrowing the guidance for our electric segment based on increases in benefits and administrative costs. We also are modifying guidance for the manufacturing segment due to the following factors; ordered volumes across the end markets of construction, energy and lawn and garden industries have softened for the remainder of the year, affecting BTD’s industries in these – BTD’s customers in these industries and lower earnings are now expected in 2013 at T.O.
Plastics, primarily due to a key customer announcing plans to produce certain products in-house rather than outsource the work to T.O. Plastics.
We’re also reducing guidance for the construction segment due the disappointing results at Aevenia during the first half of the year. Construction segment net income is expected to be higher in 2013 than 2012, due to improved control processes in construction management and selective bidding on projects with the potential for higher margins.
Foley’s underperforming 2012 projects were substantially completed last year and Foley’s internal bidding and estimating project review procedures have been improved such that the Corporation expects Foley to be profitable in 2013. We’re also increasing guidance for the plastic segment, based on the strength of performance in the first half o2013.
In our corporate, general and administrative cost are expected to be in line with the previous 2013 guidance. We believe our 2013 guidance positions us to achieve a 4% to 7% compounded growth rate in earnings per share, using 2012 as a base year, driven largely by the expected rate base investments at the utility and the existing capacities at the manufacturing and infrastructure platform.
After the Q&A, Jim will return with a few closing remarks and we’re now ready to take your questions.
Operator
[Operator Instructions]. Our first question comes from Matt Tucker from KeyBanc.
Your line is open.
Matt Tucker – KeyBanc Capital Markets
Hi Good morning. My first question is on the construction side, could you give us a little more color on or may be quantify the impact of weather in the second quarter would the segment have been – Would Aevenia have been profitable if not for those delays?
And could you comment a bit on the performance so far in the third quarter?
Kevin Moug
Well thanks, Matt for the question, this is Kevin. In terms of impact on weather in the second quarter is the primary driver for the disappointing performance at Aevenia.
The weather also impacted the productivity on the jobs where they were working in terms of efficiencies but really the weather and the slowdowns resulted from that are the primary reasons. And for that we certainly would have seen better performance at Aevenia this second quarter as it compared to where it actually shook out.
In terms of July, we’re just in the process of our closed procedures things are early and it’s pretty difficult for us to comment on where the results will be for July or how things are going on for Aevenia.
Matt Tucker – KeyBanc Capital Markets
Okay. Could you comment a little bit on the trends in bidding activity things have been picking up at all or slowing down kind of the same?
And I guess also if you could comment on pricing – the pricing environment on the bids you’re seeing any changes there?
Jim McIntyre
This is Jim McIntyre, first with regard to Aevenia just to follow on with the comment that Kevin responded to. There is plenty of work for us in Aevenia.
The weather has not only slowed us down but it also has impacted the third party that does the engineering job but as that engineering is done and as the weather is better we’ll have substantial work there. The margins that Aevenia was able to extract from its distribution and transmission business is our solid margins.
So as I made a comment in my previous comments, we expect improvement in third and fourth quarter as Aevenia looks more like it did last year when it had really strong second half performance. So, we’ve got ample business opportunities, we believe we’ll be able to take opportunities of it through the last half of the year.
With regard to Foley, I would just say this that the number of projects that we’re bidding on, are numerous but we’re very, very disciplined in our approach. And we’ve had some success in getting some bids but there is a lot of contractors chasing still a relatively few number of projects.
We’re still seeing I think across the whole segment, a fair amount of impact on the economy as far as just how much activity is going on and there are just lots of competitors there. We – As Kevin has mentioned, Foley did turn profitable.
I think we’ve had four, five months in a row now where Foley’s had profitable results. So we’re optimistic and feel that they’ve made a pretty significant stride from where they’ve been and we do expect them to have a profitable year end for us.
Matt Tucker – KeyBanc Capital Markets
Okay, thanks. And just one on the manufacturing side, it sounded like you expect sales to ramp up a bit in the second half.
Is that primarily based on what you had in backlog at the end of the second quarter or could you just give us a little more color on the outlook there?
Jim McIntyre
This is Jim McIntyre again. It is based on the backlog that we see when we compare the backlog to the same backlog from the end of the second quarter last year.
We do see somewhat stronger backlog. And also I commented earlier, we do a quite a bit of tooling in order to prepare for other customer requirements for both the balance of this year and then positioning us for customer sales in 2014.
So, we’re pleased as what we see with regard to opportunity for sales both this year – the second half of this year and going into ‘14.
Matt Tucker – KeyBanc Capital Markets
And just as a follow up to that, is this based on discussions you’re having with customers or what’s giving you the confidence to prepare for higher volumes going forward?
Jim McIntyre
Well the discussions at (inaudible) the fact that the backlog is there and they are often lead times I mean they are tooling and they are is the preparatory steps in order to actually manufacture the components that our customers request of us. So we got to get that done first and then we end up with the business and then go from there.
So the tooling is kind of an early indicator the backlog of business that we see.
Matt Tucker – KeyBanc Capital Markets
Very helpful. Thanks, guys.
Operator
Thank you. Our next question comes from Michael Bates from D.A.
Davidson. Your line is open.
Michael Bates – D.A. Davidson
Hey good morning.
Jim McIntyre
Good morning
Michael Bates – D.A. Davidson
The $1.3 million increase in G&A expense at the electric utilities that was tied to a reallocation of corporate expenses. Do you feel like the 1.3 million is a good quarterly run rate as we look forward?
Kevin Moug
It would be yes, it would be reflective Michael of the new allocation method or the trough up in the allocation method based on the changes of mix in the companies between the electric and the non-electric side. So as we sit here today in 2013, this is an indicative rate as we go forward.
Michael Bates – D.A. Davidson
Alright. Thank you.
And Otter Tail Power has a lot of opportunity to build out transmission that will be a significant driver for your rate base over the next five years. I was wondering if you could you give us a little bit as far as how you’re thinking about opportunities beyond what’s been announced so far both within the next five years and even looking a further out?
How much room for expansion is there compared to the current backlog and projects?
Jim McIntyre
Well this is Jim McIntyre again. It’s hard to see beyond what we currently identified, lot of projects CapX2020 and the MVP projects are linked to really building the whole huge infrastructure transmission grid and that’s really, really important.
But it’s also linked to where does wind go? Is there lot of wind development here or elsewhere?
And where does solar go in terms of getting it from wherever the generation might be to the actual load centers? I think what we have and I repeat for us it’s 400 million between the CapX2020 and the MVP projects and we’re comfortable that we should be able to deliver those projects on time and they do have good returns related to them.
But we do have a lot of knowledge about the transmission system and how it works – interacts together in this regional area. We don’t have any projects that we are currently in negotiation for projects beyond those which we’ve identified and talked about in our various Qs and other documents today.
Kevin Moug
Michael this is Kevin, as it relates to this isn’t transmission but out further beyond the spectrum we do have the Hoot Lake switch over of the – having to switch that over from coal to natural gas. Now that’s been agreed on with the Minnesota Commission and that’s a timeframe in that 2020 2021 period.
So we know that there is a project out there as we have to switch that over, but that’s a generation not a transmission type project.
Michael Bates – D.A. Davidson
And is Hoot Lake likely to be the next large capital project at the utility once you get these transmission projects and Big Stone out of the way?
Jim McIntyre
That’s correct. Given the timetable of 2020 and the fact that it would be a natural gas plant, it will be a fairly significant capital expenditure.
The natural gas is not as difficult to build out as is the coal takes less time and has proven technology. So it won’t be a complex project but it will be a nice add on that further reduce our emissions and be even a better steward of the environment.
Michael Bates – D.A. Davidson
Great. One other question if I could, with the revised guidance range after the strong quarter in the plastics segment and really just a strong first half of the year, guidance implies a pretty significant downtick in that segment’s earnings in the second half compared to what you’ve had so far.
Second half in 2012, did show a slightly lower earnings in that segment but not to the degree that’s being implied in guidance. Can you give us a little bit of color as to what you’re seeing there and what’s driving you that potential decline?
Kevin Moug
Michael this is Kevin. As we sit here today with the forecast, the thing we have to take in account that we don’t necessarily have great visibility on what will the weather be like in the fourth quarter of ‘13 particularly here in the North Central region part of the country.
And so last year we had a pretty mild winter fall in early winter and saw the benefits of continued shipping of product between both companies. And when we’re looking at our forecast right now for last half, we have good visibility on where we think third quarter is going to be fourth quarter we have visibility we know that in the past we can be swung by weather.
And so we’re trying to take that into account right now and as we get closer, we’ll have better visibility at the end of the year on that, by the end of the fourth quarter we’ll certainly have some better visibility.
Michael Bates – D.A. Davidson
Thank you very much.
Operator
[Operator Instructions]. And we have a follow up from Matt Tucker from KeyBanc.
Your line is open.
Matt Tucker – KeyBanc Capital Markets
Hey gentlemen I just had a follow up on the last question on plastics. I appreciate that you’d want to bake in from cushion the second half something like unpredictable like weather.
But outside of the unpredictable, uncontrollable factors like that, is there anything that you’re seeing that would suggest demand would slow on a fundamental basis in the second half?
Jim McIntyre
This is Jim McIntyre. I think we’re fairly optimistic about the second half.
I mean one of the things that can change rather rapidly is the price of resins. And if that happens, then we could see some diminished sales of profitability but as we indicated right now, we’re pretty comfortable that we should have a good second half within our plastics business.
Matt Tucker – KeyBanc Capital Markets
Thank you. That’s all I had.
Operator
Thank you. [Operator Instructions].
I show no further questions at the time and would like to turn the conference back to, Mr. Jim McIntyre for closing remark.
Jim McIntyre
Thank you. As we assess where we’re at mid-year, the successful realignment of the company has definitely better positioned us to deliver increased earnings for both 2013 and the future.
Our current success could be linked directly to the proper execution of the right strategies. Sharper focus and execution among all our businesses, has enabled us to increase profitability and (inaudible) our financial results in a more consistent manner.
Thank you for joining our 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 your participation in today’s conference. This does conclude the program, and you may all disconnect at this time.
Speakers please standby.